Strategies for Equitable Climate Finance

By Ian Galloway and Elizabeth Mattiuzzi

In November, the Federal Reserve Bank of San Francisco hosted the 2020 Financial Innovations Roundtable (FIR) in collaboration with the Center for Impact Finance at the University of New Hampshire’s Carsey School of Public Policy and the Climate Safe Lending Network. The FIR, hosted annually by the Center for Impact Finance with the Federal Reserve System, brings leaders from across the financial sector together with subject-matter experts to workshop solutions to complex challenges facing low- and moderate-income (LMI) communities and communities of color. This year, the focus was equitable climate finance. Over 100 experts representing finance, community development, and climate impact research convened virtually on November 16-17 to discuss how to marshal the resources and build the systems needed to address climate change impacts, especially for LMI communities and communities of color. In this post, Ian Galloway and Elizabeth Mattiuzzi share key learnings from the discussions.

The Federal Reserve Bank of San Francisco is committed to monitoring the impacts of climate change on the economy. As Bank President Mary C. Daly has noted, “The Federal Reserve’s job is to promote a healthy, stable economy. This requires us to consider current and future risks—whether we have a direct influence on them or not. Climate change is one of those risks.”

Climate impacts touch all aspects of the Fed’s mission: cash operations, bank regulation, and macroeconomic stewardship. As the COVID-19 pandemic continues to cause economic disruption, the impacts of climate change on the economy, including for disadvantaged communities, continues to be urgent. Below are the themes that arose over the course of the discussion.

Thinking big about climate finance to manage systemic risk

At the 2020 FIR, there was general agreement that a multi-sector approach—bringing together financial institutions, regulatory agencies, government, and others—is needed to scale up climate finance strategies that are socially and racially equitable. Panelist James Vaccaro of the Climate Safe Lending Network suggested that financial institutions need to look beyond simply managing “physical and transition risk.” He explained, “Managing physical risk can sometimes translate into stopping investment in the most climate-vulnerable communities in flood- or fire-prone areas, while managing transition risk can sometimes mean prolonging carbon-intensive investment within legacy portfolios. These strategies might be a way of managing risk for the institution whilst contributing to systemic risk to undermine overall financial stability.”

“Financial institutions can work towards managing their contribution to ‘systemic risk,’” said Vaccaro, “by putting in place targets and practical strategies to help their clients optimize their decarbonization, ensure a just transition for workers, and accelerate innovation in areas such as zero emission vehicles, retrofitting buildings, natural capital, and the hydrogen economy.” This systemic risk is general economic instability due to climate change impacts.

For panelist Marilyn Waite of the Hewlett Foundation, addressing systemic risk posed by climate change involves “embedding carbon as a metric in the financial system in the same way that return on equity and return on investment are embedded in financial decision making.” This can be accomplished through measurement and disclosure of carbon emissions across the economy.

Financial institutions of different sizes and with different service areas are exploring ways to manage and disclose climate-related risk, rather than simply avoiding investment in industries and geographies facing these risks. For example, panelist Eliza Eubank of Citigroup noted that financial institutions are working to understand climate risks in the context of clients’ specific sector and geography and what clients are doing to minimize, mitigate, and adapt to those risks in order to determine how to incorporate those risks into the overall risk profile of loans. According to Jacqueline Smith of JPMorgan Chase & Co., “good disclosure needs to center on finding the right things to measure that really help companies evaluate where they are on their transition pathways, and help investors and banks evaluate carbon performance to ultimately make more informed decisions on their portfolios.” In many cases, data challenges remain for different financial institutions to understand climate risk quantitatively and fully price it into loans.

Housing policy is climate policy

The impacts of climate change increase housing instability for low-income communities and communities of color, who have faced systemic exclusion from wealth-building in the housing market for generations. “Climate change intersects with so many areas of economic and racial justice in relation to housing, which is a key area of focus for our team,” said Laura Choi, Vice President of Community Development at the SF Fed. Participants discussed the roles lenders, insurers, housing organizations, and the public sector can play to increase housing resilience and reduce climate-related displacement for LMI communities and communities of color.

