Issue 13: Climate Finance in India
An introduction to Climate Finance in India by guest writer Neeti Shah
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Issue #2 of the Climate Catalogue Reader reviewed the book “The Case for Climate Capitalism” by Tom Rand, which focused on larger financial risks of climate change and national scale investments in clean infrastructure and energy. However, individual investments may not be able to affect change at this scale - and if we really are climate-conscious investors who want to understand the risks posed by a changing climatic system, we need to begin somewhere. Neeti Shah, an investment management professional based out of Mumbai, guest-writes today’s issue (part of a series), as a primer on ESGs and environmentally sound investing in India.
Although you may not be aware of the nitty-gritties of how climate change is impacting the globe, you can literally see and feel the changes around you. You might not have noticed the subtle changes like the days getting longer during summers, but you couldn’t have missed the Kerala floods – the worst in a 100 years - or Orissa’s Fani that caused unparalleled destruction of property and loss of life. The incidences, impact and frequency of these natural disasters are only increasing. And with loss of valuable human life comes massive financial disruption that has the ability to set a developing economy like India’s back by at least 20 years. However, more often than not, the financial impacts of climate related issues are not quantified and identifying them in the first place could be challenging. These issues necessitate actions. Increasingly, investors, lenders, and other financial regulators are becoming more focused on ensuring that the private sector is ready to address climate risks and grab opportunities brought by changing climate. Carbon Disclosure Project India’s 2020 report referred to a 2019 report which stated that the total direct economic losses incurred due to climate-related natural disasters in 2019 were estimated at US$232 billion. Indian monsoon floods in 2019 caused an economic loss of US$10 billion and claimed 1,750 lives (as per the CDP India Annual Report 2020). Additionally, the Bank of England has estimated asset losses worth US$20 trillion due to climate change if no action is taken now (according to this speech).
While these numbers may seem unfathomable when spoken of at a state or national or international level, let’s break it down to an individual level. Consider a twenty-something person, just entering the workforce. They might buy a gift for their family with their first salary and decide to invest the rest in a corporate bond or a slightly riskier equity share. The family is proud of the first ever investment and encourages the person to maintain investing discipline in the capital markets – it has helped build wealth over a longer term before.
20 years later, this person is absolutely devastated at the depreciating value of his investments. Why? This person did not foresee the Environmental Risks attached to their investments. They did not take into account the changing climate scenario and how the companies that had been researched and selected so carefully had been adversely impacted by the rising temperatures. This is where incorporating ESG considerations in your portfolio comes in.
ESG is quite the buzzword in the world of finance and investments today. Sadly, not many individual investors are aware of the term or its significance. This is a chance for them to understand and recalibrate their investments factoring in this increasingly important term.
What is ESG?
ESG stands for Environmental, Social and Governance factors. A company faces all of these challenges that directly impact its bottom line. In this issue we will delve into the minute details of environmental risks of any carbon economy and its implications on an investor’s portfolio.
It has been proved that investments that consider environmental risks together with financial metrics have performed better over the long term. And why wouldn’t they? If you were buying a house, and knew that the threat of rising sea levels is real, wouldn’t you refrain from purchasing property in a coastal city? This is exactly the same. Investors and investment managers alike are now beginning to factor in ESG risks into their portfolios. Globally, investment giants like BlackRock and Morgan Stanley and data collaborating platforms like Bloomberg and Thomson Reuters are already using their expertise to try and collect data, quantify it and score companies based on the ESG risks faced by them. Apart from scraping data off of company reports (courtesy the tightening risk reporting standards for companies across the globe), use of hi-tech methods like geo spatial technology and drones is not far away to verify reported data.
After the Biden administration’s pledge to cut the USA’s carbon emissions by half in this decade and China’s decision to become carbon neutral by 2060 (according to this article), India too has put its foot forward in the fight against climate change. The Modi government reaffirmed its pledge to the 2015 Paris climate change accord in April 2021. The plan includes cutting greenhouse gas emissions intensity of its Gross Domestic Product by 33-35% by 2030, increasing our non-fossil fuel power capacity to 40% from 28% in 2015 and substantially boost forest cover to reduce carbon dioxide. India’s Environment Minister recently said India has already achieved 21 percent of its pledge to reduce its greenhouse gas emissions per unit of economic output by 33-35 percent by 2030 (article).
