Capturing adaptation opportunities

By Anne Arvola and Juho Uusihakala, Finnfund; Mikko Halonen, Gaia Consulting Oy; and Linda Rosengren, Natural Resources Institute Finland

The article has originally been published in The catalytic effects of DFI investment – gender equality, climate action and the harmonisation of impact standards by ODI.

Abstract

The Intergovernmental Panel on Climate Change (IPCC) definition of climate adaptation highlights two dimensions of adaptation: avoiding harm as well as exploiting beneficial opportunities. However, to date, private sector approaches to adaptation finance have been dominated by the avoidance of harm and management of risk with less attention being paid to capturing opportunities. We argue that capturing the ‘upside’ of adaptation can (1) boost resilience and (2) mobilise private sector expertise and finance for adaptation activities.

In this article we describe the approach Finnfund has been developing to capture both dimensions of climate adaptation in its investment process. In the future, the approach will benefit from rigorous practical testing and sharing experiences with peer organisations. For now, however, it is hoped that the approach will bring methodological clarity and enhanced understanding on how to increase adaptation finance, especially for adaptation opportunities.

Introduction

Impacts of climate change are creating new challenges for both people and ecosystems (Ripple et al., 2019). While waiting for countries to submit new and updated national climate plans (called the nationally determined contributions) ahead of the COP26 climate negotiations of the United Nations Framework Convention on Climate Change (UNFCCC), it is clear that the current mitigation pledges are inadequate to meet the targets set in the Paris Agreement (Jeffery et al., 2018). Even if the ambitious target of limiting global temperature increase to 1.5°C is achieved, we are bound to live with the impacts of ongoing climate change. This results in an increased need for climate adaptation efforts.

In 2018, annual climate finance stood at nearly $600 billion (CPI, 2019). However, a great majority of the climate finance has been directed to mitigation efforts and only 5%, approximately $30 billion, was directed to adaptation (CPI, 2019). The United Nations estimates that by 2030, the global climate change adaptation costs may range from a staggering $140 billion to $300 billion per annum and could rise to between $280 billion and $500 billion per annum by 2050 (UNFCCC, 2019).

To close the adaptation finance gap, the role of the private sector will become increasingly important. The billion-dollar question now is, how to increase private sector financing for adaptation and resilience building?

Investing in adaptation is good business

The case for longer-term profitability of adaptation is compelling. In its 2019 report, the Global Commission on Adaptation notes that the overall rate of return on investments in adaptation financing leading to improved resilience is very high: investing $1.8 trillion globally in five key adaptation areas (from 2020 to 2030) could generate $7.1 trillion in total net benefits, its, through a combination of avoided losses and environmental, social and economic benefits1 (Global Commission on Adaptation, 2019).

In addition to the net benefits and necessity to survive, there is another, more positive side to climate change adaptation that is not sufficiently explored. Shocks bring out weaknesses and vulnerabilities that reveal needs for improvement. But there is scientific evidence that shocks and crises can also lead to more risk-mitigating innovations such as improvements in, for example, governance and management systems, and can facilitate invention and adoption of new technology (Miao and Popp, 2014). In this way climate change can be a driver for innovative solutions and business models.

Common definitions and rules to facilitate financing

To increase adaptation financing from the private sector, it is essential to better define what constitutes adaptation finance. In addition to the IPCC definition of adaptation to encompass avoidance of harm and/or exploring opportunities, the EU Taxonomy for Sustainable Finance defines two different types of economic activities that contribute to adaptation (EU, 2019):

1. economic activities that make substantial contribution based on their own performance (adapted activities)
2. economic activities that by provision of their products or services enable substantial contributions to be made in other activities (adaptation enabling activities or systemic
   adaptation).

In other words, adapted activities aim at strengthening an asset or economic activity to withstand identified physical climate risk over its lifetime. Adaptation-enabling activities aim to reduce vulnerability and build resilience of a wider system or systems such as a community, ecosystem or city. A key characteristic to adaptation is that it is context and location specific. Therefore, it is not possible to produce stand-alone, exhaustive lists of activities that could be considered adaptation finance. Instead, there is a need to develop a process-based approach to determine if an activity is itself adaption or adaptation-enabling and contributes to wider system-level climate resilience.

The Finnfund approach for managing climate risks and building resilience

Finnfund, Finland’s DFI, with the help of the authors of this essay, has been developing an approach that would identify private-sector investments with potential climate risks and/or opportunities for creating resilience benefits from very early stages of the investment process. When seeking first approval – Clearance in Principle (CIP) – to prepare an investment, the adaptation assessment would begin with a context- and sector-specific climate risk assessment using common online risk assessment tools, such as ThinkHazard2 or ND-GAIN.3 The risk assessment is followed by an assessment that screens whether the economic activity (or part of it) has the potential to increase adaptive capacity in the company or in its operating environment, thereby bringing resilience benefits. In the first phase his assessment would be done with the help of general typologies or lists such as those presented in the EU Taxonomy Technical Annex.