Regional approaches offer promise

Regional governance—action taken by cities and counties in collaboration with each and with other sectors and scales of government—is key to addressing climate risk in the housing market for disadvantaged communities and financial institutions. Panelist Dave Jones of the Climate Risk Initiative at UC Berkeley Law School’s Center for Law, Energy and the Environment, who was previously California Insurance Commissioner, outlined four examples of regional initiatives that demonstrate innovation in climate finance:

  • Wildfire Partners, a pilot program operated since 2013 by Boulder County, Colorado, links “home hardening” with insurance provision. Boulder County has established a list of evidence-based wildfire risk reduction measures that homeowners can take. After third-party verification that they have undertaken the wildfire risk reduction measures, homeowners receive a certification that they can present to home insurers. A number of major insurers participate, and so far, no home certified by the program is known to have been denied coverage.
  • A pilot project on US Forest lands in Yuba County, California utilizes a “forest resilience bond.” Created by the nonprofit Blue Forest Alliance, the bond raises private capital for forest management to reduce severe wildfire risk. Beneficiaries of the risk reduction, in this case a local public water and power utility and the State of California, pay back investors through either fixed cost-share payments or pay-for-success payments. The bond also creates rural jobs by paying up front for contractors who could not operate on a model of waiting for government reimbursement.
  • A pilot project in Placer County, California, the Wildfire Resilience Insurance project, led by The Nature Conservancy (TNC), intends to demonstrate that an at-scale ecological forestry project in the Tahoe National Forest (The French Meadows Project, which reduces wildfire risk), can also be accounted for in the modeling and pricing of insurance. TNC is working with an insurance risk advisory firm to model and quantify insurance premium savings from ecological forestry and to explore how those savings might be captured to fund or finance more investments in ecological forestry projects in national and other forest lands.
  • Similarly, insurance sector firms and TNC are exploring the notion of community-based insurance, where reduced risk from community-based risk mitigation measures can be captured in reduced premiums, with the savings potentially reinvested in community-based risk mitigation measures.

“Thinking regionally” about equitable, transformative climate adaptation necessitates greater collaboration between the financial sector and local governments, according to FIR panelists. Margaret Van Vliet of Trillium Advisors noted that the financial sector could play a greater role in helping cities and counties “take stock of their assets, not just excess land but regulatory authority, bonding capacity, and other municipal financing tools” for funding community climate resilience measures. For example, “energy-efficient buildings are less costly to operate, which future-proofs them in terms of operating costs,” said Professor Kate Simonen of University of Washington.

Where homes are built also matters

Seeing regional housing policy and planning as part of a climate strategy is critical, according to Nuin-Tara Key of the California Governor’s Office of Planning and Research, who noted that without more affordable housing in job centers, Californians will have to seek it in fire-prone areas, presenting a challenge for both the state’s emission reduction goals and its resilience goals. “The public sector has an important role in incorporating risk in a way that doesn’t perpetuate and deepen inequities in housing policy and the legacy of discrimination in housing in the U.S.,” said Key.

Building housing of different densities and affordability levels within walking distance of transit and/or other amenities, while preventing displacement, is key to meeting the state’s emission reduction and resilience goals. LMI communities and traditionally-disinvested communities of color face the biggest risks from climate impacts in the housing market, according to Lindsay Owens of the Great Democracy Initiative who posed this question: “What would it look like for climate risk to show up in prices, rates, and requirements for homeowner’s insurance and mortgage insurance more clearly, in disclosures for consumers, throughout appraisal standards, and in building and permitting codes, in a way that looks more like what we have for seismic activity than what we have for some of the other perils?”

Affordable housing is a precious resource

Affordable housing preservation in the face of natural disasters is another urgent piece of the climate puzzle for community development practitioners. Laurie Schoeman of Enterprise Community Partners noted that “it is extremely difficult to rebuild unsubsidized market rate affordable housing if it is lost” in a disaster such as a hurricane.

Losing workforce housing hurts the entire regional economy. “Frontline communities are the first impacted by disasters and take the longest to recover, and so many have been challenged by decades of policies that have impacted their ability to get investment and leverage funding,” said Schoeman. She outlined an example of a program that helps address these issues: Keep Safe, initially started in Puerto Rico and now expanded to Miami, provides guidance for subsidized affordable housing owners to build resiliency into their portfolio and their projects, leveraging community development block grant (CDBG) funding from the city.

