SOVEREIGN CLIMATE AND NATURE REPORTING Proposal for a Risks and Opportunities Disclosure Framework © 2022 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Credit: Azami Adiputera, Shutterstock >>> Contents Acknowledgments III Acronyms V Executive Summary VII Introduction 1 Macroeconomic Risks of Climate Change and Nature Loss 1 Background on Climate- and Nature-Related Financial Disclosures 2 Why Is A Reporting Framework for Sovereigns Needed? 7 Reason 1: Sovereign Reporting of Climate- and Nature-Related Financial and Economic Information Can Help Countries Attract Capital and Have “Spillover” Effects on Domestic Policy Making 7 Reason 2: There Is Growing Demand for Climate- and Nature-Related Financial Information by Investors 8 Reason 3: Existing Information Does Not Meet the Needs of Investors and Other Stakeholders 10 What Is Required to Develop a Reporting Framework for Sovereigns? 13 How Can Existing Frameworks Be Adapted for Sovereigns? 13 What Are the Information Needs and Who Are the Parties Responsible for Providing the Information? 15 Are There Other Potential Approaches to Developing A Sovereign Reporting Framework? 18 How Is Materiality Important in Driving a Reporting Framework for Sovereigns? 21 What Is the Potential for Unintended Consequences? 25 What Are the Recommended Next Steps to Develop and Implement a Reporting Framework for Sovereigns? 27 CONTENTS <<< I Annex A: Draft Sovereign Climate and Nature Risk and Opportunities Reporting Framework 29 Annex B: Supplemental Information on Existing Corporate-Focused Reporting. 33 Background on Task Force on Climate-Related Financial Disclosures 33 Background on Task Force on Nature-Related Financial Disclosures 39 References 37 II >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK >>> Acknowledgments The World Bank task team responsible for this report was composed of Fiona Stewart (Lead Financial Sector Specialist, Long-term Finance), Samantha Power (Sustainable Finance Consultant, Long-term Finance), Baljit Wadhwa (Senior Operations Officer, Climate Change), and Monika Kumar (Environmental Specialist) with support from Mark Flugge (Expert Consultant), Stacy Swann (Climate Finance Advisors), and Darius Nassiry (Climate Finance Advisors). The report benefited greatly from the valuable contributions and perspectives of our colleagues in the climate change and green finance community, who have ensured its quality and clarity. These include Otilia Ciotau (Senior Financial Officer, CFO Advisor), Bryan Gurhy (Senior Financial Specialist, ENFLT), Lea Hakim (Senior Economist, MTI), Patrick Kabuya (Senior Financial Management Specialist, Governance GP), Svetlana Klimenko (Lead Financial management Specialist, OPCS), Olivier Mahul (Practice Manager, EFNRF, FCI GP), Rozani Osman (Senior Financial Sector Specialist, East Asia), and Gabriel Sensenbrenner (Lead Financial Sector Specialist, ELCFN). Greatly appreciated input also came from Heike Reichelt (Head Investor Relations), Scott Cantor (Senior Financial Officer), and other World Bank and Department of Treasury colleagues, including several from the pension team. Input was received from external experts, including Ian Carruthers and Ross Smith (International Public Sector Accounting Standards Board). Suggested citation: Stewart, F., Power, S., Flugge, M., Wadhwa, B., Kumar, M., Swann, S., and Nassiry, D. (2021). Sovereign Climate and Nature Reporting: Proposal for a Risks and Opportunities Framework. Washington, DC: The World Bank Group. ACKNOWLEDGMENTS <<< III Amazon river aerial view. Credit: Flikr >>> Acronyms ASCOR Assessing Sovereign Climate-related Opportunities and Risks CRAs credit rating agencies EMDE emerging market and developing economies ESG environmental, social, and governance FSAP Financial Sector Assessment Program G20 Group of 20 GHG greenhouse gas IFRS International Financial Reporting Standards IMF International Monetary Fund IOSCO International Organization of Securities Commissions IPBES Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services IPCC Intergovernmental Panel on Climate Change IPSASB International Public Sector Accounting Standards Board ISSB International Sustainability Standards Board NAMA nationally appropriate mitigation action NAP national action plan NBSAP national biodiversity strategy and action plan NDC nationally determined contribution NGFS Network for Greening the Financial System PPP public-private partnership RPG recommended practice guidelines SASB Sustainability Accounting Standards Board SEEA System for Environmental Economic Accounting SIFMA Securities Industry and Financial Markets Association SOAS School of Oriental and Asian Studies SOE state-owned enterprise TCFD Task Force on Climate-Related Financial Disclosures TNFD Task Force on Nature-Related Financial Disclosures UNFCCC United Nations Framework Convention on Climate Change WBG World Bank Group ACRONYMS <<< V In the Fulani village of Hore Mondji, located in southern Mauritania on the banks of the Senegal River, a women’s cooperative uses solar energy to operate the borehole that supplies water to the market garden. Credit: Raphael Pouget / Climate Visuals Countdown >>> Executive Summary The Paris Agreement states that addressing climate change will require “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate- resilient development.”1 Policy makers, scientists, and investors recognize that the global economy must evolve to a more sustainable model that reduces its impact on the Earth, adapts to the changes already locked in, and contributes to carbon sequestration, as well as restoring and reconnecting degraded and fragmented ecosystems. To be successful, global financial flows must align with these broad objectives. More specifically, trillions of dollars of financing is needed to achieve the climate change mitigation and adaptation goals laid out in Articles 2.1.a and 2.1.b of the Paris Agreement, as well as the emerging targets of the Post-2020 Global Biodiversity Framework (UNEP-CBD). Investors will play an important role in driving this alignment through the tools of capital allocation and engagement. Sustainability reporting can play a central role in driving capital to sustainable investments and away from environmentally harmful ones. Progress has been made on corporate climate and nature reporting, but a significant information gap remains for sovereign entities, the capital-raising activities of which are not presently considered in existing climate- and nature-related disclosure frameworks. Sovereign bonds make up almost 40 percent of the US$100 trillion global bond market, and public funding and financing make up a significant proportion of global financial activity. International sustainability reporting frameworks under development, though, do not cover public sector investments, the issuance of sovereign and subsovereign bonds, the investments of public pension funds, or international development finance. Sustainability reporting is evolving quickly, making it even more imperative that sovereigns are not left behind. Understanding and disclosing climate- and nature-related physical and transition risks, as well as opportunities for priority investments in adaptation and transition activities, is essential for sovereigns seeking to address vulnerabilities and avoid unsustainable debt burdens. Research from the IMF and others shows that both climate change and ecosystem loss have a material impact on sovereign risk through direct and indirect effects on public finances (Cevik and Jalles 2020a; Cevik and Jalles 2020b). It raises the cost of capital of climate-vulnerable countries and threatens debt sustainability. Material climate- and nature- related information is as important for assessing sovereign risk as economic data, and this information should be reported with the same rigor in order to provide investors and other decision makers with a more comprehensive country overview. 1 UNFCCC, Paris Climate Agreement, article 2.1 (c) (December 12, 2015), https://unfccc.int/files/meetings/ paris_nov_2015/application/pdf/paris_agreement_english_.pdf EXECUTIVE SUMMARY <<< VII The purpose of this report is to raise awareness Natural capital accounting can be a tool that countries can and initiate a discussion on the need for sovereign use to better measure their natural assets and integrate sustainability reporting. The proposed sovereign climate them into national planning and development decisions. and nature reporting framework would assist sovereigns The “materiality” of various climate- and nature- looking to attract investment by enabling them to produce related criteria must be assessed to ensure that the comprehensive, regular, standardized, and, eventually, framework best enables effective capital allocation forward-looking disclosures of their climate- and nature- and engagement by investors. In general, materiality related risks and opportunities. Sovereign reporting would as it is used by preparers, auditors, and consumers of help meet the needs of investors who are increasingly financial information is widely understood as related to requesting such disclosures for all asset classes in their information that is “decision-useful for the reasonable portfolios so that they can measure portfolio alignment investor.” Climate change and the health of a country’s with the Paris Agreement. ecosystems could be considered potentially significant This report discusses five fundamental questions factors for a sovereign’s future financial and economic regarding sovereign climate and nature reporting: health and thus “material.” Some investors may consider (a) why is a sovereign reporting framework needed?; both financial and sustainability materiality in determining (b) what is required to develop a reporting framework for relevant factors for their investment decision making sovereigns?; (c) how is materiality important in driving (double materiality), and they may consider these factors a reporting framework for sovereigns?; (d) what is the along a spectrum that is shifting (dynamic materiality). potential for unintended consequences?; and (e) what are Managing potential unintended consequences the recommended next steps to develop and implement a such as capital flight from emerging markets highly reporting framework for sovereigns? exposed to climate and nature risk is essential to Sovereign reporting needs its own approach and wide adoption of a sovereign climate and nature framework. A customized approach suited to the specifics reporting framework. Emerging evidence shows that of sovereign reporting is recommended. This could build climate-related risks are already influencing the cost of on the core elements and underlying principles of existing capital, as evidenced by sovereign bond spreads (Volz et corporate-focused frameworks such as the Taskforce al. 2020). Financial markets now have much better access for Climate-related Financial Disclosure (TCFD). Other to information on climate risks than on the actions that frameworks such as context-based performance countries have taken to mitigate and manage these risks accounting and reporting frameworks and environmental- through investment in adaptation and resilience. A deeper economic approaches could also be drawn upon, such as and more common understanding of both physical and the UN System for Environmental Economic Accounting transition risks related to climate and nature would ideally (SEEA) framework. Annex A to this report presents result in better policy outcomes and more effective pricing a draft example of a sovereign climate and nature risk signals from the market. Climate and nature reporting and opportunities reporting framework as a starting point can enable sovereigns to articulate their approach to for discussion (noting that it is not intended as a fully managing relevant risks and give them greater ownership developed template or blueprint). of the risk narrative presented to investors. Estimates of the value of a country’s natural assets Next steps to develop and implement this concept would be a critical component of sovereign climate and include a consultative process leading to the nature reporting. In addition to reporting on climate risks, development of a reporting framework or guidance, there is a strong case for sovereigns to disclose nature- followed by country pilots. The authors invite the related criteria. A country’s natural assets are critical to International Public Sector Accounting Standards Body its economic growth and stability, and therefore should (IPSASB)—the public sector partner of the International be accounted for and appropriately managed (Dasgupta Financial Reporting Standards (IFRS) Foundation 2021). The interaction between climate change and working on corporate sustainability reporting—to lead natural assets is increasingly relevant for sovereign bond a consultative process to gain support for developing a investors, as the climate and biodiversity crises advance, framework for the public sector based on this concept. In create feedback loops, and reduce overall resilience. parallel, World Bank teams will look for opportunities to VIII >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK start to pilot and test reporting approaches through country-level engagements. Box ES.1 outlines how existing corporate- focused frameworks could be adapted for sovereign climate- and nature related disclosure. BOX ES.1 - How the Existing Corporate-Focused Frameworks Could Be Adapted for Sovereign Climate- and Nature-Related Disclosure The existing recommendations are structured around four thematic areas that represent core elements of how organizations operate: (a) governance, (b) strategy, (c) risk management, and (d) metrics and targets. These pillars could be adapted for sovereign climate- and nature-related reporting. Governance. Disclose the sovereign’s governance around climate-and nature-related risks and opportunities. More specifically: n Describe the sovereign’s governance arrangements around climate- and nature-related risks and opportunities, including which ministries are tasked with identifying, assessing, quantifying, and managing climate- and nature-related financial and economic risks that the sovereign faces; and n Describe government’s role in assessing and managing climate- and nature-related risks and opportunities, including which policy or governing bodies (parliament, executive, or presidential offices) are responsible for guiding the work of ministries in managing climate- and nature-related risks and capturing opportunities to address climate- and nature-related risks (transition, physical, liability). Strategy. Disclose the actual and potential impacts of climate- and nature-related risks and opportunities on the sovereign’s economy, key economic sectors, and overall financial conditions. Disclose the strategy and financial planning a sovereign may pursue to address such issues, including national planning and financial management. More specifically: n Describe the climate- and nature-related risks and opportunities that the sovereign has identified over the short, medium, and long terms; and n Describe the resilience of the sovereign’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower temperature increase scenario for transition risk and current warming trajectories for physical risk. Risk Management. Disclose how the sovereign identifies, assesses, and manages climate- and nature-related risks, including which ministries are responsible for ongoing risk assessment and tracking. More specifically: n Describe the sovereign’s processes for identifying and assessing climate- and nature-related risks; n