ESG Investment In An Era Of Climate Change

According to the Insurance Information Institute, 2022’s Hurricane Ian was the second-costliest hurricane in US history, after Hurricane Katrina in 2005. The cost of the damage is estimated to be between $112.9 billion and $117 billion.
The BVI has not been immune from the impact of this, with Category 5 Hurricane Irma hitting us directly in 2017, quickly followed by Category 4 Hurricane Maria giving us a glancing blow before it went on to devastate Puerto Rico.

As someone born and bred in the Caribbean, I am more conscious than most that as the world continues to face the consequences of rising global temperatures, we must find solutions to mitigate climate change and secure a sustainable future for us all.

I believe that there is a potential positive path to follow but we will only succeed if we build resilience – in our communities, in our infrastructure and in our natural assets. The creation of new and innovative funding vehicles is central to this. We need new asset management classes across the ESG field with authenticity and sustainability at their heart.

Fortunately, the establishment of such finance vehicles is exactly the expertise that international finance centres can bring to bear, and I believe that now is the time to create the necessary frameworks to encourage their development.

Blue Finance

For many international finance centres, either islands or on coasts, at the heart of this effort must be a successful blue economy. The World Bank definition of the blue economy concept is one that “seeks to promote economic growth, social inclusion, and preservation or improvement of livelihoods while at the same time ensuring environmental sustainability” (World Bank, 2017). These are all tenets the British Virgin Islands for one believes in, and the opportunities are clearly there for all of us, both to grow our businesses and build sustainable economies on the back of that.

A recent Economist conference looked at the potential of blue finance concluding that the true value of a sustainable blue economy is far greater than people realise pointing to indicators which suggest that demand for investable blue projects is beginning to outstrip supply. (Economist, 10th World Ocean Summit, April 2023).

The potential size of the blue economy certainly gives pause for thought. In a recent paper, the Commonwealth Secretariat stated that the worldwide ocean economy is valued at around $1.5 trillion per year, effectively the seventh largest economy in the world. It is set to double by 2030 to $3 trillion. Meanwhile the total value of ocean assets (natural capital) has been estimated at $24 trillion.

What perhaps makes the blue – and indeed the green – economy unique is that they are not based on unsustainable resource extraction. In fact, the opposite is true. Social equity and environmental sustainability are at their heart. This means as well as placing a value on ocean activity such as shipping and aquaculture; the blue economy also includes carbon sequestration and building coastal resilience. Importantly, protecting biodiversity is at the core of the blue economy and more often than not, a blue economy approach demands that nature-based solutions are factored into the mitigation of climate change.

For a jurisdiction such as the British Virgin Islands and for our colleagues around the world, including most recently in the English Channel, there is a clear incentive to mitigate climate change and secure a sustainable future for ourselves.

From the perspective of the financial services industry, it is in our own self-interest as well as in the interests of the communities in which we live for more investable products and services based around the blue economy to be created. There is no question that the more dominant the blue economy becomes, the more to our benefit it will be. It really is a win-win for all of us.

Many Small Island Developing States, with financial centres, or Large Ocean States, as we can be called, are already on the way.

For example, earlier this year, the Government of Barbados announced that it was prepared to contribute $50 million into ocean conservation efforts over the next fifteen years, after replacing conventional debt with the Blue Bond designed to help the country to extend marine protected areas, support biodiversity, and boost climate resilience. This is a similar approach to the one which the Seychelles took in 2018 when, with the help of the World Bank, it created the $15 million, world’s first blue bond. That financing was developed in cooperation with the InterAmerican Development Bank (IDB) and The Nature Conservancy, with financing arranged by Credit Suisse and CIBC First Caribbean.

The key to both of these bond issues was the combination of funding support they had. In the case of Barbados, the financing was developed in cooperation with the InterAmerican Development Bank (IDB) and The Nature Conservancy, with financing arranged by Credit Suisse and CIBC First Caribbean. For the Seychelles, the World Bank led the way with support from the Global Environment Facility. The World Bank also reached out to Calvert Impact Capital, Nuveen, and U.S. Headquartered Prudential Financial, Inc.