In the case that climate risks – and therefore adaptation need and potential – are identified, and a CIP is obtained, a more thorough assessment will be conducted during the due diligence phase. This would entail a more detailed and location-specific climate risk assessment typically conducted by a specialised consultancy. In addition, some primary data collection from local stakeholders may be necessary to understand if and how they experience the climate change impacts. This more detailed assessment is followed by an analysis of the company’s capacity to adapt and respond to the identified climate risk. In the case that shortcomings are detected, further requirements and support could be agreed upon before the investment decision or could be included in the Environmental and Social Management Action Plan.

In the case that economic activity is anticipated to create resilience benefits for the company, its stakeholders or wider community, it is necessary to understand how exactly these benefits are created. In defining this, during due diligence it would be useful to explore the five impact dimensions as introduced by the Impact Management Project:4 What is the economic activity and how is it building adaptation? Who will benefit from the good/service? How many are they and how much will they benefit? What would happen otherwise and what are the risks? Obtaining data on the above questions will provide a useful baseline against which progress in adaptation can be monitored and documented.

Forest First Columbia case study: combined mitigation and adaptation

Forest First Colombia is a forest plantation company operating in remote areas of Eastern Colombia, by the Meta River in Vichada Province. The company establishes fast growing, sustainable tree plantations to produce low-cost wood fibre.

The climate risk assessment for Vichada forecasts increased flooding, wildfires and extreme heat; these risks are already an everyday challenge to Forest First and the surrounding communities. However, an in-depth analysis revealed that the Forest First core business and their forest management practices contribute not only to climate change mitigation via afforestation but also to climate change adaptation.

One of the main livelihoods in Vichada has been extensive cattle grazing. For decades, grasslands have been burnt frequently to renew grass in the cattle pastures. Frequent burnings have changed soil properties and created a hard cover on the topsoil, a so-called ‘crust’, which deteriorates soil water-absorption capacity and further increases flooding. Burnings may also escape and cause significant harm as wildfires, and heat waves make the wildfires even more intense than before.

Tree plantation establishment requires soil preparation, which helps to revert soil properties and improves water absorption. Furthermore, Forest First plays a key role in managing fires in their operational areas, to protect not only their plantations but also nearby communities and the unique, protected ‘Morichal’ river gallery forests.

A more detailed assessment of adaptation needs and responses will be conducted at a later stage, possibly using the tech-enabled survey methods that have been successfully used in gender- lens investing.

Conclusion

The Association of European Development Finance Institutions (EDFI) Statement on Climate and Energy Finance calls for the development of practical guidance and initiatives for increasing financing for adaptation and resilience to climate change, particularly reducing vulnerabilities of communities and natural ecosystems to climate impacts. Tools and skills for assessing and identifying feasible adaptation measures to manage physical climate risks within the private sector are rapidly increasing. The potential for capturing the opportunities of adaptation and resilience building remains, however, largely unexplored. This ‘upside’ of adaptation can be seen as a market opportunity. The capacity to define, monetise and monitor context-specific resilience benefits is still in its early stages and should be actively promoted. DFIs, with their track record of managing risks while creating impact, can play an important role in increasing financing for adaptation and in further developing tools for resilience building.

It is also expected that with the beneficial opportunities better identified, financing from private sector is likely to follow.

1) The five areas considered for the estimate included early warning systems, climate-resilient infrastructure, improved dryland agriculture crop production, global mangrove protection, and making water systems more resilient.
2) https://thinkhazard.org/en
3) https://gain.nd.edu
4) https://impactmanagementproject.com

References

CPI – Climate Policy Initiative (2019) Global landscape of climate finance 2019. London: CPI (www.climatepolicyinitiative.org/publication/global-landscape-of-climate-finance-2019/).

EU Technical Export Group on Sustainable Finance (2019) Financing a sustainable European economy. Taxonomy: technical report. EU (https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en).

Global Commission on Adaptation (2019) Adapt now: a global call for leadership on climate resilience. Washington, DC: World Resources Institute (http://hdl.handle.net/10986/32362).

Jeffery, M.L., Gütschow, J., Rocha, M.R. and Gieseke, R. (2018) ‘Measuring success: improving assessments of aggregate greenhouse gas emissions reduction goals’ Earth’s Future 6(9): 1260–1274 (https://doi.org/10.1029/2018EF000865).

Miao, Q. and Popp, D. (2014) ‘Necessity as the mother of invention: Innovative responses to natural disasters’ Journal of Environmental Economics and Management 68(2): 280–295 (https://doi.org/10.1016/j.jeem.2014.06.003).

Ripple, W., Wolf, C., Newsome, T. et al. (2019) ‘World scientists’ warning of a climate emergency’ Bioscience 70: 8–12 (https://doi.org/10.1093/biosci/biz088).

UNFCCC – United Nations Framework Convention on Climate Change (2019) 25 years of adaptation under the UNFCCC. Bonn: United Nations Climate Change Secretariat (https://unfccc.int/documents/204710).

The article has originally been published in The catalytic effects of DFI investment – gender equality, climate action and the harmonisation of impact standards by ODI.