Climate risk, resilience and adaptation

Explanation

Quality and scope of project level climate risk management procedures

To reflect climate and environmental sustainability concerns in projects, the EBRD has introduced a number of risk assessments for individual projects. Key assessments applied to all projects are:

• Environmental and Social due diligence, reflecting the provisions of the Environmental and Social Policy.
• Paris Agreement alignment assessment.
• Climate-related financial risk assessment.

Environmental and Social Policy (ESP): The latest ESP (still in draft stage at the time of publication) will include 10 Environmental and Social Policy Standards (ESPS). They outline the Bank’s protocols and procedures for managing climate, environmental, and social risks throughout its portfolio, and define the processes for monitoring and reporting. ESPS 1 is particularly significant as it details the requirements for borrowers concerning the assessment of environmental and social (E&S) risks, encompassing risks and impacts associated with natural hazards and climate change. Projects are categorised as A (highest risk), B or C. Depending on the risk rating, the client will have to develop and implement an Environmental and Social Management Plan (ESMP), with monitoring requirements proportional to the nature of the project and associated risks and impacts. The ESP’s Appendix includes a list of what constitutes category A projects: those resulting in potentially significant new and additional environmental and/or social impact and thereby requiring an ESMP. These include fossil-fuel-related infrastructure, large-scale seaports, waste processing infrastructure, large-scale primary agriculture, deforestation and logging. No such list is established for category B and C projects. For category B projects (with potential E&S impacts), the ESP states approaches will vary based on environmental and social impacts, leaving considerable room for interpretation to project teams. Notably, the Bank has developed a toolkit to support partner finance institutions (PFIs) in meeting the requirements of its E&S risk management procedures.

Paris Agreement alignment assessment: From 2023, all EBRD projects are required to be assessed and be determined Paris aligned prior to signing, based on the methodology the Bank has developed (and which is reviewed annually). This covers direct, indirect and other financial instruments used by EBRD. For direct investments, the assessment requires each project to meet four conditions to be deemed Paris aligned:

Mitigation-specific:

• consistency with long-term low-carbon development
• low likelihood of carbon lock-in.

Adaptation-specific:

• physical climate risks have been identified and addressed
• the project’s activities do not undermine climate resilience in the context in which it operates.

To assess projects against the climate mitigation conditions, a general screening against the Joint MDB Common principles for climate mitigation finance tracking and the EU Taxonomy “substantial contribution to climate mitigation” criteria is applied, whereby all projects that meet these criteria are deemed Paris aligned. All projects at or under EUR 5 million are also deemed Paris aligned, which is concerning considering such small projects (and especially if there are several) could still have a negative climate impact when implemented. If alignment is not confirmed in this initial screening, a “specific assessment” is undertaken to determine alignment, based on reviews of the project against Nationally Determined Contributions, Long-Term Strategies and low-carbon pathways, as well as a carbon lock-in test and an economic viability test using shadow carbon pricing if necessary. The guidelines make no reference to specific thresholds for determining “low” likelihood of carbon lock-in.

To assess against the adaptation conditions, the Bank establishes the climate risk and vulnerability context of a project to identify risks. If physical climate risks are material, it is determined what climate resilience measures need to be included in the project. An appraisal of the broader climate resilience context is undertaken to ensure the project does not contravene national policies for adaptation or climate resilience of the wider system.

Indirectly financed EBRD investments follow a different procedure, comprising four steps or “pillars”:

• Counterparty commitment to the Paris Agreement: counterparties are expected to be committed to aligning their financial flows to the Paris Agreement.
• Subtransactions filter: counterparties are required to meet minimum requirements to provide confidence that subtransactions will be Paris aligned, such as application of the Bank’s ESP and fossil fuel exclusions set out in the Energy Sector Strategy.
• Assessment to understand the counterparty’s climate-related business practices: counterparties are assessed on their approach to Paris alignment based on review of their current approaches relative to leading market and regulatory practices.
• Transition plan: a requirement for counterparties to disclose transition plans to highlight credible progress being made on Paris alignment, with progress being assessed against time-bound milestones. Transition plans must include a commitment to Paris alignment, near-term action to deliver on that commitment, and all actions taken as part of the plan. The EBRD will assist in the preparation of the transition plan, for example through the Corporate Climate Governance Facility, and will annually monitor the transition plan’s implementation.

This approach to counterparties’ Paris alignment represents best practice among MDBs, alongside other practices such as the European Investment Bank’s (EIB) PATH framework. However, the EBRD states that initially the assessment relies only on the first two pillars, with the latter two to be gradually applied. The EBRD states it expects the majority of intermediated transactions to be covered by all four pillars by 2027. Nonetheless, this timeline should be further clarified.

Climate-related financial risk assessment: In 2022, the EBRD introduced a climate-related risk screening methodology for PFIs to assess climate-related credit risks in direct finance projects. Through this, the Bank screens and assesses PFIs’ institutional level carbon transitions and physical climate risks by assessing their internal risk management and their exposure to climate risk through their loan portfolios. This screening process also considers a PFI’s primary country of operation and the EBRD’s longest financial exposure. This assessment enables the EBRD to monitor and manage PFIs’ financial exposure to climate risks and determine which PFIs require climate risk management assistance from the Bank.

