Sustainable Finance: Climate Risk, Capital Planning & Product Innovation

As investors and financial institutions recognise the need to address the danger of climate change, financial leaders today are increasingly interested in exploring sustainable finance, investigating how to connect climate risks and financial opportunities.

A sustainable finance framework provides the foundation for integrating ESG goals with financial returns, ensuring a consistent approach across risk management, reporting, and product development.

For many, however, the challenge lies in navigating the complexities of climate risk and its impact on investments, while also meeting the increasing demand for environmentally and socially responsible financial products.

In this article, we examine the topic of sustainable finance, particularly how climate risk, capital planning, and product innovation are transforming the financial industry today.

Sustainable finance has evolved rapidly over the past decade and is still gaining momentum across global jurisdictions.

Despite regulatory disagreements over its relevance in the financial market today, it remains a clear channel for responsible investment and long-term profit.

As a financial leader, you are likely aware that sustainable finance is no longer a niche market, but a growing avenue for proactive opportunities to action on climate change and make profits while doing it.

With a focus on products and services that consider environmental, social, and governance (ESG) factors, an attractive market like the EU - under the New Green Deal adopted in 2019 - successfully managed ESG assets of about €6.6 trillion (or 38% of total assets under management in the EU) in 2024, compared to €6.2 trillion by the end of 2023.

As this growth is expected to reach €9.4 trillion by the year 2027, it underscores that EU sustainable finance is not only efficient but also remains increasingly attractive to investors over time.

With that said, keep in mind that a successful sustainable finance market should embed the following aspects:

• ESG integration - Incorporating environmental, social, and governance factors into decisions.
• Climate risk management - Assessing and mitigating the financial impacts of climate change.
• Sustainable products - Considering green bonds, green lending products, and other innovative financial instruments.
• Impact investing - Targeting investments that aim to generate both financial returns and positive social or environmental impacts.
• Regulatory frameworks - Aligning with guidelines and standards for sustainable finance practices.

These aspects are essential to implement to ensure that your investments are protected from traditional and emerging risks like physical climate risks, and perform well under an environmentally and socially sensitive market.

Despite the growth of sustainable finance, there are still significant innovation gaps in green lending and securities.

You should know that while green lending products and green bonds are becoming increasingly popular, there is still a need for multiple efforts to develop efficient and standardised products.

Green bonds and sustainable finance tools are gaining investor attention, but gaps in standardisation and transparency continue to hold back market maturity.

Innovation in green lending and securities should emphasise:

• Standardisation - Developing and upgrading common standards and frameworks for green lending and securities.

  An example is the International Capital Market Association's (ICMA) Green Bond Principles, which provide a widely adopted framework for green bond issuances.

• Product diversification - Creating a wider range of green financial products and services, such as green bonds, sustainability-linked loans, and green mortgages.
• Technology integration - Leveraging more fintech and digital platforms to enhance green finance.

  For example, Goldman Sachs has utilised its digital platforms, GS DAP, to launch tokenised bond issuances, including the Hong Kong tokenised green bond issuance. This serves today to increase the efficiency and transparency in Hong Kong's green finance.

• Investor education - Increasing awareness and understanding of green finance among investors.

As climate change is profoundly impacting capital flows, you need to take into account the shifting landscape of capital flows and how they are affecting your investments and business decisions.

A study by the Global Center on Adaptation has revealed that investing in climate adaptation can potentially generate $7 trillion in the global economy by 2030.

Consequently, this could unlock new opportunities for economic growth and investment.

To meet global infrastructure resilience needs by 2030, the OECD have projected a significant annual investment requirement of about $6.9 trillion on average.

With growing climate risks, you should be prepared to address the potential investment gap by exploring new financing solutions and partnerships to adapt your future investments.

Some key trends in capital flows related to climate change cover:

• Climate risk management: Involves assessing and mitigating climate risks in investment portfolios. You can protect your investments and make informed decisions that drive long-term value.
• Climate-resilient infrastructure: focuses on investing in infrastructure that is resilient to climate-related risks. You can capitalise on the growing demand for climate-resilient infrastructure, ensure a stable source of returns and meet your investment goals.
• Sustainable infrastructure finance: Involves developing innovative financing solutions for sustainable infrastructure projects. You can tap into a growing market and provide financing for projects that align with your values and goals.

Adaptation finance, more popular in emerging and developing markets, is rapidly growing as a channel for positive climate finance flow, as it presents significant opportunities for financial leaders like you to promote and achieve climate-related financial resilience.

It is worth reminding that investing in areas such as climate-resilient infrastructure and other adaptation projects can generate returns while also contributing to a more sustainable future.

The World Bank found that every dollar injected in climate-resilient infrastructure can produce returns of up to $4 in low and middle income countries alone.

Furthermore, the bank estimates that investing in resilient infrastructure can yield significant savings of $4.2 trillion over the new infrastructure's lifetime.

It is from this perspective that BNP Paribas highlights that capital markets have the potential to drive resilient infrastructure investment, which will benefit corporate and public sector issuers, underscoring the urgent need for resilient infrastructure.

The financial leaders we work with, including Triodos Bank, experience positive impact and build resilience when implementing adaptation measures like integrating climate risk data into credit decisioning to minimise risk taking, significant loss from mortgage defaults, and to meet regulatory requirements.

