Assessing climate change risks in financial sector

As of January 1, about 11,700 large companies and groups across the European Union (EU), including listed companies, banks, insurance companies and other companies designated by national authorities as public-interest entities, will need to start reporting a new set of KPIs, including what proportion of their turnover, capital and operational investments budgets are aligned to the EU taxonomy of sustainable activities.

This applies to all entities under the EU Non-Financial Disclosure Regulation (NFDR) and it pertains to the 2021 fiscal year.

As the climate change emergency, biodiversity loss, social disruptions and many other sustainability-related dimensions are increasing in impact and urgency, there is growing commitment by governments, investors, companies, cities and regions to stop their ongoing harm and instead work towards wellbeing, regeneration of ecosystems and more sustainable economic activities.

According to Central Banking – the leading information source for central bankers across 120 jurisdictions – central banks and stock exchanges have been among the first to take concrete action. In an increasing number of jurisdictions, environmental, social, and governance (ESG) dimensions of reporting have become mandatory while in some it remains voluntary.

Central banks, regulators, and governments are concerned about a number of dimensions, including the very real and increasing threats to the stability and resilience of financial sectors in the face of environmental risks.

One of the leaders in the field has been the Financial Stability Board (FSB) through the Task Force on Climate-related Financial Disclosures (TCFD) initiative.

Many regulators and governments have started to require disclosures according to that framework, while others are consulting on how to transition to mandatory requirements that are enforceable.

For example, the Reserve Bank of New Zealand (RBNZ) made TCFD-based climate-related disclosures mandatory in April 2021 for publicly-listed companies,as well as large insurers, banks, non-bank deposit-takers and investment managers.

Developments in Trinidad and Tobago

Market regulators in TT are at present in the preparatory and design phase. One of the leading organisations is the Central Bank (CBTT). At present there are no mandatory reporting or disclosure requirements pertaining to ESG dimensions. The Central Bank of TT’s (CBTT)’s overall approach at the moment includes three main actions:

• Roll out a climate-risk framework for its own operations to be consistent with national policy;

• Conduct at least one climate-risk stress-test exercise of regulated entities/the financial market within the next five years;

• Advocacy of climate change and climate risk.

One of the 20 key strategic projects by the CBTT for the period 2021/22-2025/26 is to “integrate environmental issues and climate change into policy considerations,” including initiatives to:

• Play an active role in Network for Greening the Financial System (NGFS);

• Collaborate with local financial institutions and other agencies in assessing environment/climate change developments and relevant financial measures;

• Calculate the Central Bank’s carbon footprint and determine appropriate changes.

According to Dr Dorian Noel, deputy governor, in charge of monetary operations and policy, the bank subscribes to the general principles of the NGFS, and it is working to integrate and operationalise these principles into the day-to-day operations and policy formulation (monetary, financial stability, and operations).

The bank has integrated its strategic views/positions into its new five-year strategic plan and is working to roll out the climate-risk framework for its operations, which includes governance, measurement, performance goals and integration.

Physical risks, such as extreme weather events, as well as gradual changes in the climate, affect the economy (eg business disruptions, increased commodity prices, etc) and that has an effect on the financial system (eg financial market loss, underwriting loss, operational risks). Economic deterioration can affect financial conditions, while financial contagion (market losses, credit tightening) can feed back to the real economy.

In addition to physical risks, there are also transition risks, emanating from climate policy, technology and consumer preferences. Changes in policy, such as decarbonisation and exit from fossil fuels, can lead to, for example, stranded assets (eg fossil fuels, real estate, infrastructure, vehicles).

Noel believes the transition risks could have become greater if the Glasgow Climate Pact, resulting from COP26, had made a stronger commitment with regard to the phasing out of fossil fuels.

In view of these risks to financial stability, the CBTT will conduct at least one stress test and develop regulation and policies that are proportionate to the risks it determines that financial institutions in TT face. Sectoral engagement is scheduled to start in the first half of 2022.

The majority of these projects by the CBTT should be concluded within three years. The CBTT is also working with other financial market actors and is ready to accelerate and change project timelines if the risk profile changes.

The CBTT is aware of its role in society and in addition to acting with exemplary responsibility itself, it is committed to advocating for climate change and climate risk.

Dr Axel Kravatzky is managing partner of Syntegra-ESG Inc, vice-chair of ISO/TC309 Governance of organisations, and the co-convenor and editor of ISO 37000 Governance of organizations – Guidance. The views presented do not necessarily represent those of any of the organisations he is associated with.

Comments and feedback that further the regional dialogue are welcome at axel.kravatzky@syntegra-esg.com.