Stefen Shin cannot be said to lack confidence. The sharply dressed former investment banker, now a senior financial institutions relationship officer for the Asian Infrastructure Investment Bank, wants to create an entirely new way for asset owners to consider climate risk when they invest.

He says it's time to take a more holistic approach to the problem by working towards creating a benchmark tool for assessing bond issuers' overall climate risk. He also thinks AIIB can lead the way – and wants other asset owners to help out.

The $20 billion multilateral institution has the backing of its stakeholders too, to the extent that at the annual meeting of the UN Principles for Responsible Investment (UN PRI) in September it announced a plan to invest $500 million into a new portfolio of emerging market high-yield bonds issued by companies best positioned to weather global warming. 

“We all need to lower carbon intensity, plus businesses need to adapt to [be more resilient to] climate change, and thirdly we need to see how much of businesses are green. If you do those three things you will survive; if you don’t you’ll die,” Shin told AsianInvestor.

To do this, project manager Amundi was appointed to create a quantitative database and framework to assess how bond issuers mitigate the impact of their businesses on global warming and consider their physical vulnerability to major global warming. Applicable bonds must be rated at least BB+.

The project may sound like just a fancy twist on green bonds, but Shin insists it's far more ambitious.

“The capital market reaction has been to take baby steps [in responding to the danger of global warming] and introduce green bonds, but while that offers transparency on what that particular money is being used for, it doesn’t cover the transition or resilience of the business as a whole,” he said.

“Issuers like to say ‘I’m a really green company’ but they could have 90% of their business in fossil fuels and yet issue a green bond off the remaining 10%. Green bonds are fantastic for offering green transparency but they don’t provide a solid framework for assessing a whole business.”

Instead, AIIB wants the bond portfolio to assess the carbon exposure and physical vulnerability of the entire issuing organisation to a rise in global average temperatures of two or three degrees celsius. That level is important; the Paris Climate Agreement has set a global warming target of 1.5 degrees, but scientists believe it will rise by 2.5 degrees or more under the current commitments of signatories. 

Debra Tan, head of China Water Risk, a non-profit organisation that tracks water resources in the region, noted that this one degree difference could cause major differences in weather patterns, the severity of storms, water scarcity and the rise in ocean levels. Asia, in particular, has most of its major cities based on major water arteries or coasts.

"As things stand a temperature rise of 2.5 degrees or more is already baked in, but most companies are only making plans based on a rise of 1.5 or two degrees," Tan told AsianInvestor

Countries and companies that don't plan well could end up exposed to billions of dollars of damage, which would have very costly ramifications for investors, among others. 

BUILDING A CLIMATE PORTFOLIO

While it sounds sensible for investors and asset managers to be able to assess such risks, the data to do so doesn't currently exist in one place. In part, this is because there’s been little agreement on exactly what information to use, plus it is often patchy, especially in emerging markets.

“It’s been a chicken-and-egg situation, with nobody so far willing to spend the time and money to build this sort of database,” Shin said. 

So AIIB has decided to get the ball rolling, with Amundi's help. The French asset manager has a strong environmental, social and governance commitment and it has assigned a team of 20 people to scour environmental data sources to support AIIB's eventual portfolio and borrower climate risk rankings.

They intend to release a white paper detailing the portfolio of bonds and in a special conference in February or March 2020. Shin said AIIB would welcome criticism and feedback on the framework, to improve its methodology further.

The idea from there is to use the framework to encourage companies to improve their climate rankings. "If you are a CFO and have to fund yourself more expensively because investors say 'I like your company but you are not ready for climate change', it's a quantifiable risk," Shin said. 

Of course it will take more than a $500 million portfolio to ensure borrowers seek to improve their own climate risk scores and provide more data. So AIIB hopes that other asset owners will commit funds to the portfolio, to increase it to $1 billion or more. 

Is it likely? “We are hopeful,” Shin answered, noting the multilateral institution has spoken to 23 institutional investors around the world, and particularly sovereign wealth funds. Almost all have welcomed the idea.

"They have largely said 'it's a fantastic idea ... especially as it's not our role to develop capital markets'. We have had commitments from them to look at it. I'd consider them to be potential investors."

However, Shin admitted that some are sceptical about the scale of the task. “We had four different asset owners use the same word to describe it – they said it’s a ‘noble’ goal,” he said.

BUILDING A BENCHMARK

There is also the question of return: can a portfolio of bonds focused on long-term impact of global warming really demonstrate superior returns after just one year?

Shin admits that the AIIB is unsure but believes that it is worth a try.

“We are fortunate that we are a young multilateral and we believe capital markets have the real power to make change,” he said. “While it could take five years to really see some returns, we think it’s worth pursuing. And once we can show results other investors will be interested.”

He believes that the project can easily be rolled out to encompass investment-grade bonds and equities too. AIIB’s ultimate ambition is to create a broadly accepted benchmark tool to assess issuer climate risk, which is both respected and used by asset owners to assess entire investment portfolios.

It’s early days for such a grand goal and there is a lot of work still to be done. However, the increasing seriousness with which asset owners are taking climate risk and ESG suggests there is a hunger for more investment tools outside specialised equity indices and green bonds.

If AIIB can get this right it could yet give asset owners a new means to make a difference in the battle to prevent a climate crisis.