Interview with Dr. Amr Addas – Adjunct Professor and Director of the Van Berkom Investment Management Program and Van Berkom Small Cap Case Competition at the John Molson School of Business, Concordia University

1-In the wake of the COVID-19 crisis, banks face growing calls to play their role in addressing today’s environmental and social concerns. How banks are using sustainable finance to encourage sustainability improvements among their clients and to reduce the negative ESG impacts of their own operations and investments?

  • I agree that covid-19 raised a lot of questions about the role of private enterprise in addressing some of the glaring social and environmental problems the world faces. But I would argue that this health crisis was more of an accelerator for changes in corporate and investor behavior that were already underway. Many banks have begun to develop a better understanding of some of the sustainability-related risks embedded in their loan and investment portfolios, as well as the opportunities presented by sustainable loans and investments. It is critical that banks not only understand those risks, but more importantly the opportunities associated with a transition to a low carbon economy.
  • There are several tools available to banks to encourage sustainability improvements among their clients and to reduce the negative ESG impacts of their own operations and investments. This includes but is not limited to green loans with favorable interest rates and sustainability-related covenants, green and social impact bonds, and various sustainable investment vehicles on the capital markets side.

2-How can banks transform their lending process and value chain for sustainability?

  • Banks must first understand the extent of “materiality” of ESG factors within their loan and investment portfolios. Not all ESG factors are material or relevant for all sectors, at least not to the same extent. Step #1 is therefore an understanding of the materiality of ESG factors in different sectors of the economy. There are several tools available that can help banks conduct this type of analysis, including materiality assessments from the Value Reporting Foundation (newly merged with the IFRS Foundation into the International Sustainability Standards Board or ISSB).
  • Next, banks should develop a framework to identify the material risks within individual loans and investments. Interest rates and loan covenants should be adjusted whenever feasible to reflect those risks and to incentivize borrowers to identify the risks and opportunities facing their own businesses and assets.
  • Banks should also develop knowledge and expertise to map out opportunities associated with the transition to a low carbon economy. The magnitude and speed of investments in this energy transition is unprecedented in modern times.

3-What are the risks facing green and sustainable finance over the coming years?

  • Climate risk has distinctive characteristics that mean it needs to be considered and managed differently
    1. Far-reaching impact in breadth and magnitude
    2. Foreseeable nature
    3. Irreversibility
    4. Dependency on short-term actions
  • Such complexity illustrates the challenges the world faces in dealing with climate change in the short, medium, and long-term.
    • These challenges naturally create risks, including some of the following:
      1. Policy risks related to ongoing subsidies for fossil fuels.
      2. Uneven global carbon prices (ranging from less than $1 in some developing economies to over $150 in some Scandinavian countries).
      3. Uncertainty about the evolution of carbon pricing schemes and the different sectors covered by such policies in different countries, as well as the likely imposition of carbon border adjustment mechanisms by the EU and other countries within the next two years.
      4. Uncertainty about incentive systems for renewable energy.
      5. Technological challenges related to the energy transition.
      6. Greenwashing and misrepresentation of sustainable business activities.

4-What is the bank’s role in the global climate transition and why is achieving “Net Zero” important for banks?

  • Achieving net zero is inevitable if the world is to have a chance to meet the ambitions of the Paris Agreement to limit global warming to “well-below” 2 degrees Celsius relative to the pre-industrial average global temperature. Failure to do so is certain to result in ruinous natural disasters, crop failures, involuntary migration, health crises (including viruses similar to covid-19 as well as the spread of tropical diseases) and economic destruction at a scale beyond any costs associated with the energy transition.
  • Achieving net zero is also rapidly becoming a competitive imperative, with banks failing to position themselves for the energy transition likely to find themselves lagging their peers and losing out on business opportunities. It is critical that banks not only formulate a net-zero strategy but also understand what that entails and map out a credible path towards achieving that target, including short and medium-term milestones.
  • The bank’s role is to identify risks and opportunities not only in mitigating climate change but also in climate adaptation. We know that even if we stop emitting greenhouse gases tomorrow, the climate will continue to warm for decades to come because carbon dioxide stays in the atmosphere for anywhere between twenty and one hundred years. Therefore, the world will need massive investments in adapting to the damage done by the changing climate, both the acute type (violent storms, wildfires, droughts, floods, etc) and the chronic (rising sea levels, falling crop yields, stressed coral reefs and marine ecosystems, loss of biodiversity, etc). Investment opportunities in adaptation technologies are therefore no less important than those in mitigation technologies (renewable energy, electric vehicles, carbon capture and storage, mineral extraction, smart grids, etc).

5-What are the pressures that banks that are not active or unable to cope with ESG requirements will face?

  • Climate change is a unique issue that is existential, global, and transformative. Broadly speaking, there are two risk channels by which climate change can manifest itself:
    1. Regulatory and transition risks of climate change could lead to a rapid shift in energy usage and a re-pricing of carbon-intensive assets
    2. Climate change has the potential to lead to physical impacts that, through real losses and damage, can cause financial losses significant enough to propagate contagion and cripple the global economy.
  • Climate risk has distinctive characteristics that mean it needs to be considered and managed differently:
    1. Far-reaching impact in breadth and magnitude
    2. Foreseeable nature
    3. Irreversibility
    4. Dependency on short-term actions
  • Any bank or organization that fails to understand the implications of climate change is therefore likely to find itself facing unpriced and unanticipated risks and missing out on the growth drivers of the economy for the foreseeable future.
  • Furthermore, banks that fail to take action on ESG are certain to face regulatory problems. As the Network for Greening the Financial System (NGFS) -of which the Central Bank of Egypt is a signatory- stated in a recent report: “Climate-related risks are a source of financial risk. It is therefore within the mandates of central banks and supervisors to ensure the financial system is resilient to these risks.”
  • Banks may also lose business opportunities as businesses, investors, and consumers become increasingly aware of the sustainability stance of entities they do business with.

6-What is the significance of signing the “UN Responsible Banking Principles” ? what is the progress made by banks that have signed the principles?

  • Signing the Principles for Responsible Banking sends a strong signal that a bank understands the challenges and opportunities related to sustainability and is prepared to integrate and embed sustainability across its operations and investments.
  • As a note of caution, a bank should conduct its due diligence before embarking on this step as it is not merely a symbolic act.

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