Driving #financeforchange in Malaysia — what the regulators say

This article first appeared in The Edge Malaysia Weekly, on July 12, 2021 - July 18, 2021.
Driving #financeforchange in Malaysia — what the regulators say
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GIVEN its importance to the economy and influence over corporates and individuals, the financial sector plays a crucial role in driving changes for a sustainable future.

In Malaysia, the sector has made some encouraging progress in terms of stepping up to the challenge. Financial institutions, especially the bigger ones, have begun to formulate their long-term strategies towards sustainability. And, increasingly, more of them are encouraging customers to adopt sustainable practices through their lending, underwriting, advisory and so on.

But clearly, more needs to be done and the regulators are making sure of this. Late last month, the Joint Committee on Climate Change (JC3), an initiative co-chaired by Bank Negara Malaysia and the Securities Commission Malaysia (SC), hosted its flagship conference on climate change. Themed “Finance for Change”, the virtual event brought together more than 1,000 participants comprising financial practitioners, policymakers and advocates, with the aim of sharing knowledge, best practices and solutions in tackling climate change.

In an exclusive email interview with The Edge, the JC3 co-chairs — Bank Negara deputy governor Jessica Chew and SC deputy chief executive Datuk Zainal Izlan Zainal Abidin — share their views on a host of issues relating to sustainability and climate change.

 

The Edge: The financial sector is seen by some as the most important agent of change in influencing individual or corporate behaviour when it comes to climate change/sustainability — in that it can help speed up the process of change. Please share your view. As the regulator of the sector, what are Bank Negara’s expectations of the industry on this front? What do you expect of it already at this stage and, say, in the next five years? And are your requirements prescriptive or guidelines-based? Please also share your views on how green/sustainable financing can help support Malaysia’s economic recovery amid the Covid-19 pandemic.

Jessica Chew: Given the central role of the financial sector in the economy, it is indeed uniquely positioned as a key change agent in catalysing the transition to a low-carbon economy. Financial institutions have enormous influence that can be brought to bear in encouraging and supporting individuals and businesses to transition to greener practices. For example, an increasing number of financial institutions globally are taking concrete measures to set and meet targets for emissions reductions in their financing and investment portfolios in line with the Paris Agreement. The strategies that financial institutions adopt to meet these targets will have an important impact on household and business behaviour in a number of ways, including through differential pricing and underwriting approaches, new financing and risk solutions and greater advisory support to households and businesses.

As businesses build back from the impact of the Covid-19 pandemic, financial institutions can and should work with their customers to support efforts to adopt more sustainable practices and to build climate resilience. Green/sustainable financing will play an important role here in mobilising capital for the significant investments needed to protect and renew our environment, and to strengthen the resilience of the economy to climate events. For example, the Unescap (United Nations Economic and Social Commission for Asia and the Pacific) estimates that Asia and the Pacific region requires annual investments of US$434 billion (RM1.8 trillion) for clean energy and climate action, US$373 billion to end poverty and hunger, US$296 billion to improve health and education, US$196 billion to expand public infrastructure and US$156 billion to safeguard biodiversity. Mobilising resources from the private sector and aligning financing between the private and public sectors would be critical to help finance a green and inclusive recovery for our region.

In the immediate term, we see a need for financial institutions to clearly identify the risks and opportunities present in their financing and investment activities, and start undertaking a deliberate and measured process to reflect such risks and opportunities in their business decisions. This includes rebalancing their portfolios to take into account the implications of potential climate risk exposures on their core lending, insurance, funding and investment activities. The climate change principle-based taxonomy recently issued by Bank Negara aims to facilitate this.

Following an increased focus by Bank Negara on climate risks as part of our supervisory engagements since early 2020, we see encouraging progress within the financial sector in responding to climate-related risks. Financial institutions have begun to formulate their long-term strategies towards sustainability.

