Resilience Pathway 2.0; a promising pathway for cities to accelerate climate adaptation while unlocking private money flows and raising capacity levels

A.G.A. (Eric) Schellekens, ARCADIS Nederland BV, Piet Mondriaanlaan 26, 3812 GV, Postbus 220, 3800 AE Amersfoort, Email: Eric.schellekens@arcadis.nl and D.I. (David) Ballard, Transition Pathways Ltd Transition Pathways Ltd. ,Orwell House, 50 High Street, HUNGERFORD, Berkshire, RG17 0NE. Email: david.ballard@transitionpathways.org

AbstractThe Resilience Pathway 2.0 (RP2) is a progressive new approach to accelerating transformation in cities and other coastal areas which need to adapt to climate change. What distinguishes the RP2 from existing approaches to adaptation projects is its emphasis on involving potential financers and engineers far earlier in the master planning process. Based on substantial research, RP2 maps out four phases of activity which can add much greater value to a resilience project, positioning it as an attractive investment opportunity which can meet multiple agendas. Unlike previous approaches RP2 also focuses on developing the requisite capacity, so often overlooked, to realise ambitious and visionary transformation (Geels and Schott, 2007) at local, city or regional scale.

The works primary aim - the research started in November 2013 - was to identify how to unlock a significant flow of money, especially private sector money, to accelerate climate adaptation. And by so doing to bring about reduction of social and economic losses by de-risking extreme events and climate change impacts, enhanced investment perspectives (economic prosperity); a safe and attractive living environment and opportunities for community / political leaders to achieve their visions for the long term future of cities and coastal regions.

Keywords: adaptation; climate; finance, capacity building, pathway

Introduction

The existing demand for adaptation finance presents a business innovation opportunity to match supply of private and/or public sector finance to demand. The RP2 is based on insights from a market analysis of both the demand (for finance) and the supply (of finance).

As climate change impacts are experienced around the world, and are set to continue through coming decades and centuries, adaptation is an increasing priority (IPCC, 2014). This is particularly true in coastal areas, riverine cities and densely urbanised areas, which are more frequently confronted with extreme weather events. Governments, businesses and citizens around the world acknowledge that some level of adaptation is necessary, and it is increasingly recognised that in densely populated coastal areas, adaptation will be cost efficient, particularly over longer time horizons (World Bank research, Hallegatte et al., 2013, September 2013 and Hinkel et al. 2014, OECD, 2014). Yet leaders of cities, especially of delta cities, already have full agendas, being confronted with many challenges before they even consider climate

change. They have what could be described as a ‘trilemma’; first, they need to align their cities to the needs of their population by dealing with housing and unemployment and by providing attractive and high quality living environments. Second, they need also to provide investment opportunities in order to meet the requirements of the markets that can generate wealth. Both require them to be ambitious and even visionary about their cities’ futures. Third, alongside these concerns, they also need to take account of the biophysical stressor of climate change. This can only intensify the cities’ challenging agendas. Inevitably, political pressures mean that social and economic ambitions tend to be prioritized over climate resilience. Finding a way to unlock private money is therefore vital if climate adaptation is to be funded.

Although private finance has not been engaged to any significant extent in financing adaptation to date, there are encouraging signs (e.g. climate bonds issuers, impact investing, a shortage of other projects suitable for investment) that the situation may be becoming ripe for this to change.

Demand from cities for adaptation finance and supply for financing city resilience

Lack of available funds has been identified as a very major barrier to adaptation in cities so municipalities are looking for new ways to harness money from private as well as from governmental sources. The demand for adaptation funding was demonstrated by a MIT study undertaken in 2011 (Carmin et al., 2012). A survey of 468 ICLEI partner local government administrations around the world showed that they saw the biggest obstacle in conducting adaptation work to be obtaining funding. Furthermore, the survey results showed that, although data unavailability and data inaccuracy on climate and extreme weather did remain a challenge, respondents considered data to be a less relevant obstacle than the prevailing lack of funding for adaptation actions. The survey barely discussed private sector finance but demonstrated that cities and coastal areas are open to seeking funds from private sources.

As a part of our research, the Global Climate Forum conducted a literature review to elaborate the landscape for financing adaptation and climate-resilient investment in coastal areas. This made a useful distinction between (a) the demand-side of finance (e.g. cities who need money to commission adaptation measures, as above), (b) the supply-side of finance (i.e. investors), and (c) the financial vehicles that bring together these two sides of adaptation finance. We look at these latter two in turn. The literature review on financing adaptation and other resilience measures yielded a number of significant insights:

a. There remains surprisingly little global investment in adaptation; b. Funding to date has largely been provided by public sector donors, typically

governments, who do not seek a return on investment; c. Private sector investment has been constrained because of the public good

nature of adaptation, with investors as yet unable to capture all of the benefits of investments. Besides this, other barriers to private finance include a lack of skill in calculating benefits;

d. ‘Green bonds’ (also ‘climate bonds’) are an important signal that the investment market is waking up to this issue;;

e. Issues that need to be addressed for institutional investors to participate include a need to maintain liquidity

f. A key barrier identified in the literature for institutional investors to enter new asset classes, or financial vehicles, is their lack of experience and due diligence capabilities to assess the vehicle in question;

g. Philanthropic donors may have an important role to play in helping to finance experimental projects;.

h. New developments in catastrophe insurance (e.g. parametric insurance) and in similar insurance-related securities (e.g. catastrophe bonds) may in due course play an interesting role as part of overall financing of risk management;

i. However public sector finance will continue to play an important role, as yet, there are few signs of interest in investing for adaptation from private investors with higher risk / reward preferences .

