De-Risking Low-Carbon Investments for a Sustainable Future

Low-carbon investments are increasingly seen as a sound business strategy, with many companies recognizing the long-term benefits of reducing their carbon footprint. According to a study, 70% of investors believe that climate change is a significant threat to their investments.

Companies are taking steps to de-risk their low-carbon investments, such as diversifying their portfolios to minimize exposure to specific industries or technologies. This approach can help reduce the impact of technological disruptions or regulatory changes.

By adopting a de-risking strategy, companies can also benefit from the growing demand for low-carbon products and services. A report notes that the global market for low-carbon technologies is expected to reach $1.4 trillion by 2025.

De-risking can indeed help businesses manage their risk exposure, but it's not without its challenges. De-risking can lead to financial exclusion of legitimate businesses and individuals, especially in higher-risk regions, making it difficult for them to access services or products.

Regulators and international organizations have recognized the challenges posed by de-risking and have encouraged financial institutions to adopt risk-based approaches to AML compliance instead.

De-risking decisions are often driven by profitability, with financial institutions choosing to avoid customers that require compliance resources that exceed their current capacity or could expose them to heightened regulatory or law enforcement scrutiny and risk.

The De-Risking Strategy notes that a range of customer bases are affected by de-risking, but focuses in particular on three customer categories: small- and medium-size MSBs, NPOs operating in high-risk foreign jurisdictions, and foreign financial institutions with low correspondent banking transaction volumes.

The illicit finance risks associated with these customers, including money laundering, terrorist financing, and proliferation financing activity, are a key factor in whether accounts can be maintained on a profitable basis.

Here are some of the key risk factors associated with climate-smart infrastructure investments in developing countries:

Investing in low-carbon infrastructure can be a high-risk, high-reward endeavor. High risk implies high uncertainty, and investors typically demand a risk premium, which directly affects the cost of capital.

Private investors in developed countries may be unfamiliar with emerging and developing economies, driving up risk premiums and making projects non-bankable or non-viable. Climate-smart infrastructure investments in developing countries present various risk factors, including political, regulatory, capital market, and technology risks.

Political risk can be a major concern, as countries with unstable political environments or changing energy policy priorities can make investments non-viable. Regulatory risk is another significant factor, with insufficient or contradictory enabling policies, weak legal frameworks, and limited enforcement capacity creating instability.

Investors may be deterred by these risks, but de-risking techniques like tranching can help. Tranching involves dividing investments into separate tiers, each with a different risk-return profile.

Here are some of the key risks associated with low-carbon infrastructure investments:

By understanding these risks, investors can make more informed decisions and develop effective strategies to mitigate them.

De-risking can indeed help businesses manage their risk exposure, but it also presents challenges. De-risking can lead to financial exclusion of legitimate businesses and individuals, especially in higher-risk regions, making it difficult for them to access services or products.

Regulators and international organizations have recognized the challenges posed by de-risking and have encouraged financial institutions to adopt risk-based approaches to AML compliance instead.

The De-Risking Strategy notes that a range of customer bases are affected by de-risking, with small- and medium-size MSBs, NPOs operating in high-risk foreign jurisdictions, and foreign financial institutions with low correspondent banking transaction volumes being particularly impacted.

Profitability is the primary consideration for financial institutions in choosing with whom to enter a customer relationship, with associated compliance costs, available resources, and anticipated revenue also playing a role.

De-risking decisions often consider multiple interlocking factors, with illicit finance risks associated with certain customer types, such as MSBs and NPOs, typically being a key factor in whether accounts can be maintained on a profitable basis.

The De-Risking Strategy minimizes the role that soaring compliance costs and enforcement risks associated with perceived high-risk accounts play with respect to de-risking decisions, instead emphasizing the impact of regulatory requirements and heightened supervisory attention.

Financial institutions may choose to avoid certain customers if a particular jurisdiction or class of customer requires compliance resources that exceed the financial institution's current capacity or could expose the financial institution to heightened regulatory or law enforcement scrutiny and risk.

Here are some key drivers of de-risking decisions:

De-risking is often a response to regulatory pressure, increased compliance costs, or concerns about potential legal and reputational risks associated with certain clients or transactions.

Financial institutions terminate or restrict business relationships with clients to avoid risk, not manage it, in line with the FATF's risk-based approach.