Describe the sovereign’s processes for managing climate- and nature-related risks; and n Describe how processes for identifying, assessing, and managing climate- and nature-related risks are integrated into the sovereign’s overall risk management, financial management, and economic planning. Metrics and Targets. Disclose the metrics and targets used to assess and manage relevant climate- and nature-related risks and opportunities where such information is material. More specifically: n Disclose the metrics used by the sovereign to assess climate- and nature-related risks and opportunities in line with its country strategies (NDCs, NAMAs, NAPs, NBSAPs) and risk management process; n Disclose sectoral and, if appropriate, trade-related greenhouse gas (GHG) emissions and the related risks; and n Describe the targets used by the sovereign to manage climate- and nature-related risks and opportunities and performance against targets, as well as the way its targets are aligned with its NDC. Source: Climate Finance Advisors 2021; TCFD 2017. Note: NAMA = nationally appropriate mitigation action; NAP = national action plan; NBSAP = national biodiversity strategy and action plan; NDC = nationally determined contribution EXECUTIVE SUMMARY <<< IX The ICESCAPE mission, or “Impacts of Climate on Ecosystems and Chemistry of the Arctic Pacific Environment,” is NASA’s two-year shipborne investigation to study how changing conditions in the Arctic affect the ocean’s chemistry and ecosystems. The bulk of the research takes place in the Beaufort and Chukchi seas in summer 2010 and 2011. Credit: NASA/Kathryn Hansen >>> Introduction Macroeconomic Risks of Climate Change and Nature Loss In recent years, the physical impacts of climate change, particularly on emerging economies, have become increasingly clear. The latest Intergovernmental Panel on Climate Change (IPCC) report states that it is unequivocal that human activity has warmed the atmosphere, ocean, and land and that human-induced climate change is already affecting many weather and climate extremes in every region across the globe (IPCC 2021). Governments also need to accelerate investments in adaptation and resilience to climate impacts, both those impacts being faced today and those expected in the future given already locked-in warming. Despite this mounting evidence, the analysis of how those risks transmit through economies and how they manifest in terms of financial costs is still in a relatively early stage. Every country will need to assess how its own economic health is currently being affected and may in the future be impacted by climate-related risks. Whether and how countries address these risks could have material effects on a country’s overall sustainability and economic growth and is likely to pose material risks for investors with exposure to the debt issued by these countries. Climate change affects countries’ cost of borrowing through a range of transmission channels. As economists have begun to analyze the interactions between physical climate impacts, including acute and chronic impacts and transition risks such as policy, regulatory, and technological changes, a better understanding of the transmission channels of climate risks for sovereign issuers is developing (see figure 1). When and to what magnitude such risks manifest, though, remains difficult to predict with precision in terms of size, scope, or timing (Beirne, Renzhi, and Volz 2020). Pursuing a development pathway not aligned with Paris can and will continue to be fiscally expensive for all sovereigns, not only in the long run but also in the short term. Some countries are already experiencing increasing costs, losses, and damages because of impacts occurring today. For countries that issue debt, in domestic or international capital markets, a physical, climate-related shock can have long-term impacts on a country’s ability to attract capital for investment, including for climate mitigation and adaptation. Furthermore, a country’s overall plan to transition to a low- or zero-carbon energy mix will be important information for sovereign bond holders and other investors who may wish to understand more fully that investment’s exposure to transition risks. INTRODUCTION <<< 1 FIGURE 1 - Climate-Related Risks Relevant for Ministries of Finance (transmission channels)2 Risk Transmission Channels Climate Risks Micro and Meso Contingent Affecting individuals and sectors Liability Risks* for MoF Transition Risks Households Businesses • Policy and • Loss of income (from weather • Property damage and business regulation disruption, health impacts and disruption from severe weather Ex-ante • Technology labor market frictions) events Known Fiscal development • Property damage (extreme • Supply chain disruptions Costs • Consumer weather) or restrictions (low- • Stranded capital and additional preferences carbon policies) increasing capital expenditure costs and affecting valuations • Changing demand and costs • Legal liabilities Feedback effects Government Finance • Lower tax revenues • Credit risk • Lower dividends of SOE • Market risk Ex-ante • Higher cost of borrowing • Underwriting risk Unknown Physical Risks • Lower fiscal space • Operational risk Fiscal Costs • Chronic (e.g., • Stranded SOE capital • Liquidity risk temperature, • Infrastructure damage precipitation, agricultural productivity, Feedback effects sea levels Micro • Acute (e.g., Aggregate macroeconomic impacts heatwaves, floods, • Capital depreciation cyclones, • Sudden price changes (structural changes, inflation and supply shocks) wildfires) • Productivity changes (agriculture, labor, capital, energy) Risk Risk • Socioeconomic changes (changing consumption patterns, migration, conflict) Severity Materiality • Labor market frictions (from physical and transition risk) • Impacts on international trade, exchange rates, capital flows * With or without legal obligation to act upon Climate and economy feedback effects MoF response feedback effects Source: Dunz and Power 2021. Note: MoF = ministry of finance; PPP = public-private partnership; SOE = state-owned enterprise. While analysis of the macroeconomic risks associated collapse of ecosystem services by 2030: 9.7 percent and with nature loss is more nascent, the available 6.5 percent annually, respectively (World Bank 2021a). literature indicates that potentially significant losses in GDP could stem from losses of ecosystem Background on Climate- and Nature- services. This is the clear message in a recently published Related Financial Disclosures joint Intergovernmental Science-Policy Platform on While corporate climate-related disclosures have Biodiversity and Ecosystem Services (IPBES) and IPCC been seen as an important contribution to investor report (IPBES-IPCC 2021). Recently published World information, they are not yet considered sufficiently Bank research based on an integrated global economic- consistent, comparable, or complete enough to ecosystem model estimates that the collapse of select provide decision-useful risk information for investors ecosystem services provided by nature could result in a or policy makers tracking progress against the Paris decline in global GDP of US$2.7 trillion annually by 2030. goals. External analysis is starting to highlight areas The findings underscore the strong reliance of economies where those disclosing may be falling short, including on nature, particularly in low-income countries. The report regarding tracking emissions and credit and financial highlights that Sub-Saharan Africa and South Asia would risks. A recent CDP report notes significant underreporting suffer the most relative contraction of real GDP due to a 2 Contingent liabilities are defined as obligations (with or without legal obligation to act upon) that only materialize when a certain event in the future occurs. Contingent liability risks could become gradually or abruptly more severe with ongoing climate change (depending on the specific country context), as indicated by the red “risk severity” arrow. The materiality of these risks depends on the interplay of climate-related risk transmission channels and the degree of unfavorable reinforcing feedback loops, though, as is indicated by the gray “risk materiality” arrow. 2 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK by financial institutions in portfolio emissions by as much Sovereign bonds are the largest asset class and as 700 percent and furthermore that such institutions are a preferred investment of institutional investors dramatically underestimate climate-related risks by around the globe. In some countries, where private focusing primarily on physical damages to operations sector investment and markets are nascent, sovereign rather than on defaults on loan repayments, stranded investment is the primary source of capital being assets, or financial asset price devaluation (CDP 2021). deployed. As institutional investors take steps to integrate These gaps in existing disclosures underscore that more climate and environmental, social and governance (ESG) work is needed, particularly in areas related to metrics criteria more broadly across their portfolios (Shammai and targets. et al. 2020), issues with sovereign ESG data (related to availability, quality, timeliness, and comparability) Despite the challenges that still exist, there is evidence serve as a major barrier to effective risk management that existing climate-related financial disclosure (Inderst and Stewart 2018). Sovereign “Environment” I frameworks are taking hold in financial markets. data is particularly problematic. Among the E, S, and G Investors are increasingly using these frameworks as categories, E-category data has the longest time lags a basis for inquiry and due diligence, and each of the (Shammai et al. 2020) and the greatest divergence in major credit rating agencies (CRAs) now actively inquire scores among the major ESG data providers (Boitreaud about climate-related risks when engaging with issuers et al. 2020). E-category risks are of increasing concern (IPBES-IPCC 2021). The leading global reporting entities, to investors (WEF 2020), particularly long-term investors for example, have proposed a prototype sustainability like sovereign bond holders, and are rapidly changing reporting framework based on the Task Force on (UN 2020). Climate-related Financial Disclosures (TCFD) for the International Financial of Reporting Standards (IFRS) to Given the broad and increasing market uptake of consider as global, harmonized reporting standards are existing corporate-focused frameworks for assessing developed in future years (IMP, WEF, Deloitte 2020). and disclosing climate risks and opportunities, the As more organizations begin to apply a framework for potential impacts of climate change on countries, climate-related due diligence and the communities of and the relevance of sovereign economic conditions investors, policy makers, and others improve upon these to investors, can a framework be developed for frameworks to enable the disclosure of more consistent sovereigns? As the need for disclosure of climate-related and comparable climate-related financial risk information, risks and opportunities for corporates and investors has the utility and impact of climate- and nature-related become widely recognized, there has been a growing disclosures will only increase. recognition that disclosure of climate change risks is not only needed from private organizations but could also be Under the Paris Agreement, Article 2.1.c states relevant for sovereign issuers. the aim of “making finance flows consistent with a pathway towards low greenhouse gas emissions Given the broad acceptance of existing corporate- and climate-resilient development” in order to reach focused frameworks by investors, it may make the goal of maintaining the increase in global average sense to apply as much of these frameworks and temperatures to well below 2°C (UNFCCC 2015). To meet recommendations as possible with adaptations as this objective and redirect financial flows, governments necessary for the sovereign context. Annex B provides must shape the policy and regulatory environment that further information on corporate-level reporting. Sovereign determines whether or not the private sector will direct reporting would be based on the same principles and with capital in a way that transitions to a low-carbon economic a focus on parameters that are material for both sovereign model within the relevant timeframe. As both public sustainability and, therefore, investors. Many of the main and private action are required to achieve the goals of areas of corporate-focused reporting are relevant to the Paris Agreement, there is a strong case to be made sovereigns—governance, strategy, risk management, that applying the disclosure of climate-related risks and and metrics and targets— and could be applied in the opportunities only to organizations (financial institutions sovereign context. The following sections outline specific and nonfinancial firms) may be insufficient. reasons for developing a framework for sovereign climate and nature-related reporting. INTRODUCTION <<< 3 While there is a case for nature-related criteria a sovereign’s natural environment and its contributions to be disclosed by sovereigns, alongside climate (that is, ecosystem services) to the sovereign’s society criteria, it is important to note that climate- and and the economy. nature-related risks (and opportunities) are distinct. While climate-related disclosures by sovereigns are From an economic standpoint, natural capital—stocks not yet widespread, some countries have published and changes in stocks of environmental assets—is an reports and disclosed a measure of climate-related asset that sovereigns should maintain and manage, risks and opportunities. See boxes 1 and 2 for two whereas a changing climate presents a broader threat cases where a sovereign has discussed its climate- (or opportunity) to sovereign assets. Distinct approaches related risks as part of such an issuance. (environmental-economic accounting) are appropriate for determining the risks and opportunities associated with BOX 1 - Costa Rica as a Pioneer in Public Accounting and Sustainability Costa Rica has pioneered the adoption of International Public Sector Accounting Standards (IPSAS) in Latin America. Costa Rica began the process of converting its national accounting from a budget approach to an accounting framework 10 years ago and has implemented this transformation because of commitment from its leadership and with support from partners, including the Inter-American Development Bank. Public Sector Disclosure The current implementation plan calls for full implementation of IPSAS by year-end 2021. Costa Rica faced challenges with implementation, including institutional barriers. The main benefit of implementation of IPSAS has been the real-time provision of reliable and comparable information, as well as improvements in transparency and accountability. The adoption of IPSAS positions enables Costa Rica to gain a better sovereign credit rating and makes it less susceptible to downgrades. Moreover, as is mentioned in box 4, there are three nonmandatory Recommended Practice Guidelines (RPGs) that IPSASB has developed for use alongside the IPSAS that are relevant to climate change reporting. When implemented, these will help Costa Rica to account for and disclose the impacts of climate risks and strengthen its creditworthiness and financial transparency. Private Sector Disclosure In addition to reforms in public sector accounting, Costa Rica has also pioneered sustainability reporting in the private sector. There is a significant interest in sustainability reporting in the country, as there are currently 40 reporting requirements and resources for ESG-related issues, driven in part by Costa Rica’s bid to join the Organization for Economic Co-Operation and Development (OECD), which it accomplished in May 2021. Costa Rica does not currently have a specific sustainability reporting requirement for private or public companies to publish sustainability reports, but there are reporting requirements that ask companies to disclose certain information in relation to ESG issues, according to the World Business Council for Sustainable Development (WBCSD). FIGURE B1.1- Costa Rica Data Snapshot (WBCSD 2018) R portin provisions b subj ct R portin provisions b obli tion 28/40 28/40 26/40 16/40 26/40 14/40 reference reference reference provisions provisions environment social governance are are subjects subjects subjects mandatory voluntary Source: IPSASB 2014; IPSASB 2020; OECD 2021; WBCSD 2018a. Note: ESG = environmental, social, and governance. 