So, why is this important for an Indian investor?
Indian financial institutions and companies, like most the world over, are bound to be affected by these targets set by national governments, and more importantly, the actual risks posed to production and economy by environmental risks.
Environmental Risks faced by India
The plethora of environmental risks faced by organizations today include:
Physical Risks
Damage to property and infrastructure due to extreme weather events and natural calamities.
For example, 2021 marked the fourth consecutive year of intense cyclones in the Arabian Sea and Bay of Bengal. The economic loss by Fani, the cyclone that wreaked havoc in Orissa last year, was pegged at Rs. 12,000 crore. The highest loss was estimated in the power sector at Rs. 1,160 crore while the loss in the Panchayati Raj and drinking water departments stood at Rs. 587 crore. Odisha’s tourism industry came to a standstill with a loss of Rs. 2 crore per day. Power disruption caused temporary shutdown of businesses in the state, leading to operational losses to the tune of hundreds of crores. Rehabilitation and relief efforts cost the state thousands of crores. These are all unbudgeted expenses that have absolutely zero return on investment.
Regulatory/ Policy risks like taxes, compliance with changing regulations
Carbon pricing – A carbon price is a cost applied to carbon pollution to discourage polluters. Think of it as a fine on your greenhouse gas emissions. This brilliantly researched article articulates the trade-offs and opportunities that would come with pricing carbon in India:
Pricing Carbon: Trade-offs and Opportunities for India
The author makes a compelling argument that while in the short term, putting a price on carbon may not be the best way forward for a developing economy like India due to high energy prices, in the medium to long term it will be a necessary tool to engender systemic change - if of course, crafted and implemented carefully. Global carbon pricing models have shown evidence of success in a developed political climate. However, with increased international pressure to achieve carbon reduction targets, it will not be long before the government is forced to remodel and implement a politically sound and economically feasible carbon tax. Do take a look at the policy pathways highlighted that could pose potential risks for the most carbon intensive industries.
Adopting new technology due to pollutant limiting regulations - A classic example of this would be the current upheaval in the automobile industry due to a regulatory mandate of adoption of Bharat Stage VI emission norms. Bharat Stage (BS) emission standards are laid down by the government to regulate the output of air pollutants from internal combustion engine and spark-ignition engine equipment, including motor vehicles. The central government has mandated that vehicle makers must manufacture, sell and register only BS-VI (BS6) vehicles from April 1, 2020. The auto industry in India was not ready to deal with this level of change. It came amidst the worst slowdown in demand that automakers had been facing in a decade. Piling unsold inventory, rising costs and complete phasing out of diesel variants were only some of the consequences of this mandate. However, such pollutant deterrent regulations are going to be
more common in the coming years and every industry will either have to equip themselves well in advance or face the consequences.
Financial Risks
Climate change can cause disruption of business activity directly impacting a company’s bottom line
As Dr. Claudia Custodio discusses in her paper, studies show that a rise in temperatures directly impacts the sales and therefore profits of a business. “A local temperature rise of one degree Celsius leads to a two per cent fall in sales over the course of a year” It highlights three main channels that have been observed in suppliers across different geographies and industries to arrive at the real economic costs of climate change :
Decline in employee productivity and health as it gets hotter (especially in labour intensive industries like manufacturing and agriculture) could lead to shut downs on account of employee absenteeism/harder working conditions
Financial constraints could hamper a company’s ability to adapt to weather shocks. For example, cash strapped suppliers may not have enough financial and operational flexibility to divert or reallocate resources internally to respond to weather related production disruptions.
Companies that sell standardized products or products and services that are not patented could lose out on more business as temperatures rise due to ease of substitution by customers i.e. the cost of ‘switching’ to alternative suppliers is lower.
This is, of course, in addition to the well known direct consequences of hotter temperatures on certain industries like agriculture (severe weather events impacting crop production) and increased consumption of electricity, air conditioners and water.
