Aligning financial flows with sustainability goals: The case for sovereign climate and nature reporting

The Paris Agreement states that addressing climate change will require "making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development." Policymakers, scientists, and investors recognize that the global economy must evolve to a more sustainable model that reduces its impact on the Earth, adapts to the changes already locked in, and contributes to carbon sequestration, as well as restoring and reconnecting degraded and fragmented ecosystems. But a strategy that aligns global financial flows with these goals is still needed. Investors will play an important role in driving this alignment through the tools of capital allocation and engagement.

Sustainability reporting can play a central role in driving capital to sustainable investments and away from environmentally harmful ones. Progress has been made on corporate climate and nature reporting, but a significant information gap remains for sovereign entities, whose capital-raising activities are not presently considered in existing climate- and nature-related disclosure frameworks. Sovereign bonds make up almost 40% of the US$100 trillion global bond market. Yet, international sustainability reporting frameworks under development do not cover public sector investments, issuance of sovereign and sub-sovereign bonds, investments of public pension funds, or international development finance.

Sustainability reporting is moving quickly, and sovereigns must not be left behind. Understanding and disclosing climate- and nature-related physical and transition risks - as well as opportunities for priority investments in adaptation and transition activities - is essential for sovereigns seeking to address vulnerabilities and avoid unsustainable debt burdens. Both climate change and ecosystem loss have a material impact on sovereign risk through direct and indirect effects on public finances. This raises the cost of capital of climate-vulnerable countries and threatens debt sustainability.

A new report by the World Bank, 'Sovereign Climate and Nature Reporting: Proposal for a Risks and Opportunities Disclosure Framework,' calls for a such a framework and lays out initial ideas for what it might look like. This framework could assist sovereigns looking to attract investment by enabling them to produce comprehensive, regular, standardized, and eventually, forward-looking disclosure of their climate- and nature-related risks and opportunities. Sovereign reporting would help meet the needs of investors who are increasingly requesting such disclosures for all asset classes in their portfolios, so that they can measure portfolio alignment with the Paris Agreement.

Sovereign reporting needs its own approach and framework. A customized approach suited to the specifics of sovereign reporting is recommended. This could build on the core elements and underlying principles of existing corporate-focused frameworks - such as the Taskforce for Climate-related Financial Disclosure (TCFD). Other frameworks, such as context-based performance accounting and reporting frameworks and environmental-economic approaches could also be drawn upon (e.g. the UN System for Environmental Economic Accounting (SEEA) framework). Annex A to the report presents a draft example of a Sovereign Climate and Nature Risk and Opportunities Reporting Framework, as a starting point for discussion (noting that it is not intended as a fully developed template or blueprint).

Estimates of the value of a country's natural assets would be a critical component of sovereign climate and nature reporting. In addition to reporting on climate-related criteria, there is a strong case for sovereigns to disclose nature-related criteria. A country's natural assets are critical to its economic growth and stability, and therefore, should be accounted for and appropriately managed. The interaction between climate change and natural assets is increasingly relevant for sovereign bond investors, as the climate and biodiversity crises advance, create feedback loops, and reduce overall resilience. Natural capital accounting can be a tool that countries use to better measure their natural assets and integrate them into national planning and development decisions.

The 'materiality' of various climate and nature-related criteria must be assessed to ensure the framework best enables effective capital allocation and engagement by investors. Climate change is material because it is potentially a significant factor for a sovereign's future financial and economic health. Some investors may consider both financial and sustainability materiality in determining relevant factors for their investment decision-making (double materiality), and they may consider these factors along a spectrum that is shifting (dynamic materiality). A double materiality and context-based reporting approach that uses a dynamic materiality lens could be considered for a sovereign climate and nature reporting framework.

Managing potential unintended consequences, including capital flight from emerging markets highly exposed to climate and nature risk, is essential to wide adoption of a Sovereign Climate and Nature Reporting Framework. Emerging evidence shows that climate-related risks are already influencing the cost of capital, as evidenced by sovereign bond spreads. Financial markets now have much better access to information on climate risks than on the actions countries have taken to mitigate and manage these risks through investment in adaptation and resilience. A deeper and more common understanding of both physical and transition risks related to climate and nature would ideally result in better policy outcomes and more effective pricing signals from the market. Climate and nature reporting can enable sovereigns to articulate their approach to managing relevant risks and give them greater ownership of the risk narrative presented to investors.

The authors invite the International Public Sector Accounting Standards Board (IPSASB)-the public sector partner of the International Financial Reporting Standards (IFRS) Foundation, which is working on corporate sustainability reporting - to lead a consultative process to gain support for developing a framework for the public sector based on this concept. In parallel, World Bank teams will look for opportunities to start to pilot and test reporting approaches through country-level engagements.

Topics

Climate Change

Environment

Financial Sector

Regions

The World Region