Green Accounting, Green Disclosure and Green Audit ; The 3 Gs of Climate Financing

Climate change is now upon the world. As we battle extreme heat, rain and floods, there is much that can be addressed to mitigate or cope with climate change. Dr. Kishore Nuthalapati, CFO BEKEM Infra Projects Private Limited, discusses how availability of climate finance can help address the issue of green construction. He speaks to E Jayashree Kurup, Director, Real Estate and Cities, Wordmeister Editorial Services, on what experts like him should look for.

1. What is the financial impact of climate change? Statistically, how can the magnitude of this problem be assessed? 

Climate change has an impact not only on the environment and industry, but also on human lives. The financial impact is huge. There have been several studies that contradict each other in terms of numbers and magnitude. The World Economic Forum (Davos conference) has put  the loss suffered because of climate change at $143 billion. Using that logic, in 20 years the loss due to climate change is about $2.8 trillion, more than 50 percent of the Indian GDP (approx.). And if that has to be broken down into per hour impact, $16.3 million are lost per hour due to the impact of climate change. These numbers are approximate, conservative and the actual impact could have been much more. These projections are important to facilitate institutional, governmental, industrial and professional interventions. 

The global cost of climate change is estimated to be something between $1.7-3.1 trillion by the year 2050. No individual country can handle this kind of impact with its own resources. Global GDP will suffer about 3 percent because of climate change. India is believed to lose 1.5 percent of its GDP to climate change. This means that, at this point, if we are stating that our projected GDP is 7 percent for the coming year, considering 1.5 percent is getting knocked off from that percentage, it leaves behind a net 5.5 percent GDP growth only to work with. This is expected to scale up to 2.6 percent by 2030 and 6.7 percent by 2050 - almost equal to the country’s GDP bringing effective GDP growth to 0. Areas that are affected the most include agriculture, infrastructure, health and productivity of human resources. 

2. As we speak, the world has set itself the task of containing the heat rise to 1.5 degree Celsius. How is that executed and what are the steps we need to follow ? What role does ‘finance’ play in the entire process?  

The Intergovernmental Panel on Climate Change (IPCC) has carried out a very comprehensive and scientific study to understand that life is safe if the temperature rise is restricted to 1.5-2 degrees above the pre-industrial levels. Pre-industrial levels are 124-125 years ago, the year 1870 up till 1900, which forms the historical base. Heat gain from that level has to be capped at 1.5 degree Celsius. 

The IPCC report, tabled at the Conference of Parties 21 (COP 21) at Paris in 2015, capped this heat increase to 1.5 degree Celsius since the existence of human life was at stake. Beyond this, the entire ecology and environment would suffer severe heat waves, droughts, rising sea levels and extinction of flora and fauna. Therefore,1.5 degree Celsius above the pre-industrial level global temperature is what we are targeting now. 

India was to invest about 7-18 per cent of GDP in climate change but until now not even 10 per cent has been spent. 

3. So what is this investment for?

This should be spent in mitigation - in new projects which will not cause further climate damage, and another set of investment in adaptation, which addresses the present pattern to be transformed so that activities and projects do not cause further climate damage. The power sector is now receiving a lot of these investments. 

4. If private sector investments are on board already, then what is its contribution in addressing climate change?

• Globally, the public sector is ahead of the private sector in climate finance investments. The involvement of the private sector is far lower than what is required and expected. This is because climate finance investments are mostly huge projects, with huge capex, longer duration, long-term investment, longer gestation period with even longer returns. 

• Private sector, until now, has invested about half of what the government has in the past five years. One estimate tells us that the public sector has put in around $70 billion annually, at the global level while the private sector has put in about $35 million. However, an interesting component we have to look at is the negative impact  investments that the private sector has put in - about $5 billion, relative to $35 million in climate finance investments. 

5. What is the economic cost of both mitigation and adaptation ? 

• Mitigation is for the future projects which are to be planned and implemented in order to be in harmony with the climate requirements. This would ensure that future climate change impacts could be addressed so that the alteration or modification isn't required for new projects. Adaptation is about the immediate requirement, addressing the projects which are under implementation or under operation so that they could be modified to the maximum extent possible. Transition, transformation, modification or short-term impact can be addressed through adaptation.Therefore, mitigation is for long term impact and adaptation is for short term impact. Both are required.  

Mitigation is a new project, so the whole pattern involving investment gestation period, funding and returns, could all be estimated, projected and computed now itself. The risk and reward metrics are known in mitigation projects. In adaptation projects, on the other hand, revenues are known and whatever you are investing may not give you the expected or the required high returns.

6. Which are the main sectors that require climate financing or receive climate finance? 

Power sector is one of the major sectors, receiving close to 70 per cent plus investments in both mitigation and adaptation, mostly in mitigation. In the power sector, clean and renewable energy are the major beneficiaries. The second is the transportation sector, and third is agriculture and forestry. Renewable energy (solar and wind) is the focus and these have become the order of the day. Therefore they are able to attract huge funds. These have also got an interface among three parties - government, the developer and the users. Because of this trifacta interface, the cost could be absorbed either by way of  user payments or by way of subsidies from the government. Through this system, the power sector projects appear to be convenient for more investments to flow in and get absorbed. 

There are sectors like agriculture, manufacturing, food and other related industries which deserve to receive more funding than what they are receiving now. 

