COP27 loss & damage agreement reached. Room for responsive risk transfer

After extended last minute negotiations, an agreement has been reached on forming a loss and damage fund at the COP27 climate change conference in Egypt, but the details will matter as to how this important climate risk financing initiative comes together and the role of risk transfer markets in supporting it.

There is room for responsive risk transfer and the negotiated text makes it clear that there is an urgent need for “new, additional, predictable and adequate financial resources” to help developing countries that are particularly exposed to the adverse effects of climate change.

Predictable is a key word here, as there is a growing movement towards developing financial structures that can deliver just-in-time capital, both pre and post-climate event.

These countries need assistance to cover their economic and non-economic loss and damage linked to the adverse effects of climate change, the negotiated text explains and this includes extreme weather events as well as slow onset climate-linked events.

On the financing side, the delivery of funding from those countries that are deemed to have produced the majority of emissions and therefore been drivers of climate change, is still a key goal and this is likely to be the hardest negotiated of points going forwards. With a significant amount of detail required to be added, to put together a loss and damage fund as well as the necessary related structures.

There remains some uncertainty over this aspect of loss and damage and whether there can be a broad agreement to provide sufficient financing and payments to satisfy those countries that feel most exposed to and impacted by climate change.

Reparation remains a key word in any discussion on loss and damage, but also one which the negotiated text avoids.

As we explained on the recent launch of the Global Shield facility, nothing that we’ve seen so far answers all of the questions on loss and damage and reparations for those nations most impacted by climate change, by a long way.

But where we can focus, is the potential for risk transfer, especially responsive and anticipatory, as well as on the tapping of sources of private capital to build-out loss and damage financing structures that can support global climate change response.

With predictability seen as key for the delivery of any loss and damage financing, how this new climate risk transfer financing infrastructure design plays out is likely to see a role for parametric triggers to be included, in the delivery of response funding.

On the capital side, the COP27 loss and damage agreement calls for “innovative sources” of funding to be used, to assist in mobilising capital to build loss and damage financing resources.

The loss and damage agreement calls for new and additional sources of funding to be mobilised, which refers in the main to reparation type payments, but there is also quite broad discussion on the role for private capital and a recognition that private capital involvement will be important.

Donor payments cannot fund the loss and damage financial infrastructure that is required on its own and, on a go-forwards basis, it seems likely insurance-like structures need to be dovetailed into the loss and damage financing paradigm, to ensure there is access to capital for climate change disaster response, recovery and rebuilding.

It also needs to be considered how loss and damage from climate change is protected against over the longer-term via financing.

Through greater use of risk transfer and insurance, those most at-risk can also have their communities, economies, corporate, businesses and financial actors better protected, which buffers the potential negative effects that can be felt and supports a better recovery when disaster strikes.

Private capital’s role in all of this remains unclear at this time, although there is undoubtedly room for it, as well as for supportive capital to be delivered via climate risk transfer, insurance and even climate risk securitization, in formats similar to catastrophe bonds.

Before progress is made in defining a role for private capital in loss and damage structures and arrangements, it seems likely the subject of the loss and damage fund itself, any reparation-type capital from countries, plus a framework for compensating the most vulnerable, will all need agreeing in much greater detail than is available today.

A role for capital markets must exist though, as donor and reparation payments will not support the world’s need for climate loss financing alone.

There will be a need for insurance-like instruments, with reinsurance capital in significant quantities, to underpin loss and damage financing over the longer-term.

Efficiency, in how structures are created and capital is deployed will be vital, to ensure climate risk transfer and hedging remains as affordable as possible for those most at-risk.

Which suggests that integrating the role of private climate risk capital into the design of loss and damage funding structures could drive a better long-term result in the end, enabling economies of scale, while defining who are paying the premiums needed, which can complement the flow of contributed funding from the emitters to those feeling the brunt of climate change.