What are resilience bonds and how can they protect us against climate crises?
24 July 2020
Felipe Larrain Bascunan, Dominic Molloy and Berend Sauer
These smart financial decisions will make the world better prepared for extreme weather
In the coming decades, climate shocks are set to become the norm. Despite international recognition that both mitigation and adaptation efforts are essential, adaptation funding remains a far smaller portion of total climate finance.Despite international recognition that both mitigation and adaptation efforts are essential, adaptation funding remains a far smaller portion of total climate finance. UNEP estimate that by 2030, adaptation needs could reach $300bn per year in developing countries, while the Climate Policy Initiative found that adaptation finance flows measured in 2018 reached only $30bn. The COVID-19 pandemic, along with the economic recession, are putting huge financial strains on the ability of countries to respond to the climate crisis. As a result, governments are searching for new ways to unlock development and increase resilience to exogenous shocks. One way of enabling this is an innovative financial instrument: the resilience bond.
Why invest in resilience?
Accelerating climate change adaptation is desirable from multiple perspectives. The human imperative is to address existing climate-related inequities, as the crisis disproportionately impacts vulnerable countries. The environmental challenge is to protect the ecosphere. In addition to the human and environmental imperatives, there is also a strong economic rationale. TheGlobal Commission on Adaptationfound that the overall rate of return on investments in improved resilience is very high, with benefit-cost ratios ranging from 2:1 to 10:1. Specifically, the research shows that investing $1.8 trillion globally from 2020 to 2030 could generate $7.1 trillion in total net benefits. Thus, there is a strong economic argument to be made for financing climate resilience.
What are resilience bonds?
In its simplest form, a bond is a type of a loan. The “borrower” borrows money from the “bondholder” and must repay the loan sum and interest on an agreed-upon schedule. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations.Resilience bonds, a sub-set of green bonds, seek to raise capital specifically for climate resilient investment. These investments improve the ability of assets and systems to persist, adapt and/or transform in a timely, efficient, and fair manner that reduces climate risk, avoids maladaptation, and unlocks broader development benefits. The green bond market has grown rapidly since firm standards and certifications were established, increasing from $37bn in 2014 to $257.7bn in 2019 (Figure 1), and is expected to rise to $350bn in 2020. To date these have been mostly focused on mitigation rather than adaptation related investments, partly due to a lack of a common definitions and taxonomies for adaptation. In 2019, the Climate Bonds Initiative launched theResilience Bond Principles, highlighting an opportunity for the creation of a new resilience bond market.
Resilience bond pioneer
The European Bank for Reconstruction and Development (EBRD)launchedthe first ever dedicated resilience bond in 2019, which received a AAA rating and raised US$700 million. The capital was assembled from commercial banks, central banks, and insurance companies, with the purpose of increasing resilience of assets. One such project is Tajikistan’s Qairokkum hydropower plant (QHPP). A $196 million financing package organized by the EBRD is helping to complete the climate-resilient rehabilitation and modernization of QHPP, enabling the plant to cope with the expected impacts of climate change on Tajikistan’s hydrological systems, and improving the country’s electricity supply. Even though the EBRD experience is the first of its kind, others are taking note.
Future of resilience bonds
In the context of the COVID-19 crisis, the International Monetary Fund has downgraded global growth forecast to -4.9% for 2020. Governments and central banks have already announced $10-20 trillion of fiscal stimulus to bolster economies. As a result of these injections, some countries are facing serious public debt challenges and balance of payment problems. Taking these into consideration, resilience bonds will not be appropriate across the board, given that for some countries additional debt may not be an advisable strategy. For others, bonds can offer a much-needed way to leverage finance for resilience aims. Green bonds are often oversubscribed, meaning demand for them exceeds supply, which can in some cases lead to improved interest rates for issuers. In 2019 Chilelaunchedits first sovereign green bond –the first of its kind in the Americas– dedicated to energy efficiency, water management and green buildings; it met record demand from global markets at a historically low yield for the country (2.571% for the 12-year bond and 3.275% for the 30 year-bond).
Even though the resilience bond evidence base is nascent,international institutions and national and regional governments are showing an increased appetite for investing in climate adaptation. The State of California is drawing upplansto launch a resilience bond for drought preparation and wildfire prevention. As the planet continues to warm, stakeholders need to find new and innovative solutions to address the climate crisis. Green and resilience bonds are going to play a progressively important role in future bond markets. More research into resilience bonds, and their application in practice, is essential to facilitate an effective upscaling of their use, to help deepen and broaden resilience investment in climate-vulnerable countries. The GCA is collaborating with partners to undertake this work, with new guidance and research products planned for launch in early 2021.
The ideas presented in this article aim to inspire adaptation action – they are the views of the author and do not necessarily reflect those of the Global Center on Adaptation.
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