The writer is a Public Voices fellow of the OpEd Project and the Yale Program on Climate Change Communication
Four powerful men leading the largest technology companies in the world sat before Congress last month for a six-hour grilling on how they chased and protected their dominance. In a not-so-distant future, a similar hearing could be held with the heads of insurance companies about how much they knew about climate change, and how little they did to encourage solutions.
Insurers need not bear such a heavy burden alone, but they should set an example for carbon mitigation. And it need not to be financially burdensome. Tweaks to existing financial instruments can have a big impact. Take bond covenants — financial tools used by lenders to place additional terms upon borrowers. While they typically address financial matters, there is nothing to say they must. Why not use them as a climate change mitigation tool?
In fact, there is already an example of this. Last year the Italian utility company Enel issued the first general-purpose, SDG-linked bond. In plain language, this means the company issued a bond for its ordinary financing needs (not specific to any one project) that was linked to Enel’s goal to promote the UN Sustainable Development Goals.
The bond received $4bn in orders for a $1.5bn issue, 70 per cent of which was allocated to investors focused on environmental, social and governance issues. The covenants linked the coupon to the goal of making 55 per cent of the energy company’s overall installed capacity renewable by the end of 2021. If that target is not met (as reported by an independent auditor), the interest on the bond increases by 25 basis points.
The UN welcomed the first SDG-linked bond of its kind. Some bankers ventured that it could become the new industry standard. So far, no one has followed suit. But given that we are in the midst of a pandemic, it is too early to say that this format will fail.
One place this new goal-linked covenant should be used is in catastrophe bonds. Cat bonds are, in effect, insurance policies against climate change, purchased by governments, insurance and reinsurance companies. If a natural disaster happens, the proceeds are paid to the borrower and the interest payments are cancelled, along with the principal. If there is no natural disaster, the borrower pays the interest and principal as scheduled, as with regular bonds.
Catastrophe bonds have become more popular as the cost and frequency of climate disasters increase. According to the insurance broker Aon there were 409 natural disasters in 2019, totalling losses of $232bn, of which only $71bn were insured. Cat bonds are the only source of disaster protection for the reinsurance industry and are gaining interest from sovereign issuers as more and more developing countries face mounting climate-related costs.
Reinsurer Swiss Re estimates that while advanced economies have 35 per cent of their estimated catastrophe risks covered, for emerging economies that figure is just 6 per cent. This is a market with huge needs to be satisfied. As demand for cat bonds grows, so too should the requirements on issuers. Insurance companies buying this type of protection know better than anyone how large the economic and human costs of future disasters will be. They should demonstrate leadership in mitigating risks.
ESG investors should embrace this format as they did with Enel’s SDG-linked bond. Their goals would be satisfied by requiring a reduction in the carbon footprint as a prerequisite for the issuer’s eligibility to receive the disaster funds triggered by catastrophe.
The terms are up for negotiation. It could be that the issuer does not have the principal cancelled if it fails to meet the target. How much carbon footprint reduction is reasonable to demand is also up for debate. Such details are, of course, not trivial. But it is time to let the negotiations begin.
