S&P Global Ratings' global head of sustainable finance Bernard de Longevialle and sustainable finance director Beth Burks consider the upcoming COP29 and its work in helping to mobilise private capital to developing economies
Environmental Finance (EF): What key topics do you plan to engage with at COP29 in Baku?
Bernard de Longevialle (BDL): As a provider of long-term credit ratings and sustainable finance opinions, we see the climate finance gap for developing economies as a major issue. Not only are these countries the most exposed to climate change risk, but also we believe no global transition can succeed without them, and many have high levels of indebtedness. Failure to address this issue could heighten long-term environmental and social risks to global financial stability.
As such, we are engaging with attendees on private capital mobilisation because public money alone will not be sufficient to address this gap. Private capital mobilisation has been stagnating around $60 billion per year since 2017, according to data from the OECD, when what is needed are high multiples of this figure.
Beth Burks (BB): We provide sustainable finance opinions on sustainability-labelled debt and the green equity market. So as practitioners, we can inform COP29 negotiators on how finance is aligning with the goals of the Paris Agreement for a low-carbon and climate-resilient future. With COP29's emphasis on negotiating new climate finance goals, we will provide negotiators with insights into the discussions around Article 2.1(c), which focuses on aligning financial flows towards lower emissions and climate adaptation, and Article 9 on supporting developing countries in meeting their climate goals and nationally determined contributions (NDCs).
EF: How is climate change considered in the credit ratings?
BDL: It is important to understand that a credit rating measures creditworthiness and likelihood of default, it is not an indicator of environmental impact. However, climate change and transition risks are two factors that can have a material influence on credit ratings.
Climate is considered when it is a material factor in the ability of the issuer to pay back its debt. For example, transition risk and the growth of renewable energy led us to downgrade the oil & gas exploration and production industry in 2021. To help inform our rating decisions we use climate scenarios – and research to understand what could become issues in the future.
EF: What are the roadblocks to addressing private capital mobilisation for developing countries and how do you see your role as a rating agency?
BDL: First, it is important to remember that industrial policies, like the Inflation Reduction Act in the US or the New Green Deal in Europe, have created strong incentives to invest in developed markets and that without comparable incentives private capital will not scale in developing economies.
Private capital investments in developing economies face specific roadblocks. They lack a supportive local institutional, legal and operating environment as well as local technical skills for getting projects off the ground. Foreign exchange risk is also high, as projects are mostly generating local currency revenues while funding is mostly done in hard currencies. There is often a lack of data to assess risks, blended finance tends also to be bespoke, lacking standardisation and scale to match large institutional investors' needs. Another roadblock is the lack of catalyst capital to de-risk blended finance transactions to bring them in line with investors' risk appetite, which are primarily in the investment grade category. Few projects offer first-loss guarantees in blended finance transactions to match lower investor appetites. Some projects may also lack the scale that larger investors are seeking. Finally, there is a cultural gap between the development banks and the private sector that can impact their ability to work together effectively.
As a credit rating agency and a provider of sustainable finance opinions, our primary role is to provide independent and objective opinions on creditworthiness and environmental and social impacts as part of our second-party opinion provider role. Our priorities are to make ratings as transparent as possible, incorporate new information and market developments including financial innovation like novel blended finance transactions. We review and provide feedback on the Global Emerging Markets Risk Database's recent release of multilateral development banks' default and recovery data for rating calibrations on corporate and project finance exposures in frontier economies where our rating universe is relatively limited. We believe more dialogue across stakeholders is needed to address the climate finance gap. We provide insights and our rating perspective which can be useful and contribute to capacity building by providing analytical education about ratings.
EF: Why might an issuer in a developing country choose to issue debt with a sustainability label?
BB: Sustainability labels ultimately come with enhanced transparency requirements about what is being financed, which is something investors are looking for when they assess investment merits beyond traditional indicators such as creditworthiness.
As a sustainable finance opinion provider, we provide second-party opinions for sustainability-labelled debt in emerging markets. This year, for example, we became an approved reviewer for the Brazilian Stock Exchange and its green equity listings.
We consider how aligned labels are with the goals of the Paris Agreement through our 'Shades of Green' analytical approach measuring how consistent that investment is with a low-carbon, resilient future. We are also assessing the robustness of issuers' climate transition plans through our climate transition assessment.
All this provides issuers with an external review that can help build confidence and robustness in these labels in different markets, including developed and developing countries.
EF: What differences, if any do you see working in these markets, that investors might want to know?
BB: We are seeing a much greater focus on adaptation and biodiversity management in certain developing markets, which are project categories you don't often see in developed markets.
For example, we recently did a second-party opinion for Togo's sustainable financing framework and it involved financing more efficient, but ultimately fossil fuel-powered, fishing boats. In general, we wouldn't consider those boats to be green because they are fossil fuel-powered, but within Togo's specific context, they offer near-term environmental benefits, such as reducing fuel use by up to 40% and preventing local deforestation. So, you have to have a greater understanding of the local context and what socioeconomic development is needed, which can take a bit of time.
There is no globally agreed-upon definition for green or sustainable investment. All investors have different tolerances for what they deem acceptable, and countries are setting up their own sustainable finance-oriented taxonomies. There is a lot of worry that some of these taxonomies could all be different and might create problems within these labelled instruments. But what we see in practice is quite a lot of overlap in the technical criteria.
For our second-party opinions, we try to point out anything that we might consider a strength, a weakness or an area to watch. If we think there is an eligible activity in a taxonomy that doesn't warrant a green label but might be more suited to a transition category, we can call that out in our methodology using our Shades of Green approach.
BDL: Developing markets are catching up with disclosure regulations on sustainability. Still, the level of disclosure can be lower in some countries, and for this reason, the benefit of using a label is even higher for providing transparency about the impacts and allocation. What is also important is that when we talk about transition, understanding that countries have their transition pathway and the ability to look at transition in a specific context is key.
To find out more about S&P Global Ratings' Shades of Green approach, click here.