4 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK BOX 2 - New Zealand as a Pioneer in Environmental Reporting and Sustainability New Zealand passed a first-of-its-kind Environmental Reporting Act in 2015. The act makes responsibilities for environmental reporting explicit and sets the framework for the scope and timing of environmental reporting. The government statistician (StatsNZ) and the Ministry for Environment report on the state of different aspects of the environment every six months, and the environment as a whole every three years. The act demands the involvement of the StatsNZ, which ensures that reporting is conducted at arm’s length from the government of the day and released in line with principles and protocols set by the act. Moreover, the parliamentary commissioner for the environment can comment on any aspect of reporting, which provides a further degree of independence. Public Sector Disclosure Under the act, environmental reporting is organized into five domains along with a set of topics to identify key issues within each domain and across domains, as well as indicators to provide measures of each topic. The five reporting domains are: n Air n Atmosphere and climate n Fresh water n Land n Marine Information on biodiversity and ecosystem features is provided in the land, fresh water, and marine domains. The domains are sufficiently broad to accommodate those aspects of the environment that are important internationally and domestically. Publishing information by domain allows New Zealand to build a comprehensive picture about the state, impacts, and pressures across each domain. This picture is built upon in the thrice- yearly synthesis reports. The topics to be reported on for each domain are set in the Environmental Reporting Regulations 2016: n State topics describes the broad aspects of the condition of the domain n Pressure topics describes the main sources of pressure on each domain n Impact topics cover the impacts in the areas of ecological integrity, public health, the economy, te ao Māori (the Māori world view), and culture and recreation. Private Sector Disclosure On April 12, 2021, the New Zealand government introduced an omnibus bill into parliament that aimed to implement mandatory reporting requirements for financial institutions related to the climate-related risks they face and their strategies for managing risks and opportunities. Disclosures would be made on a “comply- or-explain” basis in the public annual financial filings for each business, meaning that where there is insufficient information to allow a disclosure, reporting organizations can explain rather than disclose. The entities in New Zealand that are required to make disclosures under the climate bill are n All registered banks, credit unions, and building societies with $NZ 1 billion or more in assets; n All managers of registered investment schemes and crown financial institutions with $NZ 1 billion or more in assets under management; n All licensed insurers with greater than $NZ 1 billion in assets under management or annual income more than $NZ 250 million; and n All companies listed on the New Zealand Stock Exchange. The climate bill was reported from the Economic Development, Science, and Innovation Committee on August 16, 2021. For its second reading, the House will debate the select committee report and vote on the bill. Source: New Zealand Ministry for the Environment 2021 INTRODUCTION <<< 5 A child rides a water buffalo through a meadow. Inle Lake, Myanmar. Credit: Samantha Power >>> Why Is a Reporting Frame- work for Sovereigns Needed? Reason 1: Sovereign Reporting of Climate and Nature-Related Financial and Economic Information Can Help Countries Attract Capital and Have “Spillover” Effects on Domestic Policy Making Disclosure of climate-related risks and opportunities can help ensure a country’s continued ability to access capital markets for investments, including for priority investments in adaptation and transition activities. The overarching rationale at the sovereign level for reporting on climate and nature-related risks and opportunities is to ensure that a clear, consistent level of financial and economic risk information is available on an ongoing basis to all types of users, including investors, policy makers, regulators, donors, and development finance organizations. Such information would be important for a range of stakeholders within the sovereign to enable better-informed policy and public investment decisions. Such a framework would provide investors with more granular, consistent, and comparable information on country- level risk and opportunities. Information related to metrics and targets can be applied in investor risk and opportunity analysis. This reporting can help international policies and financial flows better support the transition of countries to a low-carbon, climate-resilient, nature-positive future. By adopting a reporting framework for sovereigns that builds on the core elements of recommended climate-related financial disclosures from corporate-based counterparts, countries will have an opportunity to augment existing information, policies, and reporting to more accurately and effectively assess and communicate their climate and nature-related financial and economic risks, opportunities, and management approaches. In addition, sovereign reporting of climate and nature-related financial and economic information could also have benefits for policy making at the national level, which help improve governance and ultimately the cost of capital. Sovereign reporting has the potential to help reduce the risk of climate and nature-related financial shocks by providing specific, relevant information on both physical and transition risks on the horizon before they manifest and enable policy makers to better manage these risks. Reporting and scenario analysis process can provide governments with a more comprehensive picture of the risks and opportunities that their country faces, and collated information in the report can feed into relevant discussions in the Ministry of Finance, Parliament, and the executive branch. Better governance of these material risks should eventually be reflected in a lower cost of capital. WHY IS A REPORTING FRAMEWORK FOR SOVEREIGNS NEEDED? <<< 7 Sovereign reporting of climate and nature-related faces due to a changing climate and loss of biodiversity financial and economic information can also help and ecosystems, as well as how a country is seeking to inform a country’s own strategic approach to its address those risks at the national level. This information spending and capital mobilization. More efficient would also enhance the potential for a climate reporting allocation of public budgets may be possible if policy framework to provide a way to assess policy coherence makers have more comprehensive climate and nature- on climate change, nature conservation and restoration, related information on both risks and opportunities and the degree to which these considerations are that can be used to take a more strategic approach to mainstreamed in public policies. maximizing the climate and nature impact of the public Reporting by sovereigns may also help to boost balance sheet. Understanding how climate and nature- other disclosures such as corporate climate and related risks result in financial and economic costs will sustainability disclosures by providing a reference be important for planning and may determine how and standard. Sovereigns are usually the major issuer in their where public funds are invested, particularly for priorities domestic markets, particularly in developing economies. that may not attract private capital but where the societal By committing to report themselves, sovereigns can benefits are significant. signal and support such reporting by corporations in their For those managing sovereign budgets and jurisdiction. Such signaling could induce positive spillover allocations, having a better understanding of climate effects among their peers and can further boost efforts to and nature-related risks and future damages may ensure that climate considerations are integrated across facilitate a better understanding of where best all parts of the financial system. to apply public funding and where it is possible mobilize private funding, as well as how to tap into Reason 2: There Is Growing Demand for both domestic and international private capital. Taken Climate and Nature-Related Financial together, understanding climate- and nature-related Information by Investors financial and economic risks could help sovereigns undertake a more efficient national public budget Demands by investors (particularly purchasers of allocation process that delineates between projects that sovereign bonds) for climate, nature, and broader are purely public (including nature-based solutions), those ESG-related information and investor flows that form that have the possibility for revenues streams that can a significant source of foreign direct investment attract private finance, and those that may require hybrid are growing. Credit ratings agencies and sustainability or public-private partnership approaches (WEF 2019). research firms have expanded their offerings as investor interest, including by institutional investors in sustainability, A reporting framework for sovereigns could provide climate, and nature-related investments, has increased in a way to facilitate policy coherence at the national recent years. and subnational levels and ensure consistency between the climate pledges of countries by using There is growing interest in climate and nature- NDCs and managing their approaches to contending related risk and opportunities reported by sovereigns, with the low-carbon transition and physical risks to and this information is increasingly being used in their economy. While NDCs provide helpful information investment decision making. Sovereign bonds are not about a country’s level of ambition and priority areas of only a preferred asset class for institutional investors but action, there is a clear need for a framework that can are also the largest asset class for these investors globally. ensure that national climate and nature-related financial The total global bond market capitalization was US$123.5 and economic risks are aligned with a country’s Paris- trillion in 2020 compared with total global equity market related investment strategies, including national emission capitalization of US$105.8 trillion in 2020, according to reduction commitments. There is also a need to reduce the Securities Industry and Financial Markets Association, the risks associated with the adverse impacts of climate or SIFMA (SIFMA 2021). Sixty-eight percent of the global change. More specifically, information from sovereign- bond market was made up of sovereigns, supranational, level climate- and nature-related disclosures can allow and agency bonds, according to the International Capital investors and the international community to understand Market Association (ICMA 2020). As of October 30, the range of financial and economic risks a country 2021, all outstanding bonds totaled US$108 trillion and 8 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK all sovereign bonds totaled US$39 trillion, based on data express concerns about the validity and veracity from Dealogic (SIFMA 2021). In other words, sovereign of ESG information from corporates and other bonds make up almost 40 percent of the global bond issuers (Bloomberg 2019). Investors have been markets. seeking some form of standardization in these reporting frameworks for some time, and as noted in a 2020 In the past few years, investors, particularly those Blackrock survey, most survey respondents cited poor under pressure to align their portfolios with the Paris quality or availability of ESG data and analytics as the Agreement, have been actively signaling their intent to biggest barrier to deeper or broader implementation of reallocate assets and develop investment strategies sustainable investing (Blackrock 2020). Recent analysis that take ESG and climate-related information into by Bloomberg revealed that the ratings provided by one account when building portfolios (Wissenburg et of the largest index providers and ESG rating companies, al. 2021). For example, the Glasgow Financial Alliance MSCI, only considers risk to companies and not the risks for Net Zero (GFANZ) announced at the United Nations those companies pose to the environment and society Framework Convention on Climate (UNFCCC) COP26 (Simpson, Rathi, and Kishan 2021). that financial institutions managing over US$130 trillion of private capital had committed to aligning their portfolios Investor demand for consistent standards has led with keeping warming below 1.5°C (GFANZ 2021). to an increase in efforts by international standards bodies to refine and revise reporting frameworks These and other considerations underscore the and approaches. This has also resulted in greater fact that ESG considerations are no longer a niche collaboration among these entities to align and topic for institutional investors in emerging market harmonize approaches to metrics, methodologies, sovereign debt, even as the level of penetration of ESG and approaches to defining ESG relevant data. In into emerging market sovereign debt investing remains April 2021, for example, the Board of the International mixed. While institutional investors are actively taking steps Financial Reporting Standards (IFRS) Foundation to integrate ESG criteria across their portfolios using ESG published proposed amendments to their constitution frameworks and taxonomies, there is a growing demand to accommodate the potential formation of a new for higher quality, granular, consistent, comparable, and International Sustainability Standards Board (ISSB) within standardized climate- and nature-related information that the governance structure of the organization (IFRS 2021). tracks multiple timeframes, including short, medium, and The ISSB issued its ‘Prototype Disclosures’ guidance long-term (Foster 2019). at COP26 in November 2021, which used the TCFD’s Notwithstanding the rise in popularity of ESG core elements of recommended climate-related financial investing, investors of various types continue to disclosures as a basis (see figure 2) (IFRS 2021). FIGURE 2 - Core Elements of Recommended Climate-related Financial Disclosures Gov rn nc Gov rn nc The organization’s governance around climate-related risks and opportunities Str t Str t The actual and potential impacts of climate-related risks Risk and