Litigation Risks
Climate Change Litigation has the potential to disrupt not only the company in question but also the entire industry in which the company operates. “Although the term ‘global warming’ started appearing in Indian environmental judgments in the 1990s, climate litigation in India is of relatively recent provenance, and with a few exceptions, climate concerns are peripheral to other, more mainstream environmental issues.” My understanding from this extract by Shibani Ghosh, an environmental lawyer, is that India’s climate cases can be classified into 2 broad categories:
Those impacting formulation/ amendment of national/ state level climate regulations
Those questioning proper implementation of existing environmental laws
Both these categories of cases have the potential to directly impact the corporations operating within the grey areas of these legislations.
Take the landmark judgement in the Ganga Pollution Case, for example. It directly impacted the business of all leather tanneries and their capital investment outlay in the years to come. The court said that “Just like an industry which cannot pay minimum wages to its workers should not be allowed to exist, a tannery which cannot set up a primary treatment plant should not be allowed to continue its existence.” Such judgements in industries most scrutinized for their negative environmental impact can lead to some major litigation risks and large financial liabilities.
Reputational/Market Risk
Perhaps the most direct risk for businesses is loss of customers due to increasing consumer awareness and changing preferences. We are all seeing the fall of fast fashion brands like Zara, H&M and Primark in the face of growing concerns about the sheer amount of wastage they entail. A forecast by Swiss bank UBS says the high volume and cheap approach may fall out of sync with customers who are increasingly more environmentally aware and see the negative impact of the industry. The same report said fast fashion retailers could see profits fall 10 to 30 percent over the next five to ten years.
As if this wasn’t enough, another issue that emerges from consumer activism is the pressure on companies to convince the buyers of their sustainability practices through “Greenwashing”. Greenwashing is a communication and marketing strategy adopted by companies that consists of putting forward ecological arguments in order to forge an ecologically responsible image among the public. Green washing masks the risks a company faces such that identifying the entire impact of its unsustainable practices becomes more complex.
A part of our responsibility as individual investors and consumers is being able to root out companies that do not take climate risks seriously and would fail or lose money, and in the long run, be detrimental to the environment.
A report by Carbon Disclosure Project (CDP) stated examples of perceived climate change related risks quoted by some of the bigwigs of India. The Report highlights how current and emerging regulations are perceived by Indian Companies as the greatest risks of climate change. These are followed by risks to brand value and reputation and of course the risk of adapting to innovative technologies that are the need of the hour in this global fight.
What is interesting is that the number of Indian companies that identified inherent climate-related risks with potential substantive financial or strategic impact on businesses rose to 94% from 88% in 2019. Disclosing Indian companies put the total inherent financial impact of climate related risks at a whopping Rs. 7.13 lakh crores. Read what visionary corporate leaders have to say about climate change and its impact on their business operations here.
The key question for investors then becomes: How vulnerable is a company to transition from a fossil-fuel based economy to a low carbon one? Understanding this carbon risk in your investment portfolio can help you make better investment decisions.
In the forthcoming issues, we will see what are the international, national and local policy actions enacted and financial innovation implemented to help professional investment managers and individual investors protect their investment portfolios against the rising threat of climate change. (Coming out in Spring 2022)
Neeti Shah is an investment management professional working in the ETFs and Index Funds division of a premier asset management company in Mumbai, India. A sustainable finance enthusiast, she believes that finance can play an instrumental role in battling the climate emergency.
She enjoys holding virtual teach sessions with primary school children from rural India as part of her responsibilities as a Lokarpan fellow (Lokarpan is an ed-tech non profit in India).
She also writes articles related to individual investing for those who are new to investment. You can find more articles by her below:
A Millennial’s Guide to Index Investing
Four Lessons COVID Teaches you About Investing
Too Lazy to Pick Stocks? Simply Buy the Index Using ETFs
The opinions expressed in this column are that of the writer. They do not in any way reflect the views and opinions of the organizations she is associated with.
This is a special issue of the Climate Catalogue Reader featuring original content produced for this newsletter. Thank you for reading through it. If you have any questions about the topics discussed in this issue, please leave a comment below, and we can address it in subsequent issues on similar topics.
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