Climate X CEO Lukky Ahmed affirms that "Our relationship with Triodos Bank underscores the power of data not just as a tool for compliance, but as a catalyst for transforming what is possible in finance. With the power of Spectra’s predictive hazard and financial risk models, Triodos Bank is enhancing its regulatory readiness while empowering its SME clients to make smarter, data-backed decisions.

This approach not only drives regulatory excellence but also contributes to a more resilient economy and a more sustainable future".

Here are the key benefits of adaptation finance:

• Enhance your portfolio diversification: Through adaptation finance, you can reduce your portfolio's reliance on traditional assets and increase potential returns, helping you achieve your investment goals.
• Protection of your investments: Adaptation finance can help mitigate risks associated with climate-related disasters, protecting your investments and reducing potential losses.
• Long-term returns: It can equally generate stable, long-term returns, providing a predictable source of income to support your business or investment strategy.
• Access to growing market: Through adaptation finance, you can access the growing demand for climate-resilient infrastructure.
• Reputation and brand enhancement: It can help enhance your reputation and brand by demonstrating your commitment to sustainability and climate resilience.

Scenario-based lending is a critical aspect of sustainable finance, and there are various climate financial risk tools and frameworks available to support this approach.

Using scenario-based analysis can help you better assess the potential climate risks and opportunities linked with your lending decisions.

These tools include climate scenario analysis, risk assessment frameworks, data analytics, and stress testing.

Banks that leveraged scenario-based lending tools from Climate X used our granular and science-backed data and tailored assumptions to project their potential assets exposure until 2100. With access to asset-level analysis of over 80 data points, they relied on our explainable and quantitative approach to make decisions with confidence.

Here are important points to consider when using these tools:

• Integrate climate scenarios into credit risk assessment: You can use scenario-based tools to assess the potential impact of different climate scenarios on your borrowers' creditworthiness.
• Use climate scenario analysis to inform loan pricing: Using scenario-based tools can help you assess the potential impact of climate-related risks on your loan portfolio and adjust your loan pricing accordingly.
• Develop climate-resilient loan products: You can use scenario-based tools to develop loan products that are tailored to the specific needs of your borrowers in a changing climate. For instance, you could develop loans that incentivise borrowers to invest in climate-resilient infrastructure or sustainable practices.
• Monitor and report on climate-related risks: You can also use scenario-based tools to monitor and report on climate-related risks in your loan portfolio. This is helpful to spot potential issues early and take steps to mitigate them, reducing the risk of losses and reputational damage.

Greenwashing generally refers to the practice of making false or misleading claims about the environmental benefits or sustainability of a product, service, or investment.

This can be particularly problematic in the context of adaptation finance, where investors and stakeholders are increasingly looking for ways to support climate-resilient projects and initiatives.

Regulators, including the European Securities and Markets Authority (ESMA), have taken proactive steps, such as developing a framework around the concept of sustainability in the EU Taxonomy and SFDR, to align market conditions with appropriate sustainable practices and continue to monitor greenwashing risks.

Here is what you should consider to avoid greenwashing sustainable finance are:

• Ensure transparency and accuracy in your communications: Be clear and honest about the environmental benefits and risks associated with your adaptation finance initiatives.
• Use credible and recognised standards and certifications: Consider using established standards and certifications, such as ICMA's Green Bond Principles or the Climate Bond Standard, to demonstrate the environmental credentials of your initiatives.
• Provide regular and detailed reporting: Regularly report on the progress and impact of your adaptation finance initiatives, including any challenges or setbacks. It is equally crucial to follow reporting frameworks and/or standards that apply to your organisation, such as the Omnibus package (EU) or ISSB's IFRS1 and S2 (Global).
• Engage with stakeholders and respond to concerns: Encourage feedback and concerns from stakeholders, and respond promptly and transparently to any allegations of greenwashing.

Focusing on climate-aligned finance is rewarding for both the investment community and the environment.

The chemistry between climate resilience and long-term value blends well.

However, it is essential to continue to integrate climate considerations into your investment decisions and business strategies. This is going to be determinant to the durability and profitability of your current and future investments.

Sustainable finance trends show a clear shift toward adaptation investments, resilience-linked products, and climate-aligned metrics becoming mainstream across major portfolios

As financial leaders, you have opportunities and the power to act on through:

• Innovation: Developing new financial products and services that support climate-aligned finance.
• Collaboration: Working with stakeholders to develop and upgrade industry-wide standards and best practices for climate-aligned finance.
• Education: Increasing awareness and understanding of climate-aligned finance among investors and financial professionals.
• Leadership: Taking a leadership role in promoting climate-aligned finance and showcasing its long-term benefits.

After looking at how climate risk, capital planning, and product innovation are transforming the financial industry, we can conclude that there is not a one-size-fits-all solution to address the challenges of climate risks and at the same time aligning to sustainable finance market principles.

However, the tools and frameworks discussed can help better assess, understand, and manage climate risks and opportunities linked with green investments.

To take your sustainable finance initiatives to the next level, consider:

• Innovating new financial products and services
• Collaborating with stakeholders
• Educating investors and professionals in your circle
• Taking a leadership role in promoting climate-aligned finance

Such undertaking can drive long-term value and profitability while contributing to a more sustainable future. If you're looking to learn more, watch our free webinar below.