opportunities on the organization’s businesses, strategy, and financial planning M n m nt Risk M n m nt The processes used by the organjization to identify, assess, and M trics manage climate-related risks nd T r ts M trics nd T r ts The metrics and targets used to assess and manage relevant climate related risks and opportunities Source: TCFD 2017, WHY IS A REPORTING FRAMEWORK FOR SOVEREIGNS NEEDED? <<< 9 Furthermore, addressing the demand for both These informational issues pose a major barrier sustainability and climate- and nature-related and can make it more difficult for investors to align information has been a recurring theme in recent their capital allocation approaches with their unique years and has been a focus of numerous financial investment return requirements over the short, policy-making bodies and associations, including medium, and long term in a way that is consistent with central bankers (Network for Greening the Financial global policy goals. Moreover, these informational issues System, or NGFS), securities regulators (International also represent a barrier to effective risk management by Organization of Securities Commission, or IOSCO), investors. More specifically, for information to be decision- Ministries of Finance (the Coalition of Finance useful, it will need to provide Ministers for Climate Action), and others. Some of n Clarity on how climate and nature risks are addressed the more important information needs these bodies have in sovereign policies, regulations, plans, strategies, found are those related to the inputs to climate-related and budgets, and how these risks impact economic financial information, such as how to apply physical and financial health of sovereigns; warming scenarios to financial risk analysis, how to understand and apply analysis over varying time horizons, n Information in both financial and economic terms understanding how climate-related impacts affects value- and needs that are to be quantified over periods at-risk, and transition scenarios. These same challenges meaningful for investor decision making, including also apply to sovereign level ESG- and climate-related short-, medium-, and long-term periods; information that can be useful for investors, policy makers, and financial regulators.3 n Regular updates to enable monitoring both by investors and regulators and ways to track changes Reason 3: Existing Information Does in climate and nature-related risks and resilience that Not Meet the Needs of Investors and in turn can enable the valuation of the benefits of Other Stakeholders sound policy, investments (public and private), and economic resilience to climate change impacts and While demand for climate-related financial and provide value to regulators; and economic information has been growing, the existing information on climate-related risks and n Context, including limits or thresholds for climate opportunities is insufficient to enable robust climate- and nature-related criteria aligned with ecological related investment decision making, particularly boundaries. with regard to understanding climate-related risks, For some investors, understanding the climate and whether by investors, country policy makers or financial nature-related risks facing a sovereign may also system regulators. Much of the existing sustainability imply understanding not only public investments information on sovereigns, for example, is provided ex at the asset level, but also broader investments in post, and information that does forecast the future often resilience. This would include community resilience and lacks a clear articulation of various warming scenarios. associated public-policy investments in resilience, such Furthermore, while good information may be available as for nature-based adaptation investments (protected for social and governance aspects, environmental areas, ecosystems that help enhance resilience or reduce information is often limited to emissions and footprints, climate-linked vulnerability). although even within these data, some inconsistencies exist in methodologies, such as between consumption Some critical information about climate and nature- and production, scope emissions (Gratcheva, Emery, related risks, opportunities, and management and Wang 2021). In the case of green bonds, the focus approaches is already publicly available in a country’s has historically been on mitigation investments, and the related strategies and plans, such as NDCs, NAMAs, green bond label has provided investor comfort through NAPs, and NBSAPs. NDCs, for example, focus on mitigation-related information provided to justify the label, climate change mitigation, adaptation, and nature-related and so climate-related risk information is limited. protection plans by parties to the UNFCCC, and in some 3 See the World Bank Sovereign ESG Data Portal (https://datatopics.worldbank.org/esg/) and the IMF Climate Change Indicators Dashboard (https://climatedata.imf.org/). 10 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK cases also include their estimated costs. Most NDCs, goals. Second, developing countries are not incentivized though, focus on a country’s contribution to reaching through sovereign borrowing rates to improve their ESG the objectives of articles 2.1.a and 2.1.b of the Paris scores. Higher quality information can help reduce the Agreement and do not address Article 2.1.c. A country’s mispricing of climate risks, particularly for developing NDC and other country-level plans such as NAPs and countries, where transparent and reliable information may NBSAPs typically lack quantitative information related currently be more difficult to obtain. to climate or nature-related financial or economic risks The role of nature in a sovereign’s management of except in rare cases over the long term such as plans climate-related risks and opportunities is important. for 2100 or 2050 or an investment pipeline or capital- There is growing awareness that effective climate risk raising plan associated with mitigation and adaptation management requires consideration of interactions at the goals. A framework for sovereigns could address these climate-nature nexus, and the financial implications of shortcomings by providing market-oriented information failing to manage such risks. Indeed, finance ministries about the investment requirements for meeting the and central banks are starting to look at how to expand country’s GHG emissions reduction and adaptation and the scope of environmental risks they manage to resilience goals. It could also include the country’s capital- include nature-related risks, including by considering raising plans to finance these investments. interactions at the climate-nature nexus. Emerging As noted in a recently published World Bank paper, examples of countries and investors supporting nature- the integration of sustainability criteria in investment based solutions (NBS) are beginning to show how such decision making has been partially driven by the investments can help to reduce future financial losses from growing demand for the financial sector to play a climate impacts. NBS are defined as “actions to protect, greater role in the transformation of the current sustainably manage, and restore natural or modified economic model into a more sustainable one. Despite ecosystems that address societal challenges effectively the growing adoption of sustainable investing practices in and adaptively, simultaneously providing human well- the corporate bond and equity space, market participants being and biodiversity benefits.” NBS and ecosystem continue to grapple with how best to adapt their ESG services are worth an estimated US$125 trillion annually, frameworks for sovereign bonds. Analysis indicates that with more than half of global GDP “moderately” or there is broad agreement among sovereign ESG data “highly” dependent on nature-linked activities, according providers on what constitutes a “good” sovereign social to the World Economic Forum. NBS investments include and governance performance but highlight that there is activities such as protecting, managing, and restoring little agreement on what constitutes a good sovereign forests; adopting “regenerative” approaches to agriculture; environmental performance. Analysis found an ingrained building artificial wetlands within cities to reduce flooding; income bias in sovereign ESG scores, which may be managing watersheds to provide clean water; and driving convergence (Gratcheva, Emery, and Wang restoring mangroves to mitigate storm damage. 2021). This has two significant effects. First, an ESG- In summary, sovereign reporting offers benefits to tilted sovereign bond portfolio will inevitably allocate sovereigns, investors, and others. Table 1 shows funds toward richer countries. As a result, ESG investing how a sovereign climate and nature reporting framework may be driving capital away from low-income countries could potentially benefit sovereigns, investors, and other and widening funding gaps to reach climate and nature stakeholders. WHY IS A REPORTING FRAMEWORK FOR SOVEREIGNS NEEDED? <<< 11 TABLE 1 - Potential Benefits to Stakeholders from a Sovereign Climate and Nature Reporting Framework Entity Potential Benefits Sovereigns n Improved access by countries to capital from a broad range of investors n Better internal understanding of climate- and nature-related risks that could affect the country’s future, could have governance benefits, and ultimately impact the cost of capital n Equipping a country with the ability to shape the narrative on its risk management and opportunities n Improved ability for countries to identify, prioritize, and invest public capital in ways that will enhance resilience n Setting of example to help spread private sector sustainability reporting Investors n Improved ability to price climate- and nature-related risk more accurately n Improved ability to identify opportunities to invest in adaptation and resilience projects and services n Improved information on which to engage with sovereigns to encourage improved risk management and realization of opportunities Other actors n Better information about credit risks affecting the country, subnational entities, (e.g., credit rating and corporates agencies) n Better visibility on steps countries take that can enhance their resilience and attract capital from investors Source: World Bank. 12 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK >>> What Is Required to Develop a Reporting Framework for Sovereigns? How Can Existing Frameworks Be Adapted for Sovereigns? Global sustainability and integrated reporting organizations have published a prototype climate-related financial disclosure standard (led by the IFRS Foundation) (IMP 2020). CDP, the Climate Disclosure Standards Board, the Global Reporting Initiative, the International Integrated Reporting Council, and the Sustainability Accounting Standards Board (SASB), together with the IFRS, have coauthored an illustration of how their current frameworks, standards and platforms, and the structure of the TCFD framework can be brought together to provide a foundation for the development of global corporate sustainability standards. Based on the adoption and implementation of existing corporate-focused recommendations by companies and investors, there is an argument that the existing frameworks, which are based on the four pillars of governance, strategy, risk management, and metrics and targets, could be applied to sovereign issuers as well with appropriate modifications. Box 3 outlines how the existing recommendations for organizations could be adapted for sovereign climate- and nature-related disclosure. Investors and other stakeholders interested in understanding climate-related financial and economic risks of sovereigns, particularly those with a sustainability investment strategy, will want to know, for example n The physical and transition risks the country is exposed to on a variety of time horizons (today, tomorrow, in five years, and future points in time such as 2030, 2040, and 2050); n The rate of change of these risks under different warming and policy scenarios; n The country’s vulnerability and exposure to economic, financial, and fiscal ramifications of the physical and transition risks; n The physical and financial mechanisms in place to reduce vulnerability to losses and damages; n The level of exposure of key industries to transition risks such as changes in policy, technology, and consumer preferences; n The potential secondary effects of a physical risk shock to the country; n The level of awareness of the country’s leadership of the country’s exposure to climate- related risks, the availability to national leadership of mechanisms for assessing and monitoring these risks, national leadership’s understanding of changes in risk profile, WHAT IS REQUIRED TO DEVELOP A REPORTING FRAMEWORK FOR SOVEREIGNS? <<< 13 and its use of such information in policy making and n The ways in which addressing these risks can help budgetary planning; sector and economic growth; and n The ways in which the country’s sustainability and n The country plan’s for mobilizing private investment climate goals address these risks; to meet its climate and nature targets. n The financial investments required to address these risks; BOX 3 - How the Existing Corporate-Focused Frameworks Could Be Adapted for Sovereign Climate- and Nature-Related Disclosure The existing recommendations are structured around four thematic areas that represent core elements of how organizations operate: (a) governance, (b) strategy, (c) risk management, and (d) metrics and targets. These pillars could be adapted for sovereign climate- and nature-related reporting. Governance. Disclose the sovereign’s governance around climate-and nature-related risks and opportunities, more specifically: n Describe the sovereign’s governance arrangements around climate- and nature-related risks and opportunities, including which ministries are tasked with identifying, assessing, quantifying, and managing climate- and nature-related financial and economic risks the sovereign faces n Describe government’s role in assessing and managing climate- and nature-related risks and opportunities, including which policy or governing bodies (Parliament, executive, or presidential offices) are responsible for guiding the work of ministries in managing climate- and nature-related risks and capturing opportunities to address climate- and nature-related risks (transition, physical, liability) Strategy. Disclose the actual and potential impacts of climate- and nature-related risks and opportunities on the sovereign’s economy, key economic sectors, and overall financial conditions. Disclose the strategy and financial planning a sovereign may take to address such issues, including national planning and financial management, more specifically: n Describe the climate- and nature-related risks and opportunities the sovereign has identified over the short, medium, and long term n Describe the resilience of the sovereign’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario for transition risk and current warming trajectories for physical risk Risk Management. Disclose how the sovereign identifies, assesses, and manages climate- and nature-related risks, including which ministries are responsible for ongoing risk assessment and tracking, more specifically: n Describe the sovereign’s processes for identifying and assessing climate- and nature-related risks n Describe the sovereign’s processes for managing climate- and nature-related risks n Describe how processes for identifying, assessing, and managing climate- and nature-related risks are integrated into the sovereign’s overall risk management, financial management, and economic planning Metrics and Targets. Disclose the metrics and targets used to assess and manage relevant climate- and nature-related risks and opportunities where such information is material, more specifically: n Disclose the metrics used by the sovereign to assess climate- and nature-related risks and opportunities in line with its country strategies (NDCs, NAMAs, NAPs, NBSAPs) and risk management process n Disclose sectoral and, if appropriate, trade-related GHG emissions and the related risks n Describe the targets used by the sovereign to manage climate- and nature-related risks and opportunities and performance against targets, and the ways in which such targets are aligned with its NDC n Disclose limits or thresholds for climate and nature-related criteria aligned with ecological boundaries than $NZ 250 million; and Source: Climate Finance Advisors 2021; TCFD 2017. Note: NAMA = nationally appropriate mitigation action; NAP = national action plan; NBSAP = national biodiversity strategy and action plan; NDC = nationally determined contribution. 