Financial

Image credits: Didier Weemaels on Unsplash, 2015

Key messages

  • The exposure of the financial sector infrastructure itself to climate change is low compared to the exposure and vulnerability of the assets they invest in. The exposure to climate risk drivers reflects an uneven vulnerability across EU regions and sectors but also a concentration in specific financial sector portfolios, banks and financial institutions.
  • Sustainable investments in adaptation are harmonised in a EU taxonomy that needs to cover more economic activities over time and is globally applicable. Via investments that are labelled sustainable, the financial sector can promote and support adaptation measures to reduce physical climate risks. Residual risks can be transferred via insurance mechanisms.

Impacts and vulnerabilities

Reporting on adaptation and measuring progress by private firms and public entities of all sizes will require different data and indicators as well as more granular data than nowadays available in most national, regional and local adaptation policies and plans.

Disregarding the implications of climate change can generate significant risks for the financial sector. Between 1980 and 2019, weather and climate-related extremes accounted for around 81% of total economic losses caused by natural hazards in the EEA member countries, amounting to EUR 446 billion. This is equivalent to EUR 11.1 billion per year and the cumulative deflated losses are equal to nearly 3% of the GDP of the countries analysed. If no further action is taken and global temperature increase by 3.5°C, climate damages in the EU could amount to at least EUR 190 billion, a net welfare loss of 1.8% of its current GDP.

 

Policy framework

Responding to the increasing material impacts of climate change, the European Commission has on one hand started to integrating climate resilience in fiscal frameworks and on the other hand the banking and insurance sector has started to take actions on its own to deal with the impacts.

When it comes to the impact of climate change on the European economy and financial system, the EU Strategy on Adaptation to Climate Change refers to the EU Sustainable Finance Strategy for more details as sustainable finance has a key role to play in delivering on the policy objectives under the European Green Deal as well as the EU’s international commitments on climate and sustainability objectives.

The Insurance sector

The share of non-insured economic losses caused by all recorded weather and climate-related hazards appears to be widening because of slow adaptation action, and more frequent extreme weather events in the absence of higher climate insurance penetration rates. Climate risks are likely to stress local economies and cause market failures that affect both consumers and insurers. More frequent catastrophic events, in combination with the need to meet evolving regulatory requirements, can threaten company business models—and make insuring some risk unaffordable for customers or unfeasible for insurers. To address these issues, the European Commission will:

  • strengthen dialogue between insurers, policymakers and other stakeholders;
  • identify and promote best practices in financial instruments for risk management, in close cooperation with the European Insurance and Occupational Pensions Authority (EIOPA);
  • explore the wider use of financial instruments and innovative solutions to deal with climate-induced risks.

Solvency II is a Directive in European Union law that codifies and harmonizes the EU insurance regulation. Primarily this concerns the amount of capital that EU insurance companies must hold to reduce the risk of insolvency. However so far, the Directive does not account fully for the risks steaming from climate change and there are several voices calling for a better capturing of this aspect in the natural catastrophe risk submodule.

The banking and investment sector

Banks are under rising regulatory and commercial pressure to protect themselves from the impact of climate change and to align with the global sustainability agenda. Due to the lack of regulatory and supervisory framework, a number of central banks and regulators around the world have become aware of their role and potential mandate in addressing climate change and environmental risks faced by the sector. For example, a group of central banks including the European Central Bank launched the Networking for Greening the Financial System in 2017. It aims to contribute to the analysis and management of climate and environment-related risks in the financial sector, and to mobilize mainstream finance to support the transition toward a sustainable economy.

Further several private banks have started to develop new products such as green bonds or green mortgages. Green bonds are debt instruments that differ from conventional fixed income securities only in that the issuer pledges to use the proceeds to finance projects that are meant to have positive environmental or climate effects. The Technical expert group on sustainable finance  published in 2020 their Usability guide for the EU Green Bond Standard.

Under a green mortgage, a bank or mortgage lender offers a house buyer preferential terms if they can demonstrate that the property for which they are borrowing meets certain environmental standards.

The regulation on disclosures relating to sustainable investments and sustainability risks introduces disclosure obligations on how institutional investors and asset managers integrate environmental, social and governance (ESG) factors into their risk management processes. Delegated acts will further specify requirements on integrating ESG factors into investment decisions, which is part of institutional investors' and asset managers' duties towards investors and beneficiaries.

 

Improving the knowledge base

A lot of activities related to sustainable, climate and adaptation finance deal with the international dimension. This page focuses on what’s of relevance for EEA member countries at domestic level. For more information on the international and development aspects, information can be found at the UNFCCC pages and its data portal.

Also the IPCC focuses mainly on international financial flows (and on low-carbon rather than adaptation aspects), but the chapter on cross-cutting investment and finance issues of the 5th IPCC Assessment Report (AR5), Working Group III, details some domestic issues as well. Contributions from the Working Group on impacts, adaptation and vulnerability (WG II) to the AR6 are planned for 2022.

The Global Centre on Adaptation runs a climate finance programme, to mainstream climate adaptation and resilience across decision-making, scale up climate adaptation and resilience finance and to develop innovative finance instruments.

The EEA published in 2007 the technical report Climate change: the cost of inaction and the cost of adaptation and is currently running a new project on this topic where the work will become available in 2022.

Recent research projects on the finance and economics of adaptation are for example the H2020_Insurance project further developed in the OASIS loss modelling framework and the OASIS Hub, or the NAIAD project focussing on the insurance value of nature. Other projects dealing with adaptation economics and finance are for example COACCH, ClimateCost or Econadapt.

 

Supporting investment and funding

The EU’s multiannual financial framework (MFF) for 2021-27 amounts to €1.21 trillion with an additional €807 billion from the next generation EU recovery instrument. 30% of this budget is earmarked for activities contributing to climate objectives. With the new MFF, the Commission has scaled up resources for climate change and adaptation finance, including through innovative mechanisms such as the European Fund for Sustainable Development Plus, leveraging resources in bilateral channels and through the EU Member States.

Further details of funding commitments are available here and an overview of the EU funding mechanisms for 2021 to 2027 can be found here.

Besides the funding mechanisms within the EU, the EU and its Member States increased their overall climate finance support to third countries by 7.4% in 2019, amounting to reach EUR 21.9 billion, 52% of which was spent on helping EU partners adapt to climate change. Providing a high share of climate finance within EU international cooperation, and specifically towards adaptation, will remain in the future.

 

Supporting the implementation of adaptation

EIOPA further develops activities to implement sustainable finance, e.g. with a dashboard on the insurance protection gap, methodological work to include climate change in natural catastrophe insurance (Solvency capital requirements), or in non-life underwriting and pricing.

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