News from the PLACARD Project: Innovative Climate Change Adaptation and Disaster Risk Reduction financing for the European Green Deal
The European Green Deal, which was unveiled by European Commission President Ursula von der Leyen on 11 December 2019, contains a set of strategic measures with the overall aim of transforming Europe into a “climate-neutral” continent (i.e. having an economy with net zero emissions of greenhouse gases) by 2050. To achieve this, the Sustainable Europe Investment Plan (SEIP) - the investment pillar of the Green Deal - should mobilise at least €1 trillion in sustainable investments over the next decade.
A recently published report (Sushchenko and Schwarze, 2020) on Climate Change Adaptation (CCA) and Disaster Risk Reduction (DRR) financing, which was prepared as part of the PLACARD (Platform for Climate Adaptation and Risk Reduction) project (www.placard-network.eu), argues for an updated version of the road map to the Green Deal. This refined document should enhance the “EU Taxonomy” (i.e. the unified EU classification system for sustainable activities) and the “EU Green Bond Standard” (EU-GBS), with more emphasis on CCA and DRR aspects.
According to the SEIP, the main financial support for implementing the Green Deal should be provided by the EU budget and the European Investment Bank (EIB). But there is a significant investment gap - 180 billion EUR per year, as estimated by the European Commission - between what should and can be done. For this reason, the EU financial market must receive a clear signal to deliver further resources to facilitate implementation of the Green Deal measures.
Unfortunately, the existing framework for disclosure regarding non-financial information, labelling of the debt financial instruments, and identification of green projects does not sufficiently cover CCA and DRR aspects. This is a missed opportunity. By updating the Green Deal and related measures (particularly the EU Taxonomy) we could significantly improve the efficiency of related CCA and DRR investments, by lowering transaction costs and avoiding expensive duplications of efforts.
The main problem in mobilising sufficient green finance is the high transaction costs, mostly related to the need for reliable and high-quality information, making access to the green financial market very expensive in terms of time and cost, for small and medium businesses. IT solutions could help to collect process and store the information, so reducing these transaction costs.
Available mechanisms for mobilisation of CCA and DRR finance range from self-financing tools to risk transfer mechanisms, where IT solutions play an important role in implementation of the so-called “3D Nexus” (de-risking, digitalisation and decentralisation), which grants collection, processing and storage of reliable and frequently updated climate-related data.
For example, distributed ledger technology (DLT) - using independent computers (nodes) to record, share and synchronize transactions in their respective electronic “ledgers“, without a centrally coordinating entity - is crucial in allowing small farmers to collect information about their financial flows and adjust it to the weather conditions. As a result, they can save money in times of ideal weather conditions and increased productivity, and use the saved money when extreme weather events or natural disasters occur.
DLT also plays an important role in providing crisis or contingent financing. Forecast-based financing (FbF) is an example where DLT could facilitate an immediate provision of financial support to every citizen in case of natural disasters or extreme weather events. Use of FbF combined with DLT could speed up financial recovery, delivering repayment within minutes.
Climate-related risks and extreme events have immense negative economic and social impacts, and resulting damages can be very high for insurance companies, requiring implementation of public mechanisms to cover the risks. Existing examples (such as the “Blockchain Climate Risk Crop Insurance” - a digital platform for standardized crop insurance for smallholder farmers in Africa) show that DLT-based climate insurance pools or sovereign insurance funds could deliver solutions in these cases.
The European Stability Mechanism was created following the European debt crisis that started in 2009, to reduce systemic risk and counteract speculative transactions on the financial market. At the same time, climate change is widely acknowledged at EU level as a systemic risk, requiring a systemic approach for protecting not only the economy, but also the financial system and society.
The share of alternative capital on the reinsurance market for climate-related risks has seen steady growth, outpacing growth rates in the traditional part of the reinsurance market. Here, collateralised financial instruments play an important role in further developing this area of reinsurance. Moreover, according to the recommendations of Solvency II (the EU Directive on EU insurance regulation) innovative and synthetic insurance derivatives (versus traditional insurance) can be considered best for managing the risks.
As a result, establishing a “European Risk Transfer Mechanism” (or ERTM) is essential, which could avail of the facilities of the European Stability Mechanism, and the opportunities of DLT. Using the ERTM, the sovereign insurance funds could transfer their climate risks to the financial market through catastrophe bonds and swaps. DLT could speed up collecting of the necessary information from the sovereign insurance funds, and use it to manage their operations with innovative risk transfer instruments. Application of DLT could also improve management of climate-related risks, whereby collecting, processing and storing the information could become quick and reliable.
Oleksandr Sushchenko, Reimund Schwarze, Gabriela Michalek, Helmholtz Centre for Environmental Research (UFZ), Leipzig, Germany, and Ingrid Coninx, Wageningen University & Research, The Netherlands.
For more information:
Sushchenko, O. and R. Schwarze. 2020. Economics and finance of disaster risk reduction and climate change adaptation: Main gaps identified in arising alignment opportunities for the EU Green Deal. PLACARD project, FCiências.ID, Lisbon.
CAPTION FOR FIGURE: [ Components of the new risk transfer scheme, in combination with distributed ledger technologies (DLT) at the EU level. Adapted from: Sushchenko and Schwarze (2020). ]