7. Are we putting enough funds to make the growing number of cities sustainable for the future? 

Despite exact estimation, there is part allocation, because of scarcity of funds. Cities which are seeing a huge explosion of migration to urban areas, expected to go up to 42 per cent shortly in four years, require four times more than the present urban infrastructure. So all the new projects that are coming up including street lighting, drainage and water supply, are all broadly harmonious with the required climate change measures. These cities also need to get connected to the huge infrastructure that is coming up, to remain sustainable and to draw clean energy. For example, electric vehicles are the order of the day and unless the city has that additional electric power to get them charged, how will it be able to see the EVs on the roads? 

8. How is this finance raised - global funds and domestic sources?

Globally, domestic finance is sufficient for developed nations to meet their requirements. They have been investing their surplus into developing countries where there is scarcity of capital and existing resources are insufficient for routine projects, let alone for climate finance equities. Even today only 20 per cent of climate projects get global money. It is domestic finance which is driving 80 per cent of climate projects in developing countries. This is because most of the mitigation projects, that is, power, energy and transportation, require huge capex. These three are absorbing a lot of funding. Traditional funds, which would have funded all the sectors are flowing into this sector mostly because it is convenient and also have been meeting Corporate Social Responsibility (CSR), Environment, Social and Governance (ESG), Sustainable Development Goals (SDG) and other new age metrics. As per global agreements, $100 billion per annum is to be paid by developed countries to developing countries as compensation to balance the climate damage that they have already triggered. In the past three years they have  surpassed that by $119 billion, which is a positive number. 

9. Do we have enough suitable financial instruments to raise funding for climate projects ?

The present instruments are loans - equity, grants, guarantees and risk sharing structures. Some of them are conditional transfers, in debt loans, climate green bonds and title instruments. There are quasi-operational instruments also like carbon trades which are neither equity nor loan and are revenue streams. These are the instruments which are being used to fund or to mobilise climate finance and harmonious projects. What is alarming now is not the shortfall in climate finance but questions regarding which instruments are the most suitable. It is striking to note that the best suited instrument is grants because as of now climate finance cannot be commercially very viable, at least it cannot compete with the non climate friendly projects or negative nature projects. If we can turn them, climate finance investments cannot earn returns that climate negative projects can earn. However, at the moment around 70 per cent is coming in the form of loans only, which means there is an inbuilt sensitisation for the new products to absorb climate finance and to be climate friendly. 

10. Certain cities are doing a great job with green bonds, Ghaziabad being a classic example where the city's STP water was channeled to its own manufacturing units. How important are green climate bonds ? 

This involves the ‘responsibility’ aspect. The moment we say bond, which is the instrument that involves payment of interest and repayment, it ought to be recovered from the users and beneficiaries of the whole ecosystem. Every stakeholder ought to participate in this kind of instrument, failing which the instrument will not succeed. So the green climate bonds are the aptly suited instruments that are used to recover the cost from beneficiaries or stakeholders in the system. They are responsible to contribute to the servicing of interest and repayment of principle because they are the beneficiaries of the money flowing into climate finance. 

Firstly, consider a fund which is constituted to offer debt to all the climate finance products. It issues instruments, gets products selected, does its evaluation and also gets the product validated by a third party. Once the third party agency's validation is in place and it matches their own evaluation, the investment will go into the products of the climate bonds, with lower coupon holding, long repayment tenure, providing long gestation period and moratorium etc. Once the funding gets disbursed, monitoring impact, reporting of the project, implementation, post implementation and operation will be a part of the green bond structure. The ground structure is very important. 

What if there is greenwashing, which is a common phenomena now. It involves claiming a project as climate friendly, thus deserving climate finance. At the same time it is relying on traditional or negative nature boards, only masquerading their activity and receiving the benefit of lower coupon, long gestation and long repayment period climate bonds. So for that, the governance structure is very important. Impact reporting, monitoring and the governance structure will together play a crucial role in ensuring that the climate bonds meet its purpose. 

Generally green bonds need not enjoy concession coupons. Whether or not concession is required depends on the repayment period. On the basis of total cost of operation, climate finance also is supposed to give positive returns/comparable returns like any other negative nature project. Yet, lenders lack interest, private developers or governments may not be keen on developing climate friendly projects. That's because the gestation period and the repayment period for a climate friendly project is longer than any other commercial project. Therefore, a concessional coupon is not required but the features have to be long term. Loan and a long gestation period have to be provided, only then will the market get a level playing field and climate bonds achieve the purpose. While we say green bonds won’t require concessional debt, at the moment there are investors and even the public at large showing keen interest to invest into climate finance, bonds and climate friendly projects. They are willing to take a hit of something between 0.05 to 0.10 per cent on their returns because of a resolve towards climate finance. 

11.  Does green audit need policy intervention ? 

Yes. There has to be a specified fund. Presently there are discussions about priority sector lending. There should be green sector lending, just as 40 per cent is earmarked for priority sector lending, there has to be 5-10 per cent directed towards climate finance projects. Into that a body could be established for interventions such as allocating 10 per cent as climate friendly loans. There could be a green bank with government support and the allocation of funds could be from budgetary allocations. Cost of funds for shorter projects  like solar energy production (green growth and lighting), water meters etc should be subsidised. Blended finance is also required. This is a mixture of public and private finance. If there is a private developer who is willing to invest Rs 60 into the project partly by debt, partly by equity, there has to be a model where the government would intervene and offer Rs 40 of the balance to be covered by the fund, eventually to be repaid. This will reduce the capex burden for the private sector while maintaining the same level of returns. However, capital budgeting and the capex size dissuades private parties from coming forward and taking up these projects. Equally important is tax incentive structure. Finally, green accounting, green disclosure and green audit - all of them must be in place, only then can climate finance improve and meet a substantial part of the targeted objectives.