Outdated Risk Perceptions Block Climate Finance  

New research finds companies in emerging and developing markets want better climate investment, but barriers to private finance flows remain.  

Perceptions of excessive risk in the Global South are deterring institutional investors from allocating to the market, Nick Robins, Professor in Practice – Sustainable Finance at the Grantham Research Institute on Climate Change and the Environment, has warned.  

Over-reliance on credit ratings and similar decision-making tools were preventing institutional investors in Europe and the North Atlantic from going to emerging markets because they had an excess risk perception “baked into out-of-date rating systems”.  

His comments followed the launch of a report by the institute, global think tank ODI and development bank British International Investment (BII) surveying the investee businesses of BII in Africa, Asia and the Caribbean on how the climate emergency is affecting them.  

The report found that 79% of companies surveyed were already being impacted by climate change, up from 68% in 2022.  

It also found that 72% of corporates surveyed had experienced an extreme weather event in the last five years with droughts, floods and heat cited as the greatest cause for concern. 

A massive 98% of companies said better investment is needed to help them navigate the climate transition, increasing from 92% the previous year.  

Speaking at an event revealing the findings, Nicola Mustetea, Head of Climate Change at BII, said respondents commonly referred to the need for capital expenditure support funding instruments and improved climate finance, deployed in combination with other mechanisms such as targeted technical assistance.  

EMDE investment gap  

To honour the Paris Agreement by 2030, the Tony Blair Institute (TBI) for Global Change estimates that the combined global annual climate spend from the public sector, international financial institutions (IFIs) and private sources needs to range from US$4.5-6.9 trillion annually. This is seven to 11 times larger than the current annual spend of US$630 billion. TBI also says emerging market and developing economies (EMDEs) should get 30-50% of the estimated spending needed, receiving around US$2.4 trillion annually.  

According to its analysis of current sources of finance, approximately a third of this amount (US$780 billion) must be supplied by international sources of private finance, in addition to funding from public sources and IFIs. At present, EMDCs receive only US$85-114 billion from international sources of private investment. 

Challenged by audience members at the BII event on the low amount of international private finance currently allocated to climate finance in the Global South, Robins said the issue was not new.  

“From meetings we’ve been having with entrepreneurs and companies in emerging economies, one of the challenges is that they see this as a little bit like ESG rain coming from the Global North. It is raining down in terms of new conditionalities and new requirements, which cannot always be adapted to the circumstances of those countries and companies,” he said. 

Robins said it was important for investors, particularly those in the public sector, to work with companies so that their requirements are appropriate for investees’ local conditions, including  their financial systems.  

He added that there was a role for central banks to address the raised costs of capital in emerging markets, due to climate shocks.  

Excessive perceived risk  

Speaking after the event to ESG Investor on the issue, Amal-Lee Amin, Head of Climate, Diversity and Advisory, at BII, said: “One of the things people (investors) haven’t quite appreciated with net zero is that it requires a structural geographical reallocation of capital into Global South emerging economies – where the investment needs are greatest.” 

Amin said examples of positive partnerships to drive more climate investment into the Global South included national infrastructure investment funds in India. By putting up 49% of the capital for renewable infrastructure deals through such funds, India has attracted US$2 billion from international investors to date.  

Also speaking to ESG Investor, Robins said an overlooked barrier to international investors allocating to Global South countries was potentially flawed risk assessments by credit rating agencies.  

“They aren’t looking at actual performance,” he continued. “They are using a notional or projected performance which may actually be out of date.”  

In the fourth quarter of 2023, the pace of defaults in emerging markets was lower than that in the US and Europe, according to S&P. Nevertheless, according to the IMF, only about 60% of emerging markets and 8% of developing economies have an investment-grade rating. The issue has come to a head with African Union planning to create a new sovereign credit rating agency that it says could provide more accurate risks assessments across the continent.  

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