An overall conclusion is that it appears likely that ‘wealth-preserving’ institutional investors with low risk / low return preferences are most likely to be attracted by investment in adaptation projects. These investors include pension funds, insurance funds and SWFs. Supporting reasons include the fact that these investors have long investment time horizons and a risk management ethic (to assure future cash flows). Moreover, these investors are moving assets towards bonds and away from equities.

Capacity to act

Figure 1 ASEC survey on capacity levels in 196 European cities (Ricardo AEA and Alexander Ballard Ltd., 2013)

The supply of funds is itself a barrier, as identified above. Further barriers were explored during work in live cases below. But one major barrier emerges on both the demand and the supply side of the a potential market for private finance for adaptation. This is the capacity to act. A perhaps surprisingly high proportion of cities

and other municipalities across Europe are still struggling to take adaptation decisions based on current extreme weather risks. Very few indeed are yet capable of specifying what is needed in designs for resilience to future climate change and the great majority may not recognise the expertise they need. Work in the Adaptation Strategies for European Cities (ASEC) Project (Ricardo AEA et al, 2013) demonstrated that capacity levels to take and implement strong adaptation decisions in cities are typically extremely low. As shown in the table below, only 23% of a sample of 196 European cities self-assessed as being at or beyond responding even to current extreme weather, with a much smaller proportion (less than 5%) beginning to adapt to future climate change (figure 1). It should be noted, however, that very few sectors of the economy are currently ahead of cities in their climate capacity.

These are important and disturbing results. Many city decisions such as public buildings or developments are intended to last for many years, even centuries. When climate change is considered, any implicit assumption that current weather patterns will continue throughout the lives of these investments is clearly unsafe, perhaps the least probable scenario. The option to adapt to future climate or to current extreme weather may not come again at an affordable cost during the life of an investment. It is important that the opportunity to take resilience measures be taken now. This means that ‘High’ capacity needs to be brought to decision-making, yet rarely available. Recent research (Ballard, Black and Lonsdale, 2013) shows that low and very low capacity organisations such as the majority of cities need help to begin action.

The pay-off to wider climate responses if the finance sector were to ‘wake up’ and apply its more generic capacities to this agenda might be very great in promoting climate resilience. The literature review summarised above suggests that there are some significant areas in which the supply side of this market (investors and financial intermediaries) lack capacity to invest where there are market risks. This conclusion was supported by research carried out prior to this study and reinforced by results of this particular study. There can be little doubt that financial institutions do need climate capacity. Many, if not all, major financial institutions will be investing in at least some projects whose outcomes will face current extreme weather risks. Many will be investing in projects that will last for decades into the future and whose cash flows will therefore be at risk from future climate impacts. This means that virtually all will require at least medium or high climate capacity (defined as taking action to respond to current extreme weather risks or going further to respond to potential future climate impacts). A study by ex-OECD Chief Economist, John Llewellyn (2006) stated that the most likely outcome for investors if climate risks enter the system without appropriate due diligence would be a sudden and apparently unexplained collapse in market asset values as forward trades of potentially climate-impacted assets suddenly lose significant value – e.g. after a series of climate-related catastrophes. The only time when due diligence can be exercised is when the risks are taken on in the first place – and this needs medium and often high climate capacity. However, recent research on adaptive capacity carried out as part of the UK’s Climate Change Risk Assessment (Ballard et al., 2013) showed that (with the exception of

some providers of insurance services), financial institutions do not have access to these levels of capacity.

So having identified the levels of capacity are all too frequently missing even on the demand side, among cities and other coastal municipalities, the capacity gap is still more serious for financial institutions: there is no prospect, at present, of their due diligence processes being able to deal with this complex agenda. Until this capacity gap is bridged, there is likely to be little activity in this market.

Material and Methods

While anticipatory financing of adaptation initiatives remains quite rare and much adaptation investment remains reactive to climate events, it was necessary to understand the reasons for this while also exploring what might bring the market to life. We therefore adopted a hybrid research methodology, based on action research. First, we explored five real and varying cases, where there was a need for adaptation measures to be financed in cities and coastal areas. We also explored a past historical case (Copenhagen). We used the cases to ground discussions with professional investors as to how this market might be developed. In doing so, we entered into and brought into active consciousness the current system that applies to financing adaptation and civic development more widely. In parallel we also conducted a desk review of the potential market for supply of finance for adaptation and also interviewed over 50 individuals currently active in investment financing.