More financial institutions are also actively promoting and helping their customers to adopt sustainable practices through their lending, underwriting, advisory and/or investment activities.

There is also a stronger focus on enhancing technical capacity and a number of financial institutions are increasing their commitment to adopt TCFD (Task Force on Climate-Related Financial Disclosures) recommendations to improve climate-related financial disclosures.

At present, climate risk management approaches and methodologies are largely still underdeveloped. Given this, our regulatory and supervisory approach will continue to be an iterative one as we progressively work with the industry to strengthen frameworks for assessing physical and transition risks. Over the next five years, we expect to see greater convergence in the financial sector’s approaches towards improved climate risk management, higher standards of climate-related disclosures across financial institutions, and more impactful and innovative funding solutions on offer to drive the economic transition. This will also drive improvements in the quality of information available from businesses on the impact of their activities on the environment.

 

How far ahead or behind is Malaysia in the whole greening-of-the-financial-sector journey within the Asian region? Do we have an early mover advantage or are we late in the game?

We have seen much greater traction within the financial sector in recent years, particularly in the region. This is also true for Malaysia, and in some areas, we have been an early mover.

•     10 countries from Asia, including the Bank, are members of the Central Banks and Supervisors Network for Greening the Financial System (NGFS). The NGFS is an important platform for central banks to come together, share best practices and contribute to the development of climate risk management in the financial sector. The Bank was among the earlier members from Asean to join the network in 2018, and is a current member of its Steering Committee to provide the views and perspectives of an emerging economy.

•     Within the Asean region, work is underway to develop a regional taxonomy that can provide a common language for sustainable finance in Asean. The Bank and the SC are both actively involved in the newly formed Asean Taxonomy Board, which has been tasked with driving this important initiative. Outside of the euro area, we believe this is the only other regional effort launched to date to align climate taxonomies in order to facilitate financial flows towards environmentally sustainable activities.

•     Domestically, we have made important progress in advancing a number of key building blocks to strengthen financial system resilience to climate risk and to drive sustainable finance through the JC3 and VBI COP (Value-Based Intermediation Community of Practitioners) platforms. Since its establishment, the JC3 — supported by five subcommittees on: (i) risk management; (ii) disclosures; (iii) products and solutions; (iv) engagement and capacity building; and (v) bridging data gaps — has become a focal point for collective climate actions in the financial sector.

We are also seeing an increased level of collaboration and engagement through JC3 with relevant ministries and agencies to align the financial sector response to national policies. For example, the JC3 serves as the financial sector focal point through the Ministry of Finance to provide inputs on national climate policies discussed at the Malaysian Climate Change Action Council (MyCAC). This is particularly important given the critical interdependencies between the financial sector and national policies that can affect our ability to achieve an orderly transition.

While we are moving in the right direction, time is not on our side and we need to further accelerate progress. This will therefore be a key priority of the Bank under the third Financial Sector Blueprint that will be released soon.

 

Coal is a controversial subject and Malaysian banks have had some bad global press for their continued funding of the coal sector. Most of our big banks are taking a phased approach in exiting the sector. Would you like to weigh in on the subject? Should Malaysian banks, by now, stop taking on new coal projects?

The challenge with coal is one that is not only faced by Malaysia but also by many other countries. However, the larger issue is energy transition, as coal is a major energy source and substantial infrastructure and technology investments are required to replace it. There is a need to balance the short-term socioeconomic needs of energy security and affordability, with the long-term sustainability imperatives, which necessarily include gradually unwinding exposures to stranded assets. This should aim to achieve an orderly transition to avoid any unintended economic, financial and social implications.

Some financial institutions have already committed to not financing any new coal projects and to phasing out existing coal financing. More importantly, alternative and blended financing solutions, alongside the mobilisation of patient capital from institutional and corporate investors, will need to be directed towards renewable energy technologies and solutions to make these solutions more viable and clean energy more affordable. It is as important for financial institutions to commit resources and evolve new financial instruments beyond traditional financing to step up investments in support of Malaysia’s energy transition plans. In this regard, financial institutions should carefully consider measures to align their business strategies with the upcoming National Energy Policy, which will provide more clarity on plans to phase out coal from the country’s energy mix.