This coming together of potential funders, blending concessional finance with private capital, is the key to generating the sheer amount of capital which the blue economy needs to build resilience in coastal communities, including our island states.

Appropriately enough, many of the skills which are needed to create these blended finance vehicles already exist in international finance centres. Indeed, for a jurisdiction such as the British Virgin Islands, creating vehicles that pool assets for investment are meat and drink to our business model, and investing in ESG-based vehicles or green and blue finance are no different.

However, these opportunities means that our business leaders must also step up to what is being asked of us. In the early days of ESG, the regulatory requirements around a fund calling itself an ‘ESG fund’ were weak, if they were there at all. The landscape has changed dramatically.

The EU’s Taxonomy Regulation, approved in 2020, helps to assess how sustainable an economic activity is which in turn enables an assessment of a particular company or investment fund on its ESG credentials. The SEC in the US is also focused on what it means to be an ESG fund and is putting forward new disclosure rules to add clarity to the issue. It is also proposing to amend its ‘Names Rule’ to cover terms such as ‘sustainable’ and ESG. Both of these efforts by major supervisory authorities are aimed at bringing more transparency around climate related financial regulations and starting the process of standardising what is and what is not meant by an ESG fund.

These bodies have significant influence and I have no doubt that we should follow their lead.

Authenticity is critical to trust in investment.

The British Virgin Islands prides itself on the flexibility of its investment products and a number of ESG funds have been established. To date, these have often utilised the provisions of international agreements as part of their board constitutions to ensure that they follow sound ESG principles and don’t invest or fund in specific areas involving, for example, forced labour, as defined by ILO Conventions, and cross border trade in waste and waste products, unless compliant with the Basel Convention, or in organisations linked to illegal fishing or in potential breach of international conventions such as CITES.

However, while these principles have served us well to date, I believe that it is time we step up as international finance centres and go further.

There is no doubt that there are significant opportunities for us, which can both benefit our business communities and help us to mitigate climate change. For example, in the Bahamas, under the Climate Change and Carbon Initiatives Act passed in 2022, the Government established the necessary framework to accredit and transact blue carbon credits based on the carbon storage potential of the mangroves and seagrasses the islands are renowned for. The trading of these credits will enable the emergence of a new asset class. It’s early days, but last year, the CEO of Wincrest Capital estimated that the Bahamas could earn $375 million annually from carbon credits.

The potential is therefore unquestionable. But like the EU and New York authorities, we must be watchful of those who would claim to be investing to support the blue economy while utilising our new products and services for green and indeed blue washing.

I therefore believe that as international finance centres, we should establish a common set of ESG investment standards we can all adhere to.

We know that in time, our friends in the FATF, which is already laser focused on the link between environmental crime and money laundering, are likely to come up with new global standards in this area. We also know that, increasingly, other international and national bodies are firming up proposals, bringing increased clarity to definitions of ESG and green and blue investment to aid investors and asset holders. Finally, we know that we need this investment.

Climate change cannot be stopped. We cannot cool the ocean down. We can however, mitigate the impact this will have, build resilience for our communities, and blue economy investment can help us to do that.

By creating a clear set of principles, we can ensure that ESG funds who establish themselves in our jurisdictions can have confidence that their investments and the rules by which they invest will be respected around the world – and that, for all of us, is a business model we can support.

Lorna Smith OBE
Chief Executive Officer and Founder at LGS and Associates, formerly Interim Executive Director, BVI Finance, British Virgin Islands. Lorna Smith has more than three decades of experience at the highest levels of the public service in the British Virgin Islands. Over the course of her senior-level service, Ms Smith has developed extensive relationships with leaders from the business community, international NGO’s and government leaders from around the world. She is well published, a popular speaker and consults on BVI financial services. For more, visit her website at LGSASSOCIATES.COM