Figure 2 Real cases supporting development and testing of the Resilient Pathway

Six live cases in cities and coastal areas were chosen (figure 2); The Rotterdam Feijenoord case, a riverside area within the City of Rotterdam, The Newcastle Science Central Project, one of four semi-linked projects in the city centre, The Aveiro case study area, a dune barrier located at the Southern Aveiro district coast of Portugal, the Demak case, where the Northern Java’s coast suffers from severe erosion, the Amsterdam Westpoort project, an industrial area below sea level on the west of Amsterdam and the Copenhagen cloud burst case. In all but one case (the Copenhagen case where there had been successful public financing), we developed ‘Investment Opportunity Reports’ with the emphasis mainly on how private financing might be attracted.

Results and Discussion

Resilience is most needed for long-lasting decisions with outcomes that last 10+ years (e.g. water and other infrastructure), which need to be viable in unpredictable and fast changing future climate and energy scenarios, where the status quo is usually the least likely scenario. These decisions are difficult and / or expensive to reverse (in money and energy terms). This is where identifying ‘moments of change’ and defining ‘investment opportunities’ seem the way to go, while creating a ‘marriage’ between technical, financial and social engineering.

Figure 3 The Resilience Pathway 2.0

The Resilience Pathway 2.0. is a blueprint for service innovation which requires high level competence in stakeholder engagement, capacity-building, deal-doing adaptive engineering and master planning (figure 3). The four phases of the Resilience Pathway 2.0 have been explained in the text below.

Phase 1: Scoping. The output of this first phase is a clear briefing document clarifying the challenges to be addressed, also to identify potential opportunities (‘moments of change’) to address them.

i. Area dynamics and ambitions; identifying known and likely activity around which ‘moments of change’ might be constructed;

ii. Climate challenges and other stressors; assessing the vulnerability of an area or city arising from changes in extreme weather events and from climate changes in both the short and the long term;

iii. Capacity and Framework assessment; Defining capability gaps that need to be filled to implement Resilience Pathway 2.0.

Phase 2: Optioneering. The purpose of the Optioneering phase is to identify one or several promising, bankable and feasible investment opportunities around a development. These will provide alternative routes to meeting climate and other objectives of projects that will be attractive to private and other investors.

i. High level solutions; defining and designing at a high engineering level the development in a way that is profitable and fundable;

ii. Socio economic Cost Benefit Analysis. Fundamental to bankable solutions, identifying socio-economic losses and benefits from the various options;

iii. Financial and legal arrangements; developing suitable financial arrangements for promising options, aligning framework conditions and defining stakeholder processes and stakeholder participation to the different phases of the pathway.

Phase 3: Deal Structuring. The purpose of the third phase, is to transform the selected intervention opportunity into a contract with detailed specifications and financial and legal arrangements (e.g. permitting’) to deliver the project objectives: resilient projects with an acceptable (typically low) risk-return profile.

i. Detailed solution engineering and permitting; transforming the high-level engineering approach into solutions engineered in detail;

ii. Detailed financial engineering; transforming the high level financial arrangements into detailed financial arrangements. For example, ‘Special Purpose Vehicle’ companies need to be set up, detailed contracts signed;

iii. Specifications and strategic control; elaborating the specifications of the promising opportunities in a detailed way. The strategic control aspect focuses on how to avoid collapsing goals.

Phase 4: Project implementation. The aim of the project implementation phase is to get the projects or developments realised and well managed. This phase is a missing link in many strategies.

iv. Project realisation; getting the development realised. This will sometimes differ from traditional project realisation; climate adaptation or climate mitigation or both are seen as one of the main goals of the development, more projects will have a ‘breakthrough’ element;

v. Asset management; maintenance of the assets of the project or development in order to optimize the climate impact in the long term;

vi. Learning and Capacity and Framework development; creating the projects as ‘learning laboratories’ (e.g. by education, coaching, hiring, etc.).

Conclusions

To adapt in time to extreme weather events and the gradual climate change in order to avoid huge costs and inefficiency either now or in the future, planning strategies need

to focus on implementation. Strategies that align the needs of all stakeholders, both representing the demand side and the supply side, e.g. the needs of authorities, companies, project developers, big industries, investors and insurers. To unlock money flows and to raise capacity of stakeholders, ARCADIS has developed and successfully tested a new and unique high level business model, the ‘Resilience Pathway 2.0’, and .reached out to potential financial partners, with encouraging results. Existing high level engineering skills and products and services have been brought together in partnership with leading deal-structuring experts and financial organisations to help riverine and coastal cities to access private and public money for climate adaptation.

The Resilience Pathway. A pathway to be seen as a new of master planning and city and area development, with both promising climate impacts and business opportunities. So “Think Moments of change, Act high level and Talk revenues while ‘optioneering’.

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