Climate Risk: It’s Time to Act
In the last five years, Climate Risk has moved from relative obscurity to an area of vital importance. It’s more important than ever for Banks to monitor climate efforts within their loan portfolios, as well as fulfil growing regulatory requirements. The pressure for greater sustainability efforts will only continue to grow as regulators and policymakers become increasingly vocal about the need for carbon reduction. Shareholders themselves will be looking at Banks to monitor ESG (Environment, Social, Governance) factors, particularly climate. This holds Banks accountable for their role within the journey to net-zero, as well as to the climate-transition risks of their own books.
Not only do these trends put pressure on Banks to improve their ESG lending considerations, but regulation and a wider obligation to society add to a sense of urgency. Banks lending to companies is a step in the supply chain, meaning that the carbon emissions, consumption of oil, water, and other resources all reflect on the ESG efforts of the Bank. Banks need to do everything in their power to deliver sustainable lending.
In terms of reporting, the Bank of England recommends using the Task Force on Climate-Related Financial Disclosures (TCFD), which has four primary elements: governance; strategy; risk management; and metrics and targets, all providing a solid foundation to improve awareness of climate-related risks and opportunities. Following this method presents Banks with new opportunities to remodel their own governance structures and risk management frameworks. The Bank of England points out — in its 2021 Climate-Related Financial Disclosure — the importance of using the latest data available, while still highlighting any assumptions that may have to be made when reporting.
Many Banks are considering how to measure climate transition and how to introduce new products that support a sustainable future. This includes having a variety of ESG-related funds, loans, and assets, which can help mobilise sustainable portfolios. New metrics also bring light to just how important climate-related disclosures have become within the Banking industry. UK banks are leading the way when it comes to the level of detail and nature of their disclosures, which can pose enormous opportunities.
It’s critical that Boards drive the push toward improved disclosures within Banks. In a 2020 KPMG study, 72% of Banks said that climate change is a financial risk and will impact their business in the long term. Properly responding to climate-related risks means changing some fundamental aspects of business operations, including deciding which clients to lend to, determining which financial instruments are best suited for clients, and assessing which businesses to invest in.
Green and sustainable financing present a huge opportunity for Banks, if they are willing to devote both time and money into expanding their product offerings. New product ideas include green home-improvement loans and sustainable exchange-traded funds for retail banks, while commercial banks are beginning to shift towards ‘green underwriting.’ Boards, as well as all employees, must be committed and dedicated to making this shift and following these regulations, in order to see further prosperity for the Bank and its clients.
In November 2020, the UK stated its intentions of a “ green industrial revolution,” which consists of a ten-point plan to recover from the Covid-19 pandemic as well as accelerate the region towards a net-zero economy. In agreement with the TCFD, comes the introduction of “mandatory reporting of climate-related financial information across the economy by 2025, with a significant portion of mandatory requirements in place by 2023.” A complete road map for this policy was published in November 2020. Furthermore, as of 2021, all companies with a premium listing in the London Stock Exchange are required to provide disclosures within their annual reports on how they are navigating and managing climate-related risks and activities. All UK- authorised asset managers will be expected to obliged to report climate-related disclosures by 2023. It is also important to understand that UK companies may still need to account for EU rules and regulations about ESG. For example, the European Union passed the Sustainability-Related Disclosure Regulation (2019) and the Taxonomy Regulation (2020).
While these regulations have not been imported as UK law, companies must keep them in mind while doing business outside of local markets. All of these regulations, whether directly or indirectly, impact how Banks must choose to lend and invest. Banks must not only be in accordance with the regulations that directly affect them, but also need to have a firm understanding of the regulations set on the companies with which they do business.
The pressure to increase overview on climate transition in loan portfolios will only increase and it’s important that Banks establish processes sooner, rather than later. There’s also a unique opportunity to provide innovative products that accelerate the transition to net-zero, aligning commercial and environmental interests.
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