De-risking can involve terminating relationships with clients or discontinuing services to minimize the overall risk to the institution.

Restricting certain types of customers or clients is a key aspect of de-risking, which can also exclude certain products, geographic locations, or industries considered high-risk for money laundering and/or terrorist financing.

Financial institutions like banks, brokers, credit unions, or investment companies reduce their exposure to certain types of customers or business activities perceived as higher risk for ML/TF.

To minimize risk, it's essential to diversify your investments, as seen in the example of spreading investments across different asset classes to reduce exposure to market volatility.

Diversification can be achieved through a mix of low-risk investments such as bonds and high-risk investments like stocks.

Low-carbon investment is a crucial step towards a sustainable future. De-risking low-carbon investments can catalyze additional private capital.

A large electricity storage system in Latin America is a great example of de-risking in action. This project used seawater to store energy, contributing to climate mitigation and adaptation.

The project faced difficulties attracting capital due to associated risks such as acquiring permits and establishing energy contracts. Traditional private investors were hesitant to enter due to these risks.

The Green Climate Fund provided $60 million in direct equity to help cover last-stage development expenses and attract private investment. This investment served as an indicator of quality to private investors, including those that are more risk-averse or less experienced.

With the support of the Green Climate Fund, the project is expected to raise $1 billion from the private sector. This demonstrates the potential of de-risking to mobilize large sums of private capital.

De-risking can make previously risky climate infrastructure projects attractive to private investors. It strategically uses public capital to mitigate investment risks that discourage the flow of private capital.

By leveraging public resources, de-risking can contribute to building a database for leveraging the private sector, facilitate learning, and provide demonstrations. It can also help build investor familiarity with the sector and achieve economies of scale.

De-risking strategies are crucial in investment, and there are several techniques that can help mitigate risk. Customer segmentation is one such strategy, where financial institutions categorize customers based on their risk profile, allowing them to apply different levels of scrutiny and due diligence to higher-risk customers.

Enhanced Due Diligence (EDD) is another de-risking strategy, which involves implementing more rigorous due diligence procedures for customers or transactions that are considered higher risk. This requires additional information and scrutiny, helping to identify potential red flags.

Risk scoring and monitoring can also be used to de-risk investments, by setting up automated risk scoring and continuous monitoring of high-risk users. This allows for real-time identification of suspicious behavior, enabling swift action to be taken.

Terminating high-risk relationships is another effective de-risking strategy, where financial institutions may terminate or avoid establishing relationships with customers or businesses perceived as high risk. This helps to minimize potential losses and protect the institution's reputation.

Here are some de-risking strategies used by Climate Investor Two (CI2):

Geographic restrictions can also be used to de-risk investments, by building stricter verification levels for onboarding users from greylisted countries or emerging markets. Continuous monitoring and periodic review are also essential, to identify and address potential risks before they escalate.

De-risking is a complex issue, but at its core, it's about making informed decisions about risk management. According to Section 6215 of AMLA, de-risking occurs when financial institutions terminate or restrict business relationships due to factors like profitability or regulatory burdens.

To effectively manage risk, financial institutions should implement targeted risk assessments and mitigation strategies. This means considering the specific risks posed by each customer and taking steps to address them, rather than making wholesale decisions about broad categories of customers.

Implementing best practices can help financial institutions manage risk more effectively. These best practices include implementing face authentication checks, adding extra identity and address verification layers, and using behavior pattern monitoring and analysis tools to detect suspicious transactions.

Here are some key best practices to consider:

Risk management is a crucial aspect of any business, and it's especially important for financial institutions to implement robust risk management strategies to prevent de-risking. Implementing face authentication checks periodically or when users carry out specific transactions is a best practice to ensure legitimate user identity.

To further mitigate risk, financial institutions can add extra identity and address verification layers, such as database checks or geolocation, for high-risk users or those from greylisted countries. This can help prevent false positives and high-risk exposure.

Behavior pattern monitoring and analysis tools can also be used to detect and investigate suspicious user transactions. By analyzing user behavior, financial institutions can identify potential risks and take proactive measures to prevent them.

Here are some key risk management strategies to consider:

By implementing these risk management strategies, financial institutions can reduce the risk of de-risking and ensure a more secure and compliant environment for their customers.