With regard to climate risk-related disclosures, the EBRD has undertaken TCFD disclosure since 2018, the first MDB to have done so. Its level of reporting is comprehensive, reflecting best practice among peers.[1]

Adaptation finance and enhancing client climate resilience

Between 2019 and 2023, the EBRD has committed EUR 26 billion to Green Economy Transition (GET) financing (i.e. for climate action and environmental sustainability). Adaptation financing as a share of climate finance was low, standing at EUR 1.79 billion. The share of adaptation financing was consistently low year-on-year, at 5.6% in 2023, 3.8% in 2022, 4.7% in 2021, 13.3% in 2020 and 10.7% in 2019. There has similarly been no progress in terms of absolute amounts: 2023 commitments (EUR 370 million) were lower than those of 2019 and 2020 (EUR 495 and 424 million respectively). The EBRD has no specific target for adaptation as a percentage of total green spending. The EBRD should consider adopting such a target in light of the need to drastically increase adaptation financing in the local contexts in which the Bank operates.

The Bank argues that the low percentage is partly explained by its business model, which focuses on the private sector, where barriers and constraints continue to limit investments in adaptation, which therefore often remain publicly financed. As adaptation and resilience needs continue to grow due to the onset of climate impacts, EBRD may consider iterating its adaptation plan (see below) to bring it more in line with the scale and pace of action required. This could entail the Bank more proactively developing bankable adaptation or cross-cutting programmes and projects and advising its clients on options to integrate adaptation into their activities.  

In its Climate Adaptation Action Plan 2023–25, released at COP27 in 2022, the EBRD commits to actions to enhance the integration of climate adaptation into the market, including:

• Accelerated mainstreaming and policy integration: The EBRD will integrate climate resilience and adaptation diagnostics, policy roadmaps, and investment assessments into national and sectoral climate policy activities. Additionally, the EBRD will support countries in assessing vulnerabilities of critical infrastructure to climate change, enhance tools for city level adaptation, assess climate risks and assist corporate clients in understanding them, and promote gender angles in resilience efforts.
• Partnerships and capacity building for enhanced impact: This includes increased engagement with the climate finance community to develop approaches to adaptation finance and identify investment needs.
• Proactive business development and private sector mobilisation: The EBRD will increase adaptation investments through various instruments, prioritising projects that mobilise private sector participation and benefit nature and biodiversity. It will expand financial products like climate resilience bonds, support SMEs with climate adaptation technologies, prioritise critical infrastructure resilience, and enhance water and agricultural sector resilience with advanced practices and technologies.

The above workstreams are designed to build on the foundation of recent actions and initiatives by the Bank, strengthening and expanding on previous achievements. Examples of actions already undertaken include:

• The expansion of the range of innovative financial instruments for climate adaptation financing, most notably the launch of a dedicated Climate Resilience Bonds (CRBs) offering, the first of its kind among MDBs. The EBRD further published a Guide for issuers on Green Bonds for Climate Resilience in partnership with the Global Centre on Adaptation (GCA) and the Climate Bonds Initiative (CBI).
• Engagement with the financial sector to develop new approaches to adaptation financing, including with international investors’ networks (e.g., the Glasgow Alliance for Net Zero (GFANZ), Institutional Investors Group on Climate Change (IIGCC)) and impact investor communities (including through the Global Impact Investing Network (GIIN)).
• Enhancement of the EBRD’s Green Cities programme to better incorporate adaptation action at city level through dedicated climate resilience strategies.
• Signature of partnerships at COP27 in 2022 with the Global Center on Adaptation (GCA) and the African Development Bank (AfDB) to collaborate on accelerating climate adaptation action in North Africa across area of focus highlighted in the Africa Adaptation Acceleration Program (AAAP), including on infrastructure and innovative financial products.

Despite the commitments made, the Climate Adaptation Action Plan 2023–2025 falls short of committing to a climate adaptation finance target for the Bank’s operations, which again represents a missed opportunity.

The EBRD provides support with climate resilience to clients in the financial, subsovereign and corporate sectors through the flagship EBRD Corporate Climate Governance Facility. The facility supports clients in the development of transition plans which incorporate climate resilience considerations into management practices and investment decisions. To this end, it supports the identification of future physical climate risks and strengthens clients’ capacity to take adequate action to make assets, systems and supply chains more climate resilient.

Recommendations:

• The EBRD should establish a specific and stretching target for scaling up adaptation finance. This should consider and respond to the challenges in mobilising adaptation finance (especially private finance) in the Bank’s areas of operation, provide a clear rationale for its level, and include a series of actions the Bank will undertake to build demand for relevant projects and programmes. Any adaptation target should be complementary to the Bank’s climate finance target and avoid creating perverse incentives for limiting mitigation financing.
• The EBRD should clarify its timeline for the implementation of the third (counterparty assessment) and fourth (transition plans) pillars of its Paris alignment assessment for financial intermediaries through setting time-bound gradual targets to ensure prompt implementation. It should also ensure it is encouraging best practice and standardisation in transition planning in its engagement with counterparties, building on emergent international norms and standards.
• The EBRD should disclose how projects are categorised as “B” or “C” projects under the ESP E&S risk assessment procedure, and detail what approaches are adopted when dealing with “Category B” projects, so as to enhance transparency and accountability.
• The EBRD should reduce the threshold for exempting projects from the Paris alignment assessment to well below the current amount of EUR 5 million, and not exempt any projects in climate-sensitive sectors such as energy and infrastructure.

[1] For more information, see the “Transparency of climate finance” metric.