14 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK What Are the Information Needs and practicalities of reporting including the proposed scope, what specific information would be sought, who could lead Who Are the Parties Responsible for this work, and who should be involved. Providing the Information? Information needed could include (both physical and The information needed for sovereign climate transition risks): and nature reporting could largely be drawn from existing sources. The information needed to deliver an n Baseline information about climate-related risks and informative sovereign climate and nature report is largely the resulting vulnerability to a country or sovereign, already available. Such information is already produced including information related to concentration of risks by the sovereign entity through various ministries (finance among certain economic sectors, geographies, or and planning ministries) or is available through derivative communities, and how these risk scenarios evolve sources of information such as the World Bank Sovereign over different warming scenarios and the financial ESG Data Portal (World Bank 2019) or IMF consultations and economic implications under different policy that include climate considerations.4 scenarios. For all baseline information, back-casting may be important to track the rate of change or It is anticipated that responsibility for preparing the acceleration of risks against the baseline; report will be assigned to the Ministry of Finance, with involvement from the Debt Management Office n Information about sovereign strategies (governance, (DMO). The DMO is in effect the state’s banker and usually risk management, and metrics) to address climate- conducts interactions with investors. This assignment related financial risks, including NDCs, NAPS, would allow for reporting and scenario analysis to draw on NAMAs, NBSAPs, and other sector-specific information generated by other fiscal processes that may be strategies that identify approaches and investments integrating climate-related criteria in parallel, such as IMF that manage and mitigate climate-related risks (both Financial Sector Assessment Programs (FSAPs) and Article physical and transitional); IV reviews. Additionally, programs like the World Bank’s Country Climate and Development Reviews (CCDRs) could n Information that supports an assessment of double also serve as critical input. Considering climate- and nature- materiality – both financial and sustainability. There related data with the same rigor and attention as economic is a broader scope of risks that are material for data could result in relevant risks and opportunities being sovereigns as compared to corporates, and these mainstreamed in economic calculations and decision may be difficult to quantify or prove financially making. Links could also be made with broader budget material, but they may be equally important to track in tagging and public reporting initiatives. terms of how a sovereign manages both vulnerability and exposure to climate change, particularly given Coordination would likely be challenging as the entity the threat multiplier effect of climate change on other within government leading the reporting would need issues like poverty, migration, and security; to have both a very good understanding of climate and nature and of economics and finance, with these two n A country’s policies and management of its natural areas of expertise usually residing in different teams. resources and nature-based resources that can New information might also be required that would require reduce vulnerability; however, failing to invest in specific coordination with the appropriate content providers, nature-based solutions can exacerbate vulnerability and in certain cases appropriate technical assistance or and exacerbate overall climate risk; funding. Any framework developed should consider the 4 IMF Article IV consultations aim to “promote the stability of member economies, as well as the effective operation of the international mon- etary system, including through maintaining global stability.” The integration of climate change into article IV consultations can serve as an important reference for the country, including as reference information for sovereign reporting. It should be noted, however, that these consultations do not take place every year, and not all article IV consultation reports are publicly available. The World Bank and IMF work together on three areas: debt sustainability analyses, FSAPs—another part of surveillance reports—and the Highly Indebted Poor Country program. A fourth collaboration was launched as a pilot in 2017: climate change policy assessments. The IMF has indicated that it intends to make these initiatives available to all countries as part of their efforts to integrate climate change into their consultations with members, a move that has received external support. 5 World Bank processes such as the CCDRs may not be the only processes that could be leveraged. Others include initiatives run by the UN, OECD, and other international organizations. WHAT IS REQUIRED TO DEVELOP A REPORTING FRAMEWORK FOR SOVEREIGNS? <<< 15 n The impact of addressing climate-related risks information needed for a disclosure by a sovereign (physical and transitional) in increasing sustainability entity. Table 2 outlines several key documents and overall, and consequently, a government’s ability existing sources of information that can be useful input to generate revenues to repay its debt, which may for a sovereign report, along with the ministry or agency become a key driver of sovereign credit ratings within a government typically responsible for producing and sovereign bond returns. Just as degradation of such information. It is likely that information from across natural assets can give rise to risks for sovereign debt different ministries and agencies will be necessary for any holders, careful stewardship of natural capital has the comprehensive sovereign disclosure. Note that many of potential to yield beneficial outcomes; and the suggested sources of information are still evolving, while many governments are still learning how to prepare n The metrics and targets that the sovereign intends to them and discerning the limitations they have while use to measure its progress going forward. collecting relevant information. Similarly, the process of In this context, there are several existing policies, preparing a credible report would need to be refined over sources of information, and processes, such as a few iterations, helping to identify the best sources of the NDC process or the IMF Article IV process, that available information over time. These sources of available can be leveraged to gather or give guidance on the information might also differ between governments. TABLE 2 - Key Documents and Existing Sources of Information That Can Serve as Input to a Sovereign Report Sovereign’s existing plans, publications, and other sources of information useful for Ministry or agency commonly responsible a TCFD-aligned disclosure for producing these reports* Country climate strategies and international Environment, finance, foreign ministries commitments n NDCs n NAPs n NAMAs Nature-based strategy and international commitments Environment ministries n NBSAPs n Natural capital accounting, wealth accounting Financial and economic assessments Finance ministries, DMOs n Fiscal headroom, macroeconomic health (GDP, Perhaps some sector-oriented ministries relevant income per capita) for exposure to transitional and physical risks n FSAPs (energy, agriculture, etc.) n Sector concentration related to economic growth, productivity Information important for sovereign bond issuances Finance ministries, DMOs n GDP growth, economic development trends n Per capita income n Inflation n External debt, history of default n Political volatility Climate vulnerability and exposure Environment, disaster/aid, finance ministries n Climate-related hazards expected to impact country Perhaps some sector-oriented ministries (energy, (acute, chronic) agriculture, etc.) n Vulnerability assessments n Disaster-related assessments (loss and damage) Source: World Bank. Note: DMO = Debt Management Office; FSAP = Financial Sector Assessment Program; NAMA = nationally appropriate mitigation action; NAP = national action plan; NBSAP = national biodiversity strategy and action plan; NDC = nationally determined contribution; TCFD = Task Force on Climate-Related Financial Disclosure. * Other ministries and agencies may potentially have primary responsibility for these reports. 16 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK Among the more important elements of a disclosure will and disclose their plan in the short, medium, and be the need for information to be provided on a regular long term. Sovereigns would be well served to note the and ongoing basis. Current processes such as the NDCs or challenges that corporates and investors have faced in (for emerging markets) country strategies may be produced handling scenario analysis for reporting and the benefits only every three or five years (or longer). Significantly, of adopting a standard set of scenarios and analytic disclosures of any form typically present information in a methodologies that can serve as “best practice” for snapshot in time, and such information is typically backward- climate-related disclosures by sovereigns. looking. Existing corporate-focused frameworks not only An important benefit of any framework is that as a recognize that climate-related risks need to be understood disclosure mechanism, it not only provides information as they are in any given moment but also recognize that for specific types of uses but also informs the risk forward-looking analysis will be important. management of other stakeholders. Given that the A key challenge for any sovereign will be the use function of risk management ideally is an ongoing process, of scenario analysis to identify, assess, analyze, it is important that any approach to disclosures both apply BOX 4 - International Public Sector Accounting Standards Board (IPSASB) IPSASB, an independent board of 18 public sector finance experts, develops and maintains the only global financial reporting standards for the public sector. A range of existing IPSASB guidelines can support sustainability reporting by considering long-term projections on public sector finances and service performance information. IPSASB’s three RPGs are all relevant in the context of climate risk analysis: n Reporting on the long-term sustainability of an entity’s finances (RPG1) provides guidance on broader disclosures about long-term fiscal sustainability and includes guidance on the projection of inflows and outflows based on assumptions regarding policy decisions, future economic conditions, and other conditions. FIGURE B4.1- Costa Rica Data Snapshot (WBCSD 2018) Past cash flows Future cash flows Present economic benefits realized in the future (assets) Inflows Assets obtained and realized to date Expected resources to be settled in the future Expected obligations to be Outflows settled in the future Liabilities incurred and settled to date Present economic sacrifices settled in the future (liabilities) n Financial statement discussion and analysis (RPG2) recommends the provision of information on the external trends, risks, and uncertainties that are impacting or may impact a public sector entity’s financial position, financial performance, and cash flows. n Reporting service performance information (RPG3) provides good-practice recommendations on reporting information on the services that a public entity provides, its service performance objectives, and the extent of its achievement of those objectives. Climate change is relevant to the extent that it is affecting or may affect the services performed by the sovereign entity and the extent to which it is achieving its service performance objectives. In addition to this guidance, IPSASB is now developing guidance on financial reporting on natural resources, which include subsoil resources, water, and living resources (plants and animals). The board plans to issue a consultation paper on this topic at the end of the first quarter of 2022. Source: IPSASB 2020. Note: RPG = recommended practice guideline. WHAT IS REQUIRED TO DEVELOP A REPORTING FRAMEWORK FOR SOVEREIGNS? <<< 17 scenario analysis and be made available on a frequent and developed for sovereign climate- and nature- risk and regular basis for users to be able to track changes in risk, opportunity reporting should include both external and see early patterns of accelerating risks, and be able to use internal considerations, also known as double materiality such insights to enable better forward planning. (discussed further in box 5) and the inclusion of context- based criteria should be considered. Are There Other Potential Approaches to Developing a Sovereign Reporting There is a strong case for nature-related criteria to be disclosed by sovereigns and there are existing Framework? frameworks for natural capital accounting that could The IPSASB, an independent, nonprofit organization be used. A country’s natural assets are critical to its that works to improve public sector financial economic growth and stability, and therefore, should be reporting by developing international financial accounted for and appropriately managed. In his landmark reporting guidance for the sector, has pointed to report, “Review of the Economics of Biodiversity,” Partha the benefit of accrual accounting by governments Dasgupta characterized the biodiversity crisis as an “asset and other public sector entities around the world. management problem” (Dasgupta 2021). The interaction Consolidated government and public sector balance sheet between climate change and natural assets is increasingly information serves as a foundation for assessing long- relevant for sovereign bond investors, as the climate and term financial sustainability in combination with projected biodiversity crises advance, create feedback loops, and inflows and outflows based on assumptions regarding reduce overall resilience. Natural capital accounting (NCA) policy decisions, future economic conditions, and other is a tool that countries can use to better measure their conditions such as those related to climate change. Box 4 natural assets and integrate them into national planning includes a summary of the work of