 

What do you see as the biggest opportunities and challenges of growing green/sustainable financing?

We see opportunities at the national level for green/sustainable financing in line with the six priorities outlined by the MyCAC, the upcoming 12th Malaysia Plan and National Energy Policy to support the country’s transition pathways.

Opportunities also lie in projects under the National Investment Aspirations (NIA) framework and the Low Carbon Mobility Development Plan 2021-2030. Transition finance and the financing of nature-based solutions also present significant opportunities in Malaysia, but will require effective collaboration between the public and private sectors.

Efforts to scale up green finance face a number of challenges today. Key among them are a lack of visibility into national climate transition pathways which are consistent with nationally determined contributions (NDCs)-linked targets and commitments; difficulties in accessing climate-related data and information, including funding needs for climate risk mitigation and adaptation in high-risk sectors; and a scarcity of talent.

The JC3 is making efforts on various fronts to address these challenges, including:

(1)    Promoting an enabling environment for green financing and investments. By building on work undertaken to identify market gaps and barriers, JC3 members are working to develop concrete measures to enhance the demand and supply of green finance.

(2)    Establishing a sub-committee on bridging data gaps to enhance the availability, accessibility and comparability of important data and information required for risk management and product solutioning.

(3)    Working with local and international partners to develop relevant capacity building programmes for the financial sector on climate-related risks and opportunities.

(4)     Deepening engagements with civil society, government stakeholders and other private sector players to promote alignment and create broader awareness on climate policies and initiatives.

 

The Edge: The financial sector is seen by some as the most important agent of change in influencing individual/corporate behaviour when it comes to climate change/sustainability — in that it can help speed up the process of change. Do you agree? Please share your view. As a regulator of the capital markets, what are your expectations of the industry on this front — at this stage and, say, in the next five years? Are your expectations of the sector prescriptive or guidelines-based?

Datuk Zainal Izlan Zainal Abidin: The financial sector is a key component of the sustainability ecosystem and does play a critical role in driving the sustainability agenda of a country. Efficient access to suitable modes of financing will facilitate and potentially accelerate the transition towards a low-carbon economy, as sustainable projects can be implemented more effectively. Within the financial sector, the capital market’s role in raising capital, mobilising financing and intermediating savings for sustainable development is important not only to meet the current financing needs, but also to ensure that the needs of future generations are not compromised.

Reports have shown that trillions of dollars are required to meet the global financing needs to achieve the Sustainable Development Goals (SDGs) and climate targets. A recent report by an international bank on SDG investments highlighted that Malaysia requires US$3.9 billion (RM16.3 billion) in clean water and sanitation; US$14.7 billion to maintain digital access; and US$73.7 billion in transport infrastructure, by 2030. Such substantial amounts of investment will certainly require an efficient financial sector to facilitate fundraising activities, much of which are likely to involve the capital market.

Studies have shown that businesses with environmental, social and governance (ESG) principles built into their strategy are better equipped to mitigate risks and drive sustainable growth, and investors are paying closer attention to the impact of ESG issues on a company’s ability to generate sustainable profits. In this environment, to be successful in being sustainable, businesses must adopt sound tools and methodologies to identify and assess their environmental and sustainability risks. This includes integrating management of sustainability risks and opportunities within their business operations.

