External environment

The world around us is constantly changing. Social, environmental and economic effects resulting from persistent challenges require not only our customers but also FMO and its partners to become ever more resilient and adaptable to turn these challenges into opportunities to create positive change. 

This chapter outlines the most relevant external trends and developments that affected the way we do business and our ability to achieve our strategic ambitions towards the Sustainable Development Goals (SDGs).

Global trends affecting our markets  

Increasing geopolitical tensions and instability

Heightened geopolitical tensions in certain regions have impacted the markets in which we invest. This included the ongoing war in Ukraine, new emerging conflicts in Sudan and Niger and the ongoing civil war in Myanmar. In the Middle East, the war in Gaza has raised concerns about the situation further escalating in the region. FMO remains vigilant in monitoring these situations and ensuring we provide the necessary support to our customers amid these challenging circumstances.

Economic growth fueled by strong debt issuance

FMO aims to maximize its contributions towards SDG 8, Decent Work and Economic Growth. Global debt, including borrowing by governments, households and businesses, reached an all-time high.1 Factors that have driven high sovereign debt levels in recent years, particularly in developing countries, include the need for increased public spending to tackle the global pandemic, the cost-of-living crisis and the effects of climate change. This is further exacerbated by an unequal access to finance, higher interest rates, currency depreciation, and sluggish growth. According to the IMF, more than half of low-income countries are at risk of distress or are already in distress.

The IMF estimated a decline in global growth from 3.5 percent in 2022 to 3.1 percent in 2023. Growth in emerging markets and developing economies was estimated to remain at 4.1 percent. There were notable regional differences, with growth in emerging and developing Asia at 5.4 percent, mainly driven by India (6.7 percent). For low-income countries GDP was estimated at 4.0 percent.2

In low- and middle-income countries, the slower than expected economic rebound and cost-of-living crisis had a downward pressure on job decency and real wages and increased the risk of poorer households slipping into poverty. In its 2023 report the ILO warns that working poverty is on the rise in low-income countries, meaning that employed people live in households that fall below the poverty threshold.

Inequalities remain high

FMO continues to see a need to focus on SDG 10, Reduced Inequalities. The pandemic has exacerbated income inequality globally, marking the most significant rise in three decades. Furthermore, after 25 years of decline, the number of people living in poverty is again on the rise. Particularly in low and lower middle-income countries, income gains for the bottom 40 percent have been sluggish, contributing to a widening income gap between the poorest and wealthiest nations (between-country inequality).

With regards to between-country inequality, least developed countries (LDCs) are among the low-income countries that are most often faced with severe structural impediments to sustainable development. In recent years, LDCs have experienced a sharp slowdown in economic growth as they are less equipped to absorb the effects of recent crises related to the pandemic, climate change, geopolitical tension and inflation. In 2023, the combined GDP of LDCs was estimated to be 10 percent lower than was projected before the pandemic. This is estimated to have resulted in 15 million more people living in extreme poverty compared to 2019.3 The International Institute for Sustainable Development reports that while foreign investments in SDG-related sectors in developing countries increased by 70 percent in 2021, the share of investments flowing to LDCs dropped from 19 percent in 2020 to 15 percent in 2021.4

With regards to within-country inequality, income gains for people among the bottom 40 percent of the income distribution living in low and lower middle-income countries continue to lag. People within this group often deal with a plethora of other challenges that hinder their long-term social and economic development, including lack of access to electricity, food security and decent work. At the same time, technological developments such as digital ID, fintech, and cell phone usage offer opportunities to provide basic services to improve people's livelihood.

Climate change will undermine SDGs if not urgently addressed

Climate action continues to be high on the agenda for FMO. In 2023, we experienced the hottest year on record and were again faced with extreme weather events, resulting in loss of life and biodiversity and entire communities being affected. Climate change, including increases in frequency and intensity of extreme weather events, reduces food and water security, hindering efforts to meet the SDGs. For instance, in the Horn of Africa, more than 300 people lost their lives due to severe flooding following a three-year drought, which left millions facing food shortages. Similarly, in Libya, prolonged heavy downpour resulted in the collapse of three dams, claiming the lives of 3,400 people and displacing many others.5 Unfortunately, such events are becoming more common.