IPSASB (IFAC 2020). and development decisions. While natural capital accounts can take time to develop, there are emerging geospatial Context-based performance accounting and reporting and machine learning tools that estimate the value of frameworks could offer a more holistic sustainability ecosystem services in a given area. Estimates of the value performance assessment. To fully understand the of a country’s natural assets would be a critical component creditworthiness or quality of an investment opportunity,6 of sovereign climate and nature reporting, which can build investors must be given a view of not just how entities on stocks and flows and provide information on investment cope with risks (climate change, ecosystem loss) from and management approaches. It is possible that this the outside world, but also of the risks (GHGs relative to reporting may drive governments to integrate their natural threshold-based and science-based targets and goals) capital accounts into their national financial accounts as posed by its impact on the outside world. Context-based the United Kingdom has done (HMT 2011). approaches intrinsically address materiality and inherently extend the reporting boundaries to include external as well The most commonly used NCA approach is the UN as internal risks and opportunities. Particularly because System for Environmental Economic Accounting sovereigns are such large actors (as compared to (SEEA) framework, which is already being implemented corporates), their potential impact on and exposure to the in more than 89 countries (its implementation environment (both local and global facets) is potentially is planned in a further 27 countries) (UNCEEA significant. Additionally, their economic stability is directly 2020). The SEEA framework integrates economic and linked to social and environmental factors. A study by the environmental data to provide a more comprehensive and University of Leeds (O’Neill et. al. 2018) shows how such multipurpose view of the interrelationships between the sovereign context-based indicators might be developed. economy and the environment and the stocks and flows The study downscales four planetary boundaries of environmental assets. It contains standard concepts (climate change, land-system change, freshwater use, agreed upon internationally, definitions, classifications, and biogeochemical flows) to per capita equivalents accounting rules, and tables for producing internationally and compares these to footprint indicators at the comparable statistics, accounts, and indicators with many national scale. Regardless of methodology, a framework different potential analytical applications. The United 6 For a summary of the context-based approach to materiality, see McElroy (2019) and Thurm et al. (2018). 18 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK Nations Statistics Division adopted the SEEA Ecosystem provides support to countries to implement natural capital Accounting at its 52nd session in March 2021. This adoption accounting and aims to promote sustainable development follows a comprehensive and inclusive process of detailed by ensuring that natural resources are mainstreamed in testing, consultation, and revision. Ecosystem accounts development planning and national economic accounts. have already been used to inform policy development GPS brings together a broad coalition of UN agencies, in more than 34 countries (UNCEEA 2020). The World governments, international institutes, nongovernmental Bank-led Global Program for Sustainability (GPS)7 organizations, and academics to implement NCAs where there are internationally agreed standards and to develop approaches for other ecosystem service accounts. Flooded streets in Houston, Texas, USA after Hurricane Harvey. Credit: Shutterstock 7 The Global Program for Sustainability (GPS) promotes the use of high-quality data and analysis on natural capital, ecosystem services, and sustainability to better inform decisions made by governments, the private sector, and financial institutions. See https://www.worldbank.org/ en/programs/global-program-on-sustainability. WHAT IS REQUIRED TO DEVELOP A REPORTING FRAMEWORK FOR SOVEREIGNS? <<< 19 Swedish forest. Credit: Shutterstock >>> How Is Materiality Important in Driving a Reporting Framework for Sovereigns? An important concept for any reporting framework is materiality. In existing corporate- focused recommendations, the TCFD noted that under its remit from the Financial Stability Board, “any disclosure recommendations by the task force would be voluntary, would need to incorporate the principle of materiality, and would need to weigh the balance of costs and benefits” (TCFD 2017). In the recommendations, the TCFD recognized “that most information included in financial filings is subject to a materiality assessment” and underscored the need to provide disclosure at least with respect to governance and risk management in annual financial filings. [Because] climate-related risk is a nondiversifiable risk that affects nearly all industries, many investors believe it requires special attention. For example, in assessing organizations’ financial and operating results, many investors want insight into the governance and risk management context in which such results are achieved. The task force believes disclosures related to its governance and risk management recommendations directly address this need for context and should be included in annual financial filings. For disclosures related to the strategy and metrics and targets recommendations, the task force believes organizations should provide such information in annual financial filings when the information is deemed material (TCFD 2017). In existing corporate-focused recommendations, the TCFD noted that organizations should consider climate-related materiality consistent with existing approaches to materiality in regulated financial filings (TCFD 2017). In general, materiality as used by preparers, auditors, and users of financial information is widely understood as related to information that is “decision-useful for the reasonable investor.” Climate change and the health of a country’s ecosystems could be considered a potentially significant factor for a sovereign’s future financial and economic health and thus “material.” As the World Bank recently noted: Risks thought to be financially immaterial in the past are quickly becoming material. Climate change analysis shows that financial markets are not efficient when there are significant externalities such as the impact of greenhouse gas emissions and biodiversity loss on societies and the global economy. Financial sector actors seeking to get ahead of the curve should consider what they expect to be material in the future, as actors in the public and private sectors work together globally and locally to create more efficient HOW IS MATERIALITY IMPORTANT IN DRIVING A REPORTING FRAMEWORK FOR SOVEREIGNS? <<< 21 markets for sustainable investment rather than consider these factors along a spectrum that is shifting merely what they can prove to have been financially (dynamic materiality).8 material under inefficient markets. One category A double materiality and context-based reporting of risks that merits special attention is systemic approach that uses a dynamic materiality lens could risk, described by the Green Swan report (Bolton be considered for a sovereign climate and nature et al. 2020) as “potentially extremely financially reporting framework (see box 5). It is recommended disruptive events that could be behind the next that the consultation process thoroughly consider systemic financial crisis” (World Bank 2020). including information related to a sovereign’s impact on Material information is widely considered to include the climate and nature in the framework. Performance any information whose omission would make a against global thresholds, such as the nine planetary difference in the decision an investor takes regarding boundaries (Stockholm Resilience Center n.d.), and investment in an asset or security. The “materiality” of allocations, such as emissions per capita, should be various climate and nature-related criteria will need to be discussed as potential approaches for sovereigns assessed in order to ensure that a sovereign climate and to report information in a context-based way. The nature reporting framework best enables effective capital application of a dynamic materiality lens may allow allocation and engagement by investors. Some investors the architects of the framework to identify criteria that may consider both financial and sustainability materiality are likely to become material (for both sovereigns and in determining relevant factors for their investment investors) in the short to medium term, even if they are decision making (double materiality), and they may not in the current economic environment. 8 With guidance from the IFRS Foundation, SASB is considering the concept of “dynamic materiality” adopted by five sustainability reporting standards organizations in their report, “Statement of Intent to Work Together Towards Comprehensive Corporate Reporting,” which refers to the concept that what investors consider to be material ESG issues can change over time (Eccles 2020). For further information, see Kuh et al. 2020. 22 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK BOX 5 - Double and Dynamic Materiality Double materiality: perspective from the European Commission In its “Guidelines on Nonfinancial Reporting: Supplement on Reporting Climate-Related Information” issued in 2019, the European Commission noted the following: “According to the nonfinancial reporting directive, a company is required to disclose information on environmental, social, and employee matters, respect for human rights, and bribery and corruption to the extent that such information is necessary for an understanding of the company’s development, performance, position, and impact of its activities. Climate-related information can be considered to fall into the category of environmental matters.” In the guidelines, the European Commission adopted a “double materiality” perspective: n The reference to the company’s “development, performance, [and] position” indicates financial materiality in the broad sense of affecting the value of the company. Climate-related information should be reported if it is necessary for an understanding of the development, performance, and position of the company. This perspective is typically of most interest to investors. n The reference to the “impact of [the company’s] activities” for an understanding of the external impacts of the company. This perspective is typically of most interest to citizens, consumers, employees, business partners, communities, and civil society organizations. An increasing number of investors also need to know about the climate impacts of investee companies, though, in order to better understand and measure the climate impacts of their investment portfolios. Companies should consider using the proposed disclosures in these guidelines if they decide that climate is a material issue from either of these two perspectives. FIGURE B5.1- Representation of Double Materiality DOUBLE MATERIALITY Financial Materiality Environmental Materiality The impact of biodiversity on a The impact of a company’s company’s development, activities on biodiversity performance, and position Companies’ impact on biodiversdity can be financially material and systemic Green Swans Source: World Bank 2020, adapted from EU 2019. Dynamic materiality: perspective from the World Economic Forum The concept of dynamic materiality, popularized by the World Economic Forum (WEF) in 2020, emphasizes that there is a path for issues to become financially material over time, due to triggers. WEF looks at materiality as a process that unfolds, often very rapidly. According to this perspective, what appears financially immaterial today can quickly prove to be critical to corporates (or sovereigns) in the near future. The COVID-19 pandemic and the resulting economic crisis have illustrated how quickly and dramatically the economy can change. Indeed, double materiality and dynamic materiality are interrelated concepts representing different aspects of the same process. Dynamic materiality is the phenomenon that moves issues along the continuum from financially or economically nonmaterial to material. Source: European Union 2019; World Economic Forum 2020. HOW IS MATERIALITY IMPORTANT IN DRIVING A REPORTING FRAMEWORK FOR SOVEREIGNS? <<< 23 Kelp fishing. Credit: Shutterstock >>> What Is the Potential for Unintended Consequences? Ideally, a deeper and more common understanding of both physical and transition climate and nature-related risks should result in better policy outcomes and better pricing signals from financial markets, not only from sovereign bond investors but also ratings agencies, insurance providers, and other financial institutions, including banks. Climate- and nature-related disclosures are key to such policy and pricing signals. At the same time, improved information on and attention paid to climate and nature-related risks could lead to capital flight, particularly from Emerging Market and Developing Economies (EMDEs). Improved information on and increased attention paid to climate risks in EMDEs could be harmful to highly vulnerable communities and countries if they result in the perception of increased sovereign risk by financial market actors. EMDEs as well as certain cities and localities, many of which are already vulnerable due to poor quality of infrastructure, lack of economic development, and poor governance, are at particular risk. Capital flight could lead to significant headwinds for economic development, poverty alleviation, and growth, potentially even causing dislocation and migration in these places (CFA and GCA, 2019). Under these circumstances, the public balance sheets (of sovereigns, and to some extent of their donors and providers of development aid) would bear these risks ex-post if left unaddressed ex-ante. Emerging evidence indicates that climate-related risks have already started to influence the cost of capital, as evidenced by changes in sovereign bond spreads and credit ratings (Buhr et al. 2018, Volz et al. 2020). While there is a risk that sovereign climate and nature reporting could lead to an increased perception of risk in some countries, it is also possible that reporting could decrease the perception of risk if it is able to effectively integrate adaptation and resilience criteria into financial market analysis. Currently, financial markets have much better access to information on climate risks than on actions countries have taken to mitigate and manage these risks through investment in adaptation and resilience (Buhr et al. 2018, Volz et al. 2020, World Bank 2019). Climate models are global, while adaptation and resilience actions are local. To the extent that information on adaptation and resilience actions by different countries is publicly available for investors and credit ratings agencies to review, it is not communicated in a regular, standardized, or comparable way (Aguilera et al. 2020). Climate and nature reporting can enable sovereigns to articulate their approach to managing relevant risks and give them greater ownership of the risk narrative presented to investors. Currently, ESG data providers have a great deal of control over the climate risk information and narratives that investors use to assess sovereign risk (Gratcheva, Emery, WHAT IS THE POTENTIAL FOR UNINTENDED CONSEQUENCES? <<< 25 and Wang 2021). Reporting by sovereigns can help to downside of such risk being better integrated into financial address the adaptation and resilience information gap markets. Simultaneously, these actors can develop so that these actions are considered by financial markets national plans to invest in adaptation and resilience and alongside risk information. The World Bank’s Resilience communicate these plans to investors through reporting. Rating System and System-Level Resilience Assessment Investors are increasingly looking for opportunities for could serve as frameworks to help governments identify their investments to contribute to positive impact, aligned relevant adaptation information to report (World Bank with achieving the sustainable development goals. 