ESG: the political risk market takes on its biggest challenge yet

Authored by Caroline Tran, Product Leader Europe, Political Risk, Credit & Bond (PRCB) at AXA XL

ESG presents huge opportunities, but also challenges, for the political risk and credit insurance market, according to Caroline Tran, Product Leader Europe, Political Risk, Credit & Bond (PRCB) at AXA XL.

Environmental, social and governance (ESG) investments are increasing at a phenomenal rate. Total global ESG assets surpassed USD 35 trillion in 2020 and are forecast to reach USD 41 trillion by 2022 and USD 50 trillion by 2025, according to Bloomberg Intelligence.

Investment in renewable and clean energy alone will need to triple by 2030 to around USD 4 trillion if the world is to achieve net zero emissions by 2050, according to the International Energy Agency.

The political risk and credit insurance market finds itself at the forefront of developments in ESG and the transition to Net Zero. ESG-related investments, in particular for renewable energy projects like wind and solar, are driving increased demand for political risk and credit insurance. At the same time, insurers, lenders and corporate are developing criteria to measure the ESG performance of the projects they support, while translating their own climate and sustainability commitments into actions.

ESG challenge

Insurers are an essential link in the financing chain for large ESG-related projects, which range from renewable and clean energy projects to much-needed investment in infrastructure and social development. ESG-related projects currently account for around 25% of political risk and credit insurance submissions, a proportion that continues to grow year on year. Yet, while ESG is a potential source of growth for the market, it is also a major business challenge.

Lenders and insurers are increasingly subject to ESG-related disclosure requirements and have made public commitments to operate more sustainably and reduce their environmental impact. AXA, for example, was among the first insurers to commit to carbon neutrality and it has been a signatory to the UN Principles for Sustainable Insurance since 2011. The group also joined the UN-sponsored Net-Zero Asset Owner Alliance (NZAOA) in 2019 and spearheaded the Net-Zero Insurance Alliance in 2021.

As a result, our underwriters and portfolio managers are now integrating environmental and social risks, including human rights concerns, as well as more generally ethical concerns, in their product development processes and policies.

Mandatory disclosure

If ESG investment is to be a success, investors and financial institutions need to find ways to accurately and consistently assess and benchmark ESG performance. Among the most widely used voluntary frameworks for ESG reporting is the Task Force on Climate-related Financial Disclosures (TCFD), although there are also standards from the Global Reporting Initiative and the International Sustainability Standards Board.

ESG disclosure is also increasingly becoming mandatory. From April, the largest companies and financial institutions in the UK are required to make climate-related disclosures in line with the Task Force on Climate-Related Financial Disclosures (TCFD). In the US, the Securities and Exchange Commission launched its consultation on climate-related disclosures for investors in March 2022.

The EU goes even further. It is working on a new Corporate Sustainability Reporting Directive (CSRD) and Sustainable Finance Disclosure Regulation (SFDR), which will work alongside the EU’s Taxonomy Regulation. The Taxonomy - a classification system for environmentally sustainable activities - should help tackle ‘greenwashing’ and provide a basis for standard criteria to assess whether activities are genuinely contributing to a future Net-Zero economy.

Measuring ESG

The big challenge for insurers and lenders is to integrate frameworks like the EU’s Taxonomy and the TCFD into everyday operations, as well as meeting their Net Zero and sustainability commitments. AXA XL already assesses each and every transaction against our sustainability criteria, measuring the social and environmental impact of a project and this is then benchmarked against our risk underwriting policy.

ESG is still a work in process. To date, the main focus has been largely on the ‘E’ – namely climate change and emissions disclosure. However, interest in the ‘S’ and ‘G’ are growing. ESG is also not black and white. There are inevitable trade-offs between various ESG components. For example, a windfarm or hydro project might bring environmental benefits, but they could also negatively impact local communities.

Measuring ESG is also an evolving process. There is currently a lack of consistency in ESG reporting, while the data and methodologies required to measure certain ESG factors is still lacking. ESG assessments will also need to take into account a company’s intentions, as well as its current performance, and its ability to deliver. Many industries are in transition, and the ability of companies to meet targets may be uncertain, for example, where it is dependent on new and unproven technology or changing government policy and regulation.

AXA XL has a dual role in supporting ESG, as a facilitator of export and project finance, and through the group’s wider sustainability agenda.

Investing in volatile times 

Large renewable investments have been flowing into countries in Asia, Africa, and Latin America at a time of heightened geopolitical risk, fuelled by geopolitical tensions, energy dependency and food shortages. There are currently large wind and solar projects underway in India, Brazil, India, China, South Africa, Egypt, Morocco, to name just a few.

However, such projects can take up to 20 years or more to complete, and cost many billions of dollars. Unsurprisingly, investors in these projects often seek to insure against the risk of non-payment due to unexpected political events.

Political risk and credit insurance can protect corporates and lenders participating in ESG projects against financial loss triggered by political events, such as acts of war, civil unrest, terrorism or insurgency, as well as changes in government or policy that result in expropriation, currency convertibility, contract frustration and revocation of licenses.

Leadership role

Private and public finance, supported by insurance, is expected to play an important role in a successful transition to a Net-Zero carbon economy. ESG will become a must-have for all organisations going forward, affecting their ability to raise finances and build revenues.

AXA XL has a dual role in supporting ESG, as a facilitator of export and project finance, and through the group’s wider sustainability agenda. We are one of a relatively small group of insurers that have the financial strength and expertise to support long-term ESG-related project finance, which can extend to 15 or 20 years.

Insurers have a unique role in supporting positive change through our investment and underwriting activities. Today, we are just at the beginning of an ambitious journey, but the development of ESG criteria will lead to new products to address specific demands and help companies meet their own ESG goals.