S&P Analysis Finds Insurance Could Spur Climate Change Investments

Climate change commentators have often spoken of capital markets as a source of funding, but many hurdles have to be overcome before institutional investors will allocate money to environmental projects in developing countries, according to Standard & Poor’s.

There is a yawning gap of around $200 billion between the current level of climate change finance and even the conservative estimates by the World Bank of the amount required by developing countries, the ratings agency said in a report released on Tuesday.

Climate action in developing countries — specifically mitigation and adaptation initiatives — requires important financing by the international community, from both public and private sources.

Risk transfer instruments, especially insurance, can play a huge role in offsetting the barriers faced by capital market investors, who will invest only if they can earn adequate risk-adjusted returns on their capital, said S&P.

“The harsh reality facing both policymakers and climate campaigners is that soft capital is in limited supply — investors tend to seek an appropriate return, even in climate change investments,” the report said.

The long-term nature of capital commitments in climate change financing and the relatively short time frame of climate change regulations are deterrents for capital market investors, as is the high probability of insufficient returns.

Some countries pose a risk for climate change investment because the possibility of war or expropriation may scare off climate change finance — but this could be countered by political risk insurance, said S&P.

Finance structures such as bond markets have the depth and scale of investment required to cater for climate change investments, said S&P. Investors are already familiar with bond instruments, and as of 2009, the size of the worldwide bond market was an estimated $82.2 trillion, the report said.

“Since international policymakers view the mobilization of substantial amounts of private sector capital into climate change financing within the next two years as a major priority, we see the results of this risk-ranking exercise as a useful illustration of the obstacles that need to be cleared in order to achieve this aim,” said S&P.

Some investors have bought green bonds, which help poor countries cut greenhouse gas emissions and adapt to climate change. In December 2009, the California State Teachers’ Retirement System, one of the world’s largest pension funds, bought green bonds in a $130 million issuance by the World Bank.

Other alternative risk transfer instruments have been used to protect countries from the risk of natural catastrophes, which will increase the frequency of bad weather according to climate change commentators.

Munich Re, the world’s biggest reinsurer, said there had been 725 natural hazard occurrences linked to weather in the first nine months of the year, which is a strong indication of climate change.

Catastrophe bonds, in which insurers transfer the risk of natural hazards such as hurricanes to the capital markets, have been used to protect countries from such risks.

In October 2009, Swiss Re worked with the Fund for Natural Disasters of Mexico to issue a $290 million cat bond to protect Mexico against earthquake risk.