2021b, Rozenberg et al 2021). Steps taken to conserve Table 3 summarizes potential risks of sovereign climate and restore nature should be communicated alongside and nature reporting. A tiered reporting approach could climate adaptation and resilience actions, as such policies be developed, by which countries could start reporting and investments can help to mitigate both climate- and immediately with the information they have and work their nature-related risk. way up to more in-depth and comprehensive reporting over time. As physical risk, adaptation, and resilience Since the outcome of sovereign climate and nature data is relevant for all countries, sovereign data on reporting on risk perception is uncertain, it will be critical various criteria should be assessed within the context of a for governments, their donors, multilateral development country’s income level. banks, and partners to be prepared to manage the TABLE 3 - Summary of Potential Risks of Sovereign Climate and Nature Reporting Entity Potential Benefits Sovereigns n Greater capital outflows when climate- or nature-related risks are officially identified n Harmonized TCFD scenarios may differ from government’s own views of the future trajectories of emissions n Despite appealing plans for investment, there may be limited human or technical capacity and access to capital may leave countries under-invested in key areas Investors n Stranded assets in areas that are understood to face higher climate and nature risks (floodplains, uninsured assets) n Increased visibility of opportunities may attract more investor interest and capital, pushing up prices for these investment targets and lowering financial returns Other actors n Greater visibility of climate and nature-risks could make it more difficult for subnational entities such as cities to raise capital or put pressure on companies to disclose and explain how they are managing those risks to their investors n Incumbent actors who see the current system as working—it just needs more political will—may see problems with adding more paperwork rather than more investment capital 26 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK >>> What Are the Recommended Next Steps to Developing and Implementing a Reporting Framework for Sovereigns? Efforts to develop a sovereign climate and nature reporting framework should be closely aligned with ongoing work to develop global, harmonized international sustainability standards for corporates. The key stakeholders involved in the process of developing baseline, global sustainability reporting standards (including the IFRS Foundation and IOSCO) have recognized that, while starting with the private sector is necessary to progress with the speed and urgency needed, standards will also eventually be needed for a broader set of issuers, including public sector entities. Institutions that have public sector expertise such as the World Bank and IPSASB are already engaged as observers in the process around the proposed establishment of the International Sustainability Standards Board (ISSB), under the IFRS Foundation structure and plan to continue to provide input on the public sector perspective as the standards themselves are developed. This will allow the standards to be informed with as broad a user base as possible in mind from the start, despite the capital markets focus proposed for the ISSB. Once the ISSB standards are more developed, IPSASB together with other partners could draw on its public sector standard-setting experience to determine, through a consultative process, how such standards could be adapted for public sector issuers. There are a number of important stakeholders who are well positioned to feed into the consultation process led by IPSASB, including governmental networks such as the Coalition of Finance Ministers for Climate Action and the G20 Sustainable Finance Working Group; international standard setting organizations like the TCFD, TNFD (Task Force on Nature-Related Financial Disclosures), IFRS, and IOSCO; international organizations including the IMF and World Bank, the UN, those UN agencies supporting the UNFCCC and Paris Agreement, and the OECD; and national standard setters who are starting to develop or apply international guidance for their own jurisdictions. A multistakeholder group could be convened to contribute to the framework development process to ensure its credibility, robustness, and effectiveness at meeting desired objectives. These stakeholders can also help to ensure that the framework can be effectively implemented and that the information and metrics are already available or can be developed. Lessons learned from corporates and other entities that report according to the existing frameworks will be relevant. The benefits of a more standardized approach to enable comparability and the challenges associated with limitations in current information sources will WHAT ARE THE RECOMMENDED NEXT STEPS TO DEVELOPING AND IMPLEMENTING A REPORTING FRAMEWORK FOR SOVEREIGNS? <<< 27 need to be balanced. The group could also coordinate Over the longer term, assistance will be needed. This with the G20 Sustainable Finance Working Group, which help would be in areas such as building capacity in the highlights reporting in its sustainable finance road map.9 Ministry of Finance or DMO functions of the sovereign As the users of this framework, investors should also to enable ongoing climate-risk management and be engaged. Ceres and UN Principles for Responsible disclosure; undertaking benchmarking, baselines, or other Investment have already formed a group of investors assessments (which may not be in place) to understand committed to working on this topic—the Assessing the existing climate- and nature-related financial risks Sovereign Climate-related Opportunities and Risks facing a sovereign; help in translating climate- and nature- (ASCOR) project—that could be consulted. related risk assessments (both physical and transitional) into country investment strategies, particularly for the Pilots could be identified to test a draft sovereign low-carbon, nature-positive transition; ensuring that the reporting framework and to determine the potential role of nature-based solutions are included in sovereign structure of complementary technical assistance for investment pipelines and overall resilience efforts; and, countries. Trialing the framework in jurisdictions with by using such assessments to inform budget planning, different contexts, including through joint World Bank strategies to raise capital and the more effective use of pilots with other multilateral development banks such development and disaster aid, particularly by developing as the Inter-American Development Bank, the Asian countries. Existing programs within development finance Development Bank, the African Development Bank, and institutions may be well suited to provide the necessary the European Bank for Reconstruction and Development technical assistance. Examples include the IMF’s Article IV could help refine the structure and approach and ensure Assessments and the World Bank’s Country Climate and its practicality and usefulness. Development Reports (CCDRs). 9 See G20 Sustainable Finance Roadmap and https://www.g20.org/wp-content/uploads/2021/10/G20-Sustainable-Finance-Roadmap.pdf. 28 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK >>> Annex A Draft Sovereign Climate and Nature Risk and Opportunities Reporting Framework Developed by the Finance, Competitiveness, and Innovation Global Practice of the World Bank A draft example of a Sovereign Climate and Nature Risk and Opportunities Reporting Framework developed by the Finance, Competitiveness, and Innovation Global Practice of the World Bank is presented here. Note that the example is included as a starting point for discussion only and is not intended as a template for a standard. Any framework developed should follow an extensive, coordinated, and inclusive consultation process including pilots in client countries that should in no way be constrained or predetermined by the example presented here (Table A.1). TABLE A.1 - Draft Sovereign Climate and Nature Risk and Opportunities Reporting Framework Category Criteria Introduction n Describe the actual and potential impacts of climate- and nature-related risks including physical risks. n Describe the risks and opportunities for the sovereign’s economy (its potential effects, for example, on the main sources of revenue and debt and on the real sector and financial sector) and society. n Provide physical and economic data on the country’s natural assets, including information on the bioregions of the country. Provide relevant metrics (to the extent that they are available) on the health of bioregions (these metrics can be related to ecosystem func-tionality or biodiversity). Governance n Describe whether the sovereign has committed to or ratified international The sovereign’s climate change and other environmental agreements, including the UNFCCC govern-ance systems Paris Agreement, the Convention on Biodiversity, the UN Convention to Combat around climate and Desertification, the Convention on International Trade in Endangered Species, or nature relat-ed risks other relevant conventions. and opportuni-ties n Describe the sovereign’s policies, regulations, and laws related to climate and nature-related risks and opportunities, including those concerning clean energy targets, carbon pricing, energy sector reforms, agriculture and land use reforms, biodiversity conserva-tion, payments for ecosystem services programs, restoration, and other relevant climate or environmental areas. Provide dates on when various legislation was passed and when programs were implemented. ANNEX A: DRAFT SOVEREIGN CLIMATE AND NATURE RISK AND OPPORTUNITIES REPORTING FRAMEWORK <<< 29 n Describe the specific ministries and departments and units dedicated to coordinating the sovereign’s climate change response and relevant activities, including carbon emissions inventories, national disaster management responses, national resilience action plans, clean technology and clean energy initiatives, nature-based solutions, and climate budget and funding planning. n Describe the specific ministries and departments and units dedicated to coordinating the sovereign’s management of its biodiversity and ecosystem services, including natural capital accounting, environmental regulation, biodiversity offsets, sustainable agriculture initiatives, conservation and restoration initiatives, sustainable use initiatives, payments for ecosystem services markets, public land and waters management, and natural resource extraction. n Describe the role of key stakeholders in the national climate and nature governance structure, including state-owned enterprises (SOEs), regional governments and local authorities, trade unions, NGOs, corporations, indigenous people’s groups, and others. Strategy n Describe the short-, medium-, and long-term exposures of sovereign public and The sovereign’s risks private assets resulting from the physical and transition risks of climate change. and opportunities n Describe the sovereign’s short-, medium-, and long-term strategy for managing identified at different biodiversity and natural assets and the exposure from the physical and transition time horizons, the risks of biodiversity and ecosystem services loss. expected impacts, n Describe the economic and fiscal impacts associated with the following scenarios: and the government’s resilience assessment – NGFS Net Zero 2050 (1.5°C in 2050) under different – NGFS Delayed Transition (2°C in 2050) scenarios – NGFS Current Policies (3°C in 2080) – IPCC SSP3 (2.8–4.6°C in 2080–2100, best estimate 3.6°C) n Describe the impact of climate change and biodiversity loss on economic, social, geopolitical, and financial systems such as expected patterns of migration, potential impact on public health and healthcare systems, availability of re- sources for private sector and citizens, food security risk, technology investment gaps, risk to reputation, and ability to raise capital; the need for disaster-related financial protection instruments such as insurance and contingent financ-ing; rent from natural resources; the potential for natural or economic assets to become stranded; fiscal impacts; competitiveness; potential changes in international trade and tariffs; and social stability. n Describe the government’s strategy and agenda to manage climate- and nature- related physical and transition risks. Risk Management n Describe the governmental process for identifying and managing climate- and nature- The processes used related risks and the ways in which risk man-agement is integrated into the sovereign’s by the sovereign to planning documents: NDCs, NAPs, NBSAPs, and other related policy or strategy docu- identify, assess, and ments relevant to climate- and nature-related risks and opportunities. manage climate- n Describe the role of SOEs, regional governments, local authorities, and any other related risks relevant stakeholders in the identification and management of climate and nature- related risks. 30 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK n Describe the sovereign’s approach to taking into consideration climate change- related risks (carbon pricing, energy and forestry sector reforms) and opportunities (clean energy and energy efficiency technologies) in financing publicly funded projects and institutions. n Describe the sovereign’s approach to taking into consideration nature-related risks (agricultural reforms, forestry sector reforms, biodiversity conservation) and opportunities (sustainable agriculture, forestry, and tourism) in financing publicly funded projects and institutions. n Describe the sovereign’s approach to taking into consideration climate- and nature-related risks in its fiscal strategy (budgetary deficit, borrowing strategy, creditworthiness management, compliance with international economic treaties). n Describe how climate change and nature-related risk management is integrated into the government’s strategy related to diploma-cy, defense, economy, and finance. n Describe the sovereign’s participation in partnerships and advocacy for low carbon and resilient pathway for development such as the Coalition for Finance Ministers for Climate Action, the Network for Greening the Financial System, Carbon Pricing Leadership Coalition, the Partnership for Market Readiness, and the Partnership for Market Implementation. Metrics and Targets n Describe the sovereign’s performance against public climate change and nature- A disclosure of related targets. the metrics and n Disclose the sovereign’s targets used by the – Total CO2 emissions (in metric tons); CO2 emissions per capita; CO2 emissions sovereign to assess per unit of GDP; CO2 emissions per sector; CO2 emissions growth rate; net CO2 and manage relevant emissions (for both produced emissions and consumed emissions); and total climate-related risks GHG emissions (metric tons of CO2 equivalent per capita);10 CO2 emissions of and opportunities. imports; progress on CO2 and GHG emissions reductions as percent (emissions in current year versus emissions in base year); – Gross ecosystem product (if measured);11 change in land use specified for each type of land (forest, wetland, coastal, other); percentage of forested land as percent of recommended coverage; hectares of terrestrial and marine protected areas as respective percentages of total territorial area; hectares of areas managed by indigenous peoples (and relative percentage of total territorial area); agriculture, forestry, and fishing, value added (percentage of GDP); and mammal species threatened (as a percentage of total mammal species); and percentage of population with access to green space; and – Annual freshwater withdrawals, total (billion cubic meters, percentage of internal resources, and per capita); renewable internal freshwater resources, total (billion cubic meters, percentage of internal resources); water stress (total water withdrawal and available renewable supply). 