At COP28, the ‘global stocktake’ of the world’s efforts to counter climate change concluded that “progress was too slow across all areas of climate action”.6 In response, commitments were made by countries to speed up climate action. A clear signal was given to transition away from the use of fossil fuels in energy systems in a just, orderly and equitable manner, although no agreement was made to fully phase out fossil fuels. In addition, it was made clear that the negative effects of climate change are not borne equally. Poor and marginalized people are more likely to be adversely affected by extreme climate events and the potential negative social impacts of transformation to a low or zero carbon economy. There was a clear call for more progress on adaptation and financial support towards poorer countries. The Loss and Damage Fund was established to help developing countries cope with losses incurred by adverse climate events.

Funding for the SDGs is hampered by a lack of bankable projects

Achievement of the SDGs and the objectives of the Paris Agreement require an additional US$4.2 trillion in investments each year. However, there is lack of investment-ready bankable projects. And while there is ample DFI liquidity, overall liquidity is falling short. This means private investors need to step in, in particular as risk capital for emerging markets is falling short. In addition, there is a need to unlock market potential which requires taking risks and moving away from more traditional business models. In 2023, several reports suggested a revision of the funding models of multilateral development banks (MDBs) and DFIs so they can take on more risk.7 DFIs can increase the level of risk in their portfolios without recourse to new capital injections or increased use of external concessional resources.8

New technologies enable development impact but also pose new risks

Over the past decade, emerging technologies have given rise to new business and delivery models. In addition to improving productivity and lowering marginal costs, new technologies can have a strong development impact. At the same time, new technologies give rise to risks and raise ethical questions. The use of artificial intelligence (AI), for instance, has become more popular among individuals, businesses and governments. By January 2023, ChatGPT had become the fastest-growing consumer software in history. Driven by advances in large language models, AI can help people work more productively but poses threats to (cyber)security and privacy. Researchers have cautioned that AI could widen the productivity and innovation gap between and within countries. High-skilled, high-income workers and larger corporations may benefit more from the adoption of AI, increasing their capital returns and labor income9, and developed countries are more likely to be early adopters. This might create a competitive advantage and increase inequalities between countries that will be difficult to overcome.

Sector developments

In the agribusiness, food and water sector, high food prices continued to affect global food security. Around 30 percent of the global population experience moderate to severe food insecurity10 caused by the ongoing war in Ukraine. In addition, extreme weather events have severely impacted agriculture production. Yet, finance to support sustainable agriculture, climate-resilient agri-food systems and biodiversity conservation has diminished in recent years.11

In the energy sector, clean energy projects were hampered by inflation, supply chain bottlenecks and rising interest rates, particularly in developing countries, where capital is more expensive. The debt crisis faced by many of them put an additional strain on the roll-out of energy projects, limiting the ability of public entities to enter into power purchasing agreements, which can be a source of hidden public debt. On the other hand, the global energy crisis in 2022 is believed to have been a turning point, highlighting the sense of urgency to enhance policy support for and reduce costs of a clean energy transition. To further stimulate this transition, rapid developments in clean energy technologies, such as green hydrogen, could become a viable option for storing energy from renewables.

In the financial market, a meltdown of three regional banks in the US caused turbulence in the US and European banking sector, but the crisis was contained. At the same time, recovery from the pandemic progressed, albeit at a slower pace than expected. With commodity prices decreasing and with fewer supply chain disruptions, inflation started to ease in 2023.12 The IMF noted that interest rate hikes did not lead to rising repayment defaults, as borrowers might have used savings or repayment delays, but the overall debt repayment capacity diminished. Demand for loans decreased globally and loan standards tightened, due to higher funding costs of financial institutions, a weaker economic outlook, and borrower risk perception. Although banks continued to be profitable, net interest margins came under pressure as a result of higher funding costs. At year end, projections were pointing towards a ‘soft landing’ by bringing inflation down without a major downturn of economic activity.12 Developing countries have seen weaker recoveries. Low-income countries struggle most, often aggravated by higher interest rates and depreciated currencies.

