Investors Undervalue Climate Mitigation Opportunities In Emerging & Developing Markets

A chapter in the IMF’s Financial Stability Report highlights how emerging and developing countries will need to mobilize $2 trillion per year for climate mitigation – 90% of it from the private sector when China is excluded. Many countries face an uphill task because credit ratings that are lower investment grade, sub-investment grade or not rated turn off many institutional investors, and multilateral development banks don’t attract as much private finance as they could. In some cases, these countries would increase their long-term creditworthiness by investing in climate mitigation rather than if they are unable to at the scale required.

One contributing factor to this – besides investor reliance on ratings that don’t fully account for climate, nature and sustainability-related issues – is that investor assessments of climate risk substantially underprice the disruption that even modest climate change is likely to have on the global economy. More severe impacts are likely to face emerging and developing countries ranked as the most vulnerable to climate.

A paper released earlier this year by Carbon Tracker detailed a critique of the economic models that underpin many investors’ assessments of the cost of climate action versus delay. These models assume that the acceleration of climate impacts remains static. So although they match with realized historical climate losses, their assumptions of the future damage function are out of line with what climate scientists’ forecasts, which predict that climate tipping points would greatly accelerate the economic damage from climate change.

The combined impact of structural blockages of private sector capital to emerging and developing countries and the underassessment of the likely cost of inaction leaves substantial missed opportunities. For example, if emerging markets’ credit ratings reflected their stock of natural capital or climate mitigation potential, more investment could flow. On the flip side, if investors used more realistic, forward-looking estimates of the economic damage from climate change, this could shift their allocation towards more opportunities to support transition.

As it stands, financial institutions are likely to continue to face questions about greenwashing by allocating investments in ways that conflict with messages from scientists about the impacts of climate change at even 2° C. In addition to removing some of the blockers for new investment into emerging and developing countries, the IMF’s Global Financial Stability Report suggested policymakers should “refocus on creating climate impact rather than supporting activities that are already ‘green’ and should consider the specific needs of emerging market and developing economies.”