10 This is inclusive of carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sul- phur hexafluoride (SF6), and nitrogen trifluoride (NF3). 11 For an example of an approach that could be used, see https://www.pnas.org/content/117/25/14593. ANNEX A: DRAFT SOVEREIGN CLIMATE AND NATURE RISK AND OPPORTUNITIES REPORTING FRAMEWORK <<< 31 n Disclose the actual and planned budget for climate and nature positive activities12 (if any) as a percentage of total budget: – Disclose relevant taxes, subsidies, and direct expenditures on climate and nature positive activities (renewable energy, energy efficiency, climate- smart and sustainable agriculture, green finance, water efficiency, land and forest restoration and conserva-tion, disaster and emergency preparedness, academic research, public funding of research and development); and – Disclose climate and biodiversity funding programs (disclose if earmarked green and climate bonds and loans, sustainability-linked bonds and loans are funds linked to key performance indicators). n Disclose the actual and planned budget for climate- and nature-negative activities13 (if any) and as a percentage of total budget (rele-vant taxes, subsidies, and direct expenditures, including in the energy, agriculture, forestry, fisheries, and waste sectors). n Provide information on the budgets for units in Ministries, departments, and agencies dedicated to coordinating the sovereign’s climate change and biodiversity responses and activities. Note: “Nature” refers to the natural world, with an emphasis on biodiversity and ecosystem services. Nature contributes to societies through the provision of contributions to people. Nature-related risks stem from the dependencies and impacts of countries and communities on nature and its biodiversity through their dependencies (reliance on ecosystem services and natural capital) and through their impacts (positive or negative effects of activity) on nature. GHG = greenhouse gas; IPCC = Intergovernmental Panel on Climate Change; NAP = national action plan; NBSAP = national biodiversity strategy and action plan; NDC = nationally determined contribution; NGFS = Network for Greening the Financial System; NGO = nongovernmental organization; UNFCC = United Nations Framework Convention on Climate Change. United Na- tions Framework Convention on Climate Change. 12 This refers to activities contributing to climate change mitigation and adaptation, biodiversity conservation, restoration, and sustainable use. 13 This means activities contributing to climate change and destruction of nature. 32 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK >>> Annex B: Supplemental Information on Existing Corporate-Focused Reporting Background on Task Force on Climate-Related Financial Disclosures The Financial Stability Board created the Task Force on Climate-Related Financial Disclosures to improve and increase reporting of climate-related financial information at the request of G20 finance ministers and central bank governors in April 2015. The TCFD was tasked with developing a framework and guidance for “voluntary, consistent climate-related financial disclosures” that would be useful to investors, lenders, and insurance underwriters in understanding material risks that are derived from a warming planet. After extensive public consultations in June 2017, the TCFD finalized their recommendations for climate-related financial disclosures, which were structured around four thematic areas as illustrated in figure 2: governance, strategy, risk-management, and metrics and targets. TCFD’s initial target audience were corporates, listed equities, banks, and insurers in the private sector. Over the past few years, the TCFD’s recommendations have become widely recognized as the reference framework for reporting on climate-related financial risks and opportunities, with nearly 60 percent of the world’s 100 largest public companies expressing support for the TCFD framework, actively reporting in line with the TCFD recommendations, or both (TCFD 2020). As of October 6, 2021, TCFD had over 2,600 supporters globally (including 1,069 financial institutions) responsible for financial company assets of US$194 trillion. TCFD supporters now span 89 countries and jurisdictions and nearly all sectors of the economy, with a company combined market capitalization of over US$25 trillion, a 99 percent increase since 2020.14 Such widespread support from a cross-section of stakeholders reinforces both the need for climate-related financial information across a range of users from policy makers and regulators to a variety of investor types and the value of the TCFD framework in enabling transparent, clear, and consistent information about how climate change may impact financial returns and have potentially systemic consequences of economic relevance across communities and markets. 14 ANNEX B: SUPPLEMENTAL INFORMATION ON EXISTING CORPORATE-FOCUSED REPORTING <<< 33 A key challenge for any sovereign will be the use practice” for sovereigns’ climate-related disclosure. Box of scenario analysis to identify, assess, analyze, B.1 outlines emerging approaches recommended by the and disclose their plan in the short, medium and NGFS for undertaking scenario analysis that are relevant long term. Here, the proponents of a TCFD-based for sovereign-level disclosure objectives (TCFD 2021). framework for sovereigns would be well served to note An important benefit of the TCFD framework is that the challenges that corporates and investors have faced as a disclosure mechanism, it not only provides in handling scenario analysis for TCFD reporting and information for specific types of uses, but also informs the benefits of adopting a standard set of scenarios the risk management of other stakeholders. Box B.2 and analytic methodologies that can serve as “best BOX B.1 - Potential Options for Scenario Analysis for Sovereigns Network for Greening the Financial System The Network for Greening the Financial System (NGFS) is a group of 105 members and 16 observers. The NGFS climate scenarios, which were developed with the assistance of a coalition of private, public, and academic institutions, explore the impacts of climate change and climate policy with the aim of providing a common reference framework. Four broad scenarios area considered based on whether climate targets are met and whether the transition pathway is orderly or disorderly: n Orderly assumes that climate policies are introduced early and become gradually more stringent. Net- zero CO2 emissions are achieved before 2070, giving a 67 percent chance of limiting global warming to below 2°C. Physical and transition risks are both relatively low. n Disorderly assumes climate policies are not introduced until 2030. Since actions are taken relatively late and limited by available technologies, emissions reductions need to be sharper than in the orderly scenario to limit warming to the same target. The result is higher transition risk. n Hot-house world assumes that only currently implemented policies are preserved. NDCs are not met. Emissions grow until 2080, leading to 3°C or more of warming and severe physical risks. This includes irreversible changes like higher sea-level rise. n Five alternate scenarios have been produced to explore different assumptions, such as different temperature targets, policy responses, and technology pathways. FIGURE B.1 - NGFS Climate Scenarios Framework Strength of response Based on whether climate targets are met Met Not met Disorderly Disorderly Too little, too late Sudden and unanticipated response is We don’t do enough to meet climate Transition pathway disruptive but sufficient enough to goals, the presence of physical risks Transition risks meet climate goals spurs disorderly transition Orderly Hot house world We start reducing emissions now in a We continue to increase emissions, Orderly measured way to meet climate goals very little, if anything to avert the physical risks Physical risks Source: NGFS 2020. 34 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK BOX B.2 - Private-Sector Tools That May Be Applicable to Sovereigns Private-sector actors have begun to explore scenario analysis for sovereigns and several tools exist that may be applicable and relevant for sovereigns to consider. Since 2010, multiple communities have collaborated on the so-called Shared Socioeconomic Pathway (SSP)-Representative Concentration Pathway (RCP) framework, a set of alternative socioeconomic development pathways (SSPs) and atmospheric concentration pathways (RCPs) with their associated climate change outcomes. However, it has been noted that the SSP- RCP framework has not improved the integration of societal and climate conditions. Following are some initiatives that try to bridge this gap and help provide more comprehensive integration of both climate and societal conditions under different scenarios: n Science-based targets for financial institutions. A financial institution’s submission to the Science-Based Targets Initiative (SBTi) consists of scope 1 and 2 targets and scope 3 portfolio targets that meet SBTi criteria. At the time of target submission, financial institutions submit a brief summary of the strategy and actions it will implement to reach their portfolio SBTs and the reasons why they selected these actions. SBTi’s phase 2 strategy is expected to cover asset classes as they relate to sovereigns. n Four Twenty-Seven and Carbone 4 include the results of their sovereign risk assessments in their company-level analyses. – Four Twenty-Seven includes its country climate risk indicators in the supply chain and market risk analyses of companies, which consider countries contributing to the supply chain and countries where products are sold. – Carbone 4 covers a wide set of risks, many of which are not included in other methodologies. It examines the acute risk of groundwater floods and the chronic risks of urban heat islands, coastal erosion, and biodiversity migration and loss. n Principles for Responsible Investment (PRI) has developed a practical guide to environmental, social, and governance (ESG) integration in sovereign debt. The guide is designed to help PRI signatories integrate ESG factors into the research and analysis of sovereign issuers and the construction of sovereign debt portfolios. n FTSE Russell and Beyond Ratings offer a methodology to assess implied global warming temperatures of countries based on their national commitments concerning climate change mitigation and their NDCs. Building on the NGFS approach, their analysis explores two independent “worst-case” scenarios. Their framework enables a country-level assessment of the physical risk through the lens of a hot-house world scenario, and the transition risk via a disorderly transition scenario. FIGURE B.2 - Overview of the FTSE Russell Methodology 1 COUNTRY CARBON 3 BUDGET Budget TEMPERATURE EQUATION Country vs 2 (including the previous temperature NDC gap gap applied to a COUNTRY global budget) POLICY TARGET (NDC) Source: FTSE Russell 2021; SBTI 2021; UNEP-FI 2019. ANNEX B: SUPPLEMENTAL INFORMATION ON EXISTING CORPORATE-FOCUSED REPORTING <<< 35 outlines additional methodologies and approaches that their strategic planning, risk management, and asset may be employed in a sovereign context and that may be allocation decisions. The TNFD will build upon the structure able to provide additional, assessments of sector or asset and foundation of the TCFD. One way it is different level risks that are more granular. Given that the function from TCFD, however, is that it aims to take a double of risk management ideally is an ongoing process, it is materiality approach, looking at the impact of nature loss important that any approach to disclosures apply scenario on corporations and the impact of corporate activities on analysis and is provided on a frequent and regular basis for nature. The TNFD will build on the analysis of the Science- users to be able to track changes in risk, see early patterns Based Targets Network, which is developing an approach of accelerating risks, and be able to use such insights to that will enable corporations and cities to set science-based enable better forward planning. targets for “an equitable, nature-positive, net-zero future.”16 The development of these targets follows the development Background on Task Force on Nature- of science-based targets for climate.17 The TNFD is aiming Related Financial Disclosures to launch a beta framework in early 2022 with the goal of delivering a final framework by 2023. Such a framework A parallel task force exploring a framework which could feed into the development of a sovereign climate and can assess nature-related risks has been created. An nature reporting framework. initiative to bring together a Taskforce on Nature-related Financial Disclosures (TNFD) was announced in July 2020, The rationale for the TNFD includes the following: with the preparatory phase of the initiative running from September 2020 until June 2021. In June 2021, the TNFD n Nature loss poses material risks and opportunities formally launched to widespread support from financial for the finance sector, while action for nature-positive institutions, corporates, governments, and civil society. transitions could generate up to US$10.1 trillion in The G7 finance ministers and G20 Sustainable Finance annual business value and create 395 million jobs by Roadmap have endorsed the TNFD. The G20 and G7 2030, according to the World Economic Forum. environment and climate Ministers have also recognized n Financial institutions and corporates are demanding the establishment of the TNFD.15 nature-related data and information. TNFD’s framework for nature-related financial risk n Standardizing nature-related disclosures can help management and disclosure may be a necessary shift finance from nature-negative to nature-positive component for any country to produce a comprehensive investments. climate and nature disclosure. The TNFD aims for its framework to enable financial institutions and companies n The TFND complements the Task Force on Climate- to incorporate nature-related risks and opportunities into related Financial Disclosures (TCFD). 15 See https://tnfd.global/ 16 See https://sciencebasedtargetsnetwork.org/how-it-works/what-are-sbts/. 17 See https://sciencebasedtargets.org/. 36 >>> SOVEREIGN CLIMATE AND NATURE REPORTING: PROPOSAL FOR A RISKS AND OPPORTUNITIES DISCLOSURE FRAMEWORK >>> References Aguilera, R. 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