How climate change is shaping financial markets

Climate risk management is identifying, assessing, monitoring, managing, and reporting on climate and environmental risks by banks. PHOTO | POOL

With the recent United Nation’s 27th Conference of the Parties on Climate Change, known as COP27, behind us, there is an urgent need to enhance strategies to combat the effects of climate change and how they affect the financial markets.

Africa’s population bears the greatest burden of climate change, yet it contributes less than three per cent of the pollution responsible for climate change.

Many countries are experiencing extreme weather conditions, leading to unprecedented droughts, and flooding across African countries in recent years.

The impact of climate change in Africa is best explained by the shrinkage of Lake Chad. The lake has shrunk by 90 per cent over the last 60 years. The surface area was 26,000 square kilometres in 1963 and has dropped to less than 1,500 square kilometres.

Over 10 million people across the region need emergency assistance. For years, the lake has been supporting drinking water, irrigation, fishing, livestock, and economic activity for over 30 million people in the region. It is vital for Indigenous, pastoral, and farming communities in some of the world’s poorest countries.

The State of Climate in Africa Report 2021 paints a grim picture. Water scarcity is estimated to affect 250 million people in Africa and is likely to displace up to 700 million people by 2030.

In the past 50 years, drought-related events have led to economic losses of over $70 billion. It is estimated that by 2050, climate change could cost Africa $50 billion annually.

The Horn of Africa region, including Kenya, is experiencing the worst drought in 40 years. The food security of over five million people is at risk.

Children have also dropped out of school. People are facing challenges to sustain their lives — their ability to adapt to climate change and its effects is diminishing.

The financial sector has not been spared. The risks of climate change may result in fluctuations in the production and sales capacity of enterprises, the number of insurance claims, and the scale of idle assets.

These changes affect investors' attention and behaviour, which further impacts financial market stability.

Financial sector regulators pay less attention to the transition risk climate change poses to financial institutions and markets.

They are expected to take decisive steps to ensure that the financial system can withstand climate-related shocks since sustainability is a key concern.

According to FSD Kenya, the country’s commitment to addressing climate change through green finance has progressively emerged as a key topic underpinning policy development in promoting sustainable development and financial market growth.

Large amounts of financial resources are needed to address climate change, both for mitigation to reduce emissions, but also for adaption to the impacts that are already apparent.

Kenya launched a Green Bond Programme in 2017 to promote financial sector innovation by developing a domestic green bond market. Since it was established, there have been several key developments, including the issuance of Kenya's first green bond in October 2019.

According to Dr Patrick Njoroge, Governor, of the Central Bank of Kenya, climate change poses three risks to banks.

The first physical risk to the loan portfolio arises from damage or loss caused by climate and weather-related events such as floods and drought.

Second, the transition risk arising from the changes towards a low-carbon economy.

Third, liability risk could arise for banks financing companies whose activities impact the environment negatively.

Efforts to mitigate and adapt to climate change also generate business opportunities for banks. These include the adoption of low-emission energy sources, the development of new products and services, and access to new markets, housing, and resilient infrastructure.

Electric engines are gaining traction with the scaling up of investments in electric commuter buses and motorcycles and associated infrastructure such as charging points.

There are ongoing efforts to create a culture of Environmental Social & Governance (ESG) disclosure for firms listed on the Nairobi Securities Exchange (NSE).

NSE issued ESG Guidelines in December 2021 with only 10 per cent of the 63 listed firms complying with the voluntary process thus far.

ESG reporting has become a strategic consideration globally over the past year. Increased focus and pressure from investors, regulators, employees, and other stakeholders make ESG a topic that is not only critical at the board level but also essential to cascade throughout organisations.

The writer is the CEO, of Scopes Markets Kenya.

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