Expanding regulations that impact FMO

Financial institutions are required to responsibly manage the impact of their operations and value chains on the environment and local communities. Regulators and supervisors are continuously updating standards and setting new ones for companies to adhere to. In this section, we highlight the most important changes and updates to some of the regulations that (are likely to) impact FMO.

Basel IV

The EU’s new legislative package on the Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD) is aimed at implementing the Basel III (also known as Basel IV) standards within the EU. The legislative procedures are in the final stages and expected to be implemented with a phase-in approach starting from 2025. The draft text published in October 2021 and amended in February 2022 proposed a higher risk weight for equity investments. FMO will also be required to apply a higher capital charge for some types of credit risk exposures and for market risk. Further information is provided in the ‘Risk management’ chapter.

Climate and environmental related impacts and risks

In 2020, the European Central Bank (ECB) published guidance on the safe and prudent management of climate and environmental related risks. A review conducted by the ECB in 2022 showed that banks were far from adequately managing climate-related and environmental impacts and risks and require them to fully meet expectations by the end of 2024. The ECB also published a collection of good practices. Since 2021, FMO has been integrating climate and environmental related risks into the bank’s governance, strategy, risk management framework and disclosures in line with the ECB expectations. We expect to complete this work by 2024. Further information is provided in the ‘Risk management’ chapter and in the separate Task Force on Climate-Related Financial Disclosures (TCFD) report published on our website.

Corporate Sustainability Reporting Directive

The Corporate Sustainability Reporting Directive (CSRD) entered into force in 2023, which revises and extends the requirements of the previous Non-Financial Reporting Directive (NFRD). As a large public interest entity, FMO is in scope of the NFRD and will be among the first group of companies required to implement the CSRD. FMO and other companies subject to the CSRD will be required to report according to the European Sustainability Reporting Standards (ESRS). FMO will issue its first report following the ESRS in 2025, for the 2024 financial year. In 2023, FMO continued monitoring the developments and has been preparing towards the implementation of the CSRD and ESRS as part of the EU Sustainable Finance project.  

EU Taxonomy

In 2020, the European Commission introduced a taxonomy for sustainable activities. This is a classification system that defines criteria for economic activities that are aligned with a net zero trajectory by 2050 and broader environmental goals other than climate. The regulation is still in development. From 2023 banks are required to report their level of Taxonomy alignment with the first two environmental objective as well as Taxonomy eligibility on all six environmental objectives. Refer to the ‘EU taxonomy’ section for further information.

1 Institute of International Finance. Debt Policy and Research.
2 International Monetary Fund (January 2024). World Economic Outlook: Navigating Global Divergences.
3 United Nations Conference on Trade and Development (2023). The Least Developed Countries Report 2023.
4 IISD SDG Knowledge Hub (June 2023). Bridging the SDG Financing Gap Through First-Time Fund Managers.
5 World Weather Attribution (December 2023). Climate change fueled extreme weather in 2023; expect more records in 2024.
6 United Nations Framework Convention on Climate Change (January 2024). COP28: What Was Achieved and What Happens Next?
7 OECD (September 2023). The Funding Models of Bilateral Development Finance Institutions.
8 ODI (December 2022). An Exploration of Bilateral Development Finance Institutions’ Business Models.
9 International Monetary Fund Blog (January 2024). AI Will Transform the Global Economy. Let’s Make Sure It Benefits Humanity.
10 Food and Agriculture Organization of the United Nations (February 2024). FAO Food Price Index.
11 Food and Agriculture Organization of the United Nations (2023). Climate-related development finance to agrifood systems: Global and regional trends between 2000 and 2021.
12 World Economic Outlook (October 2023). Navigating Global Divergences.

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