Navigating the intersection of climate change and financial markets

Devising mechanisms to transfer energy from surplus to deficit countries
Navigating the intersection of climate change and financial markets
Finance and climate concept

With major world powers committing to the Paris Climate Accord pledging to contain global warming at 1.5 degrees Celsius, subsequent deliberations have inevitably centered on mitigating climate risks by galvanizing financial resources to address challenges in the transition towards sustainable energy without causing excessive economic friction. Evidently, the hurdle between developed markets (DM) and emerging markets (EM) has hovered around timelines towards achieving the transition as well as the overarching definition of ‘clean energy’, open to conflicting interpretations. With the upcoming COP28 to be hosted in UAE this year, recognized as one of the major energy suppliers to the world, the timing is propitious to examine challenges critically and propose innovative resolutions.

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Technology: Clean vs. carbon-efficient

In one of the earlier forums on “energy transition” hosted by Future Investment Initiative (FII) under the aegis of Public Investment Fund (PIF) in Riyadh, KSA, Chairman of Reliance Industries, Mr. Mukesh Ambani emphasized the need to adopt portfolio-wide energy mix striking strategic balance between conventional and non-conventional energy sources. As one of the significant stakeholders in the energy transition debate, Mr. Ambani articulated the need to focus on efficient technologies capable of reducing carbon emissions significantly with respect to conventional sources including Oil & Gas. Investment in emergent technologies enabling hydrocarbon-rich countries to invest in these technologies to achieve carbon neutrality must gain traction to forge progress in upcoming climate talks. Economic jeopardy at the behest of decommissioning fossil-fuel infrastructure could lead to potential ramifications constraining the global consensus needed to hit Net Zero by 2050.

climate financial
Dr. Ullas Rao

Even as costs associated with generating energy from clean sources including solar, wind and water have been trending downward, challenges galore both in terms of accessibility of vital raw materials like rare-earth minerals charging batteries as well as significant disparities in the availability of sources of clean energy subservient to geographical considerations. To that extent, new-found alliances like the International Solar Alliance (ISA) founded by India could play a major role in devising mechanisms to transfer energy from surplus to deficit countries through investment in efficient grid infrastructure.

Ethical finance and Carbon credits

Informed debates surrounding sustainability are well aligned with ethical sources of finance encompassing ESG investments, Impact investments, and Islamic Finance. In fact, the forum dedicated to the Global Ethical Finance Initiative is a pioneering initiative involving each of the above in championing ethical finance under a single umbrella in offering innovative financial solutions to tackle climate risks.

As COP28 starts gaining world attention, it is also worthwhile to look at the role of carbon credits, which are traditionally employed as an efficient financial security to transfer financial resources from a carbon-intensive firm to a carbon-neutral firm in exchange for carbon credits earned by the former utilized for reducing the firm’s carbon footprint. Even as the secondary market for carbon credits is growing including the derivatives market, the pace of development in terms of volume and value remains low. With GCC and UAE emerging as the ‘new Wall Street for the West’, it isn’t inconceivable to envisage Abu Dhabi Global Markets (ADGM) or Dubai Financial Markets (DFM) launching an active secondary market for carbon credits. With UAE’s firm resolution towards achieving sustainability goals, the initiative would significantly ramp up interest and investments from institutional investors.

Accounting regulations

Recent studies have shed light on the need for improvement in reporting practices regarding climate change implications in financial statements. Even as global accounting bodies including International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP) make concerted efforts to bridge the anomalies, wider consultation with different stakeholders including governments, industry and society would play a crucial role in streamlining climate-related reporting to mitigate financial risks associated with climate change as well as reducing information asymmetry among investors.

Education on sustainability

Finally, there has been a steady ramp-up amongst specialist institutions towards offering certification on sustainability, climate risk, and ESG. These initiatives are worthwhile in conferring required technical skills amongst stakeholders including universities, professional organizations, industry, and government.

These initiatives together could play a vital role in ameliorating emerging risks associated with climate change with a clear roadmap to develop strategies across each of the above strands. Sustaining sustainability initiatives inevitably assumes significance as climate change will remain one of the existential risks with intertwined ramifications encompassing geographies and economies.

Dr. Ullas Rao is Assistant Professor of Finance at Heriot-Watt University Dubai

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