Thus, the capital market can facilitate the acceleration of better sustainability practices by addressing the gap in green, social and sustainable financing needs; and shaping a better corporate ESG culture in Malaysia. Capital market intermediaries play an important role, too, in the mobilisation of capital for the sustainable development needs of the economy. As such, having a facilitative and enabling ecosystem to spur the growth of Sustainable and Responsible Investment (SRI) in Malaysia is an important priority for the SC. Strategies to develop this ecosystem are encapsulated in the Sustainable and Responsible Investment Roadmap for the Malaysian Capital Market (SRI Roadmap) launched in 2019. The recommendations identified in the SRI Roadmap also make clear the SC’s expectations of the industry, of how they can contribute to the development of a thriving SRI ecosystem in Malaysia, and strengthen Malaysia’s position as a regional SRI centre. In this regard, industry participants must adapt and position themselves to capitalise on opportunities presented by the permanent shift towards sustainability by putting in place appropriate business strategies and practices that will enable them to play their part within the SRI ecosystem.

In addition, the Joint Committee on Climate Change (JC3) plays a crucial role in driving the Malaysian financial industry towards ensuring its readiness to address climate change. Recognising the urgency, the JC3 has intensified its initiatives to support efforts to build resilience against climate-related and environmental events, and secure an orderly transition to a more sustainable economy. In this regard, it is important for financial institutions and intermediaries to take greater cognisance of the various initiatives rolled out by the regulators and other relevant bodies, and step up to the plate.

In enabling the capital market’s role of facilitating the development of sustainable and climate finance, a principles-based approach is generally preferred so as to provide flexibility to industry and other relevant stakeholders, especially given that at present there is no single global standard governing the financing for sustainability or climate change.

 

What do you see as the biggest opportunities and challenges of climate finance?

It has been more than five years since the signing of the global climate accord and the ratification of the SDGs. However, there is still much more that needs to be done to achieve these global goals, particularly as we are now in the ‘Decade of Action’. As conversations on sustainability and climate change take centre stage, there is increasing awareness that the systemic impacts arising from poorly addressed sustainability and climate risks are likely to be devastating.

Although the pandemic has set back progress towards achieving the SDGs and climate targets, it has also brought about renewed commitments from countries around the world, as we strive to build back better. For example, the EU has set aside 25% of its €740 billion (RM3.65 trillion) pandemic recovery package for climate-friendly measures under the Green New Deal for Europe. This deal for Europe will focus on investments in clean technologies, low-carbon vehicles, retrofitting of old buildings and sustainable land use. Meanwhile, the Asean Comprehensive Recovery Framework, which is the region’s consolidated exit strategy from the Covid-19 crisis, also aims to advance a more sustainable and resilient future for the region.

It has been reported that the impact of the pandemic on SDG financing needs in developing countries is estimated to increase the financing gap by 70%, to US$4.2 trillion per year post-pandemic. However, to put this substantial figure into perspective, plugging the financing gap would require the reallocation of only 1.1% of global financial assets held collectively by banks, institutional investors and asset managers, which amount to US$379 trillion, to SDG-aligned economic activities.

Within the Asean context, the SDG financing needs for transport, digital access and clean water and sanitation in five Asean countries amounted to a total of US$840.6 billion, of which almost 40% can be met by private sector financing.

In 2020 alone, global green bond issuances reached US$290.1 billion, resulting in the green bond market surpassing the US$1 trillion mark in terms of total cumulative issuances, with an annualised increase of 30% in issuances in the most recent three-year period. In addition, global social bond issuances reached a record high of almost US$150 billion last year, spurred by the need to finance pandemic relief efforts.

With the accelerated global shift towards developing a climate-resilient future, certain high-emitting industries are at a high risk of being phased out. Thus, the transition of companies in carbon-intensive industries into low-carbon or, more ambitiously, net zero, are important milestones towards achieving climate targets. An estimated US$120 trillion to US$160 trillion is required from 2021 to 2050 to address energy transition alone.

This gives rise to the need to facilitate transition finance that would help high-carbon companies start implementing long-term changes to become greener, and bridge the gap between traditional and sustainable financing as businesses begin the journey to net zero. The development of transition finance instruments to accommodate a broader range of issuers is essential in extending the universe of the green, social and sustainable bond and sukuk market, and could facilitate the inclusion of a wider range of businesses typically engaged in emission-intensive activities, which are looking to reduce their carbon emissions through changes in their business models or the use of new technologies.

