Regulators, central banks, investors stand firm on climate goals

Bank of England (BoE) governor Andrew Bailey delivered a recent speech in which he conceded the British central bank’s COVID-19 responses paid little heed to climate change.

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“In the face of such an emergency in all conscience it was not right to say to people that they would be denied a livelihood because their employment was of the wrong sort for the climate. I say this very starkly, because there is no point hiding from reality,” he said.

"Central banks and financial system regulators globally are placing much greater demands on the finance system to address and prepare for the risks of climate change.”

The speech was called “The time to push ahead on tackling climate change”. His point: COVID is an acute crisis but climate change a chronic one which requires greater, concerted, action.

Bailey went on: “Compared to the financial crisis and the pandemic, the risks from climate change are even bigger and more complex to manage. And acting now gives us the best opportunity to manage those risks.”

The BoE is not just paying lip service to the need to address climate risk and for organisations to cut their carbon intensity.

“Last year we became the first central bank and supervisor to set out supervisory expectations for banks and insurers on the management of climate risks. And this year we wrote to CEOs with more guidance, putting in place a deadline for firms to meet our expectations by the end of 2021,” Bailey said.

The BoE is far from alone. Central banks and financial regulators globally are placing much greater demands on the finance system to address and prepare for the risks of climate change. That’s true for Australia and for the region and, in many cases, the demand for financial institutions to manage and indeed drive climate change responses goes beyond individual governments.

Heightened financial risk

The imperative for financial institutions and their clients and investors was well summarised by Kevin Stiroh, Executive Vice President of the Financial Institution Supervision Group of the Federal Reserve Bank of New York, in his speech “A microprudential perspective on the financial risks of climate change”.

“Banks are becoming increasingly attuned to the heightened financial risks from a changing climate,” Stiroh said. “These risks can manifest in a number of ways: the impairment of collateral due to severe weather events; mark-to-market losses from the devaluation of companies with stranded assets; stress to contractual cash flows as regional shocks are realised; or the reduced provision of financial services as business strategies adapt.

“All of these are salient concerns for financial firms and their supervisors.”

Hong Kong Monetary Authority (KHMA) Chief Executive Eddie Yue said the question of "whether" around climate change “is behind us”.

“We need to walk the talk and address the question of ‘how’,” he said in a speech entitled “Managing climate risks in Hong Kong” at the Signing Ceremony of the HKMA-IFC Alliance for Green Commercial Banks.

“As a banking regulator, we are working together with banks to manage climate risk. Being a good corporate citizen is important, but for banks there is the added dimension of managing the climate-related physical risk and transition risk associated with the projects and businesses they are funding.”

Make no mistake about the meaning of “working together with banks” when it is said by a regulator….

More than regulation

These are measures banks simply cannot ignore just as they cannot choose to ignore global anti-money laundering reporting or labour laws.

But it’s not just regulation driving this. Pressure to respond to the reality of climate change is coming from the providers of investment capital – be that debt or equity, provided to or by banks, across industries.

The HKMA also has a role in this regard.

“As one of the largest reserves managers globally, we embrace responsible investing. ESG principles are now an integral part of our investment criteria, processes, and asset allocation,” Yue said.

There remains considerable uncertainty around ESG – environmental, social and governance – principles and other sustainability measures. However this is a debate over definitions, homogenisation of regulation and measurement – there is no debate in the broader corporate world and financial services sector about the need to expand reporting and risk measurement to account for sustainability.

For investors, one of the more established ESG assessments is the Dow Jones Sustainability Indices (DJSI). DJSI tracks the performance of the world's leading companies in terms of economic, environmental and social criteria. For this bank, ANZ, its ranking in the top 10 banks globally reflects the work done over several years now on ESG measurement and performance.

“The DJSI is used across financial markets as a research tool and we also use it when assessing new and existing corporate customers,” ANZ Chief Executive Shayne Elliott said. “It’s also part of our Group scorecard.. This year ANZ jumped three points to seventh (from 10th) in the banking sector and received top scores in areas including climate strategy, social and environmental reporting and human rights.”

Board agendas

DJSI is not the only such scrutineer. There are a plethora of ESG ratings tools in the market, all   endeavouring to capture climate, culture and sustainability related-factors important to investors and regulators.

On release of this year’s assessment, DJSI made the following observations about the financial services sector: “In response to more regulatory scrutiny, many banks have transitioned to simplified business models and focused increasingly on the core principles of ethics and customer trust. Corporate governance and banking culture remain significant items on board agendas, and establishing effective incentive schemes are increasingly viewed as a way of aligning attitudes and behaviours with the long-term interests of shareholders and society.”

Like climate change risk assessment, social and governance initiatives go directly to the long term quality of an organisation’s earnings. Failure on these fronts – for example, missing the risk implications of climate change, failing to create a culture which is sensitive to conduct flaws or managing for the short rather than long term – will ultimately lead to underperformance.

According to DJSI: “Confidential and customer data is increasingly managed and protected, minimising cyber risk. In efforts to support the transition to more sustainable business models and adherence to regulatory developments on sustainable finance, banks are becoming increasingly proactive and transparent, enabling financial market participants to better identify sustainable activities and investments.”

While the broad direction of sustainability imperatives is clear, the detail is long and complex. For example, how should banks measure their total “emissions”? Including those they finance?

Enter the Partnership for Carbon Accounting Financials (PCAF), a group of banks. The group is significant because, according to the Financial Times’ (FT) Moral Money newsletter, less than 1 per cent of financial institutions reported the emissions linked to their balance sheet.

According to the FT, “climate-conscious investors are clamouring for this data” along with big banks and their supervisors.

Needless to say, measuring and disclosing total financed emissions, especially in carbon-intensive sectors, is critical if banks are to understand their climate impact.

While some may see it as overreach or interference in public policy, banks taking steps on the climate front are responding to their regulators, their investors – and their business risks and opportunities.

Andrew Cornell is managing editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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