Greening public credit guarantee schemes for net zero

The climate debate can be summarized in three interrelated questions: Is there an emergency? Are we going to address it? Who’s going to foot the bill?

The first question has been unequivocally answered by the recently published IPCC sixth assessment report, which is a “code red for humanity”. Temperatures are now expected to increase by 1.5C by 2040 under all scenarios, with catastrophic consequences for the environment and significant costs for society and the economy.

The second question will hopefully be answered at the forthcoming COP26 climate conference, where leaders are expected to come forward with ambitious 2030 emissions reductions targets that align with reaching net zero by the middle of the century.

The third question is the toughest and most contentious to tackle. Achieving the goal of net zero by 2050 requires an immediate expansion of annual investment, which in the energy sector alone will need to more than triple by 2030 to around $4 trillion. Unlocking private capital, especially in developing economies, will be key to meeting climate goals.

Public action and support can attract private investment by reducing the cost of capital of green projects ─ green technologies are not always commercially viable at first, making them more expensive and riskier ventures, especially for small businesses.

Public credit guarantee schemes (PCGSs), which have been widely used to support access to finance by firms during the pandemic-induced shock, have the potential to de-risk private capital and mobilize green investment.  Yet, like any other financial institutions, PCGSs should systematically integrate climate change considerations across their strategies, programs and operations.

Here is a four-point plan for mainstreaming climate action within PCGSs ─ whether newly established or existing, well-functioning ones:

1. Commit to climate strategies

PCGSs should integrate climate change considerations into their strategic direction and vision as well as through their actions. PCGSs should be an element of the government’s policy framework to ensure that supportive policies and regulations are in place. They should adopt clear and stable green mandates that include supporting national development strategies and aligning strategy objectives with Nationally Determined Contributions, that is countries’ commitments to reduce national emissions and adapt to the impacts of climate change. PCGSs should be well resourced and have sufficient capital. This funding could come from tapping new sources such as CO2 taxes or climate funds, as well as from multilateral development finance institutions. An effective governance and management structure that demonstrates understanding of the structural nature of climate change should ultimately be in place.

2. Manage climate-related risks

PCGSs should understand and address climate change risks in their existing portfolio and operations, as well as pipeline and future guarantees. They should identify how climate-related risks, both physical risks and transition risks, may impact their outstanding and future portfolios and assess the materiality of those risks, for example through scenario analysis. Material climate-related risks should be mitigated through risk reduction (e.g., accessing counter-guarantees and insurance programs) and avoidance (e.g., integrating climate-related considerations into due diligence and adopting exclusion policies). Finally, PCGSs should actively monitor material climate-related risks at both the portfolio and the client level.

3. Promote climate smart objective

PGSs should work with lenders and stakeholders to create opportunities for increasing climate smart investment. They should align eligibility criteria for both borrowers and lenders with their new green mission and strategy. Climate-rated considerations should be factored into product offerings regarding the use of the proceeds (e.g., green loans), and/or the characteristics of borrowers (e.g., sustainability-linked loans). PCGSs should develop new products to provide borrowers with adaptation finance (e.g., disaster-triggered guarantees like in Japan) and mitigation finance (e.g., equity guarantees). Guarantee coverage rates should be calibrated based on eligibility criteria, product offering and risk appetite, among others.

4. Account for climate performance

PCGSs should track, monitor, incorporate climate considerations into day-to-day operations and disclose climate information. They should upgrade their Monitoring & Evaluation frameworks to measure and report climate performance, promoting active client engagement to bridge data gaps. Finally, PCGSs should be expected to disclose the carbon footprint of their guarantee portfolio in annual reports, aligning with TCFD recommendations and other national/international guidance.

The World Bank Group is working with relevant stakeholders to advance this ambitious agenda. At the global level, we are reconvening the task force that in 2015 developed the Principles for PCGSs ─ a set of good practices to guide the design of PCGSs ─ to discuss potential design changes to reflect the climate-related challenges ahead. At the regional level, we are engaging with regional associations of PCGSs to survey existing market practices (gap analysis) and identify and quantify climate-related risks in current guarantee portfolios. Finally, at the national level we are initiating a policy dialogue with governments and stakeholders on the green transition of PCGSs.