This is an area that the SC is looking at actively, as the capital market has a role to play in facilitating industries and businesses that seek to become greener, as part of collective efforts in the transition to a net zero carbon economy and a more resilient and equal society.

While the significant funding requirements reflect the potential for sustained demand and growth of climate and sustainable finance, there may be challenges to raise funding at the project level, given that there are still no common global standards. There are widely recognised taxonomies, principles and standards applicable across the various regions, but there remain differences that may render some projects accepted as green or sustainable in one jurisdiction but not in another, thus potentially complicating the fundraising plans for such projects. This challenge is being addressed in Malaysia through the development of national-level taxonomies to guide relevant stakeholders.

At the same time, the relative unfamiliarity with the technical specifications of climate-related projects, especially those involving new technology, has also posed challenges for issuers, intermediaries and investors in assessing their commercial and operational viability and thus, in pricing the associated risks.

Furthermore, despite the commendable growth in climate finance, as reflected by the steady increase in the issuance of green bonds globally, the overall awareness and appreciation level for the sustainability agenda among various stakeholder groups remains uneven. For instance, the concept of the 3Ps (people, planet and profit) is still gaining traction among businesses, though the risk of being excluded from the global supply chain for failing to transition towards sustainable practices is prompting some of these businesses to take heed.

To help address some of these challenges, three centres of excellence have been set up by Capital Markets Malaysia (an SC affiliate) to facilitate capacity building in sustainability and sustainable finance for corporates, financial intermediaries and institutional investors respectively.

 

Please share your views on how green/sustainable financing can help support Malaysia’s economic recovery amid the Covid-19 pandemic.

As Malaysia fights its way through the pandemic to bring this health crisis under control, it also needs to engineer an economic recovery that is built upon a gradual ‘return to normal’ of business activities across the various sectors. In this regard, the economic recovery plans should aim at building back a more resilient and more sustainable economy. This presents a significant opportunity to use green and sustainable finance, not only for the funding of Covid-19 recovery efforts, but also to advance climate mitigation and adaptation goals.

The recent issuance of Malaysia’s first sovereign sustainability sukuk, amounting to US$1.3 billion, was recognised as the world’s first US dollar sustainability sukuk issued by a sovereign. This issuance, which was aligned with the Asean Sustainability Bond Standards, signifies the key role of the government in driving the sustainability agenda in Malaysia. The proceeds raised from the sukuk will be used for eligible social and green projects aligned with the SDGs, which will also contribute to the country’s socioeconomic development.

In addition, since the start of the pandemic, six more issuances of green and sustainability bonds and sukuk were made by Malaysian companies for the financing of renewable energy, affordable housing and other environmentally sustainable projects. With the growing traction in this market segment, there is certainly huge potential for further expansion, particularly given the role that green bonds and sukuk play in facilitating financing for Malaysia’s sustainability agenda and in supporting corporates in their transition towards a green and low-carbon economy.

To encourage more issuances of such financing instruments, in January this year, the SC expanded the scope of its Green SRI Sukuk Grant Scheme, established in 2018, to include all sukuk issued under the SRI Sukuk Framework and, now, bonds issued under the Asean Green, Social and Sustainability Bond Standards. The grant scheme is now known as the SRI Sukuk and Bond Grant Scheme, and issuers can benefit from the tax-exempt grant to partly offset the issuance costs.

Apart from the issuers’ perspective, green/sustainable financing will help support the country’s economic recovery as it fulfils investors’ growing demand and priority for responsible investing. As more green/sustainable financing solutions are offered, a wider investor base will be able to participate, thus enabling more efficient fundraising activities to finance the broad array of green/sustainable projects that will, in turn, support the country’s economic recovery.

 

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