According to Schoeman, making subsidized affordable housing resilient to disasters calls for “patient capital, which is more often in the form of a grant or a direct subsidy or revolving loan than a traditional loan because many affordable housing owners have a small reserve. We know it’s a win-win if we invest in this housing because it reduces the damage” to facilities in a disaster and strengthens the “cultural capital” and community resilience of residents.

Inclusive climate finance benefits everyone

Panelists at the FIR discussed strategies for making climate finance “inclusive” in terms of benefitting, in addition to reducing harm for, low-income communities and communities of color. For example, they cited the need for community-engaged policymaking and investing, high-road job creation, and collaboration between the public sector, private investors, and Community Development Financial Institutions (CDFIs).

California State Controller Betty Yee noted, “We have an opportunity to future-proof our disproportionately-affected communities and populations with decisions that are informed by sound science, and—even more importantly—by the input of the communities themselves. Community voice and leadership are essential to helping develop and harness local talent for quality jobs.” In order to do this, she says, “We need to prioritize our investments and direct funding to communities that have experienced persistent inequities and disparities, through place-based investments and population-based investments.”

Many panelists pointed to the need for public and private sector climate adaptation and mitigation investments that benefit historically disinvested communities. According to Professor Michael Méndez of UC Irvine, climate finance strategies “should seek to transform communities by providing economic opportunities, building sustainable infrastructure, and improving public health” for low-income communities and communities of color, such as “Black, Latino, and Indigenous communities that suffer from severe economic and public health disparities.” He noted that this can be accomplished through “direct investment and local hiring practices that provide opportunities for a just transition from fossil fuel-based economies and provide climate resilient infrastructure and economic mobility options for communities most impacted by pollution and historic disinvestment.”

Panelists gave examples of inclusive private sector and public sector climate investments. For Randall Strickland of Cornerstone Capital Group, equitable investments provide access to capital in low-income communities and communities of color. He noted that expanding access to health care, education, clean water, and broadband, as well as criminal justice reform and other policies, helps build community resilience to climate shocks and stresses. “A portfolio that addresses those things will not only result in better performance but also addresses systemic problems and helps all of society, not just communities of color,” said Strickland.

California Energy Commission Chair David Hochschild pointed to examples of equitable public sector climate investments that the Commission has recently approved as part of meeting the state’s 100% clean energy mandate for the electric grid, including:

  • electric vehicle charging stations in low-income and disadvantaged communities;
  • demonstration projects for clean energy projects such as microgrids and energy storage in low-income and disadvantaged communities; and
  • electrification of new low-income homes.

A multi-sector approach is needed for a just climate transition that reduces systemic risk

Collaboration across sectors as a strategy for addressing systemic climate risk was a key theme that emerged from the 2020 Financial Innovations Roundtable. “Climate finance must play a critical role in how we avert catastrophic climate change and tackle social equity issues at the same time. A multi-stakeholder approach—with collaboration from financial institutions, regulators, and civil society—will be key to success,” said Fran Boait of Positive Money and the Climate Safe Lending Network.

Speakers noted the role that regulatory institutions can play in a just decarbonization of the economy. Returning to the theme of systemic risk, Boait noted that “central banks and others have an important role to play in proactively building resilience into the system itself.”

The Roundtable included participants from across the U.S. and Europe and representatives from a range of institutions including large and small banks, CDFIs, insurers, private foundations, regulators, policy groups, government agencies, investors, builders and others. In his closing remarks, Michael Swack of the Center for Impact Finance at the University of New Hampshire’s Carsey School of Public Policy reflected that “Although these groups often approach the issues from different angles, what we saw at the FIR this year was an emerging consensus on financial policies and practices needed to address the climate crisis. More important, participants discussed specific action strategies to address the crisis and how each of their institutions could contribute.”

Share your voice

The Board of Governors of the Federal Reserve System recently released an advanced notice of proposed rulemaking (ANPR) and opened a public comment period that asks whether the Federal Reserve should specifically consider “disaster preparedness and climate resilience as qualifying activities” when giving consideration to financial institution activities under the Community Reinvestment Act (CRA).

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