De-risking is a crucial aspect of risk management in financial institutions. It involves assessing and mitigating risk in a targeted way, rather than making wholesale, indiscriminate decisions about broad categories of customers.

According to Section 6215 of AMLA, de-risking occurs when financial institutions terminate, fail to initiate, or restrict business relationships with customers due to factors like profitability, reputational risk, or regulatory burdens.

De-risking can be used to mitigate various risks, including money laundering, terrorist financing, and regulatory non-compliance. By avoiding high-risk customers or transactions, businesses can lower the likelihood of non-compliance with AML regulations.

Effective de-risking strategies involve implementing face authentication checks, adding extra identity and address verification layers, and using behavior pattern monitoring and analysis tools. These measures can help detect and investigate suspicious user transactions.

Here are some best practices for implementing de-risking strategies:

By implementing these best practices, financial institutions can reduce their risk exposure and improve their overall risk management.

The Africa Energy Guarantee Facility (AEGF) is a game-changer in risk management. It's a risk-sharing facility that insures and reinsures sustainable energy projects in Africa.

AEGF was created by several public- and private-sector parties, including Munich RE, African Trade Insurance Agency (ATI), European Investment Bank (EIB), and German Development Bank KfW. These organizations have come together to provide a system of backstops and insurance tools to eliminate potential risks faced by energy sector investors.

Primary insurers like ATI assume a portion of the risk related to green energy projects, mobilizing resources from lenders and investors. This is where AEGF comes in, re-insuring primary insurers like ATI to increase their capacity to insure and better address the risks and timelines of green energy projects.

Here's how the AEGF works:

The AEGF is expected to facilitate around $1.4 billion of private investment for energy access, energy efficiency, and renewable energy projects in Africa. This is a significant step towards enhancing access to finance for energy projects in the region.

De-risking is crucial in today's fast-changing world, and one area that's becoming increasingly important is climate and energy.

Rising global temperatures are causing more frequent and intense natural disasters, making it essential to transition to renewable energy sources.

According to the article, 80% of global energy consumption is still reliant on fossil fuels, which is a major contributor to greenhouse gas emissions.

By investing in renewable energy, we can reduce our reliance on fossil fuels and mitigate the effects of climate change.

In fact, a study mentioned in the article found that a 10% increase in renewable energy can reduce greenhouse gas emissions by 5%.

The article also highlights the importance of energy efficiency, with a focus on reducing energy consumption through smart building design and technologies.

According to the article, buildings account for 40% of global energy consumption, making energy-efficient design a crucial aspect of de-risking.

By implementing energy-efficient measures, we can not only reduce our carbon footprint but also save money on energy costs.

The article emphasizes the need for a multi-faceted approach to address the climate and energy crisis, including policy changes, technological innovation, and individual actions.

Individuals can make a difference by making conscious choices about their energy usage and investing in renewable energy sources.

It's essential to understand that de-risking a physical portfolio can take days or even weeks to implement. Having the right tools in place, like an overlay program, can speed up the process and minimize potential regrets.

A plan-level overlay can help clients implement de-risking trades within days or even hours of their decision, ensuring they're not overexposed to a market selloff.

It's essential to have a plan in place to minimize potential regret and Monday-morning quarterbacking of a delayed implementation in the event of market turmoil.

Having the proper tools at the outset, such as an overlay program, can speed up the de-risking process and help clients implement de-risking trades within days - and even hours - of their decision.

The current elevated volatility means that any misstep in positioning comes with a higher potential cost, which is why a plan-level overlay can dramatically lessen this risk.

It's a must-have for many, especially when the main objective is de-risking, as it helps ensure that the plan is not overexposed to a market selloff that could occur between decision and action.

Financial institutions will need to adapt to new regulations, specifically the National AML/CFT Priorities, which may allow them to more efficiently allocate resources and offer services to a broader customer base.

The timeline for FinCEN's issuance of regulations implementing the National AML/CFT Priorities is unclear, so financial institutions will continue to manage their customer bases on a risk basis.

Regulators may expect financial institutions to devote more resources to identified priorities without relaxing their focus on other areas, which could exacerbate the cost and regulatory risk drivers of de-risking.

Financial institutions should carefully consider customer risks and the costs associated with mitigating those risks when making decisions to cease offering services to a particular customer base.