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Climate-Related Risk:
Are Financial Institutions Feeling The Heat? 

 

 

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Author

Kevin McElroy

Senior Vice President - Regulatory and Risk Management

Published
Monday 1 November 2021 
Risk
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The Intergovernmental Panel on Climate Change (IPCC) published their latest report outlining Climate Change as the biggest challenge the world is facing due to changes in the Earth’s climate being observed in every region. (Ref 1 IPCC)

Financial Regulators and Central Banks want to minimise the negative impacts of Climate Change on financial stability and promote a sustainable pathway to a low-carbon economy. Important steps have been taken worldwide, most notably by the PRA, European Central Bank and in the US with the formation of the Supervision Climate Committee within the Federal Reserve.

However, the tangible benefits of this progress are lagging. OECD have reported that total fossil fuel support in 44 OECD and G20 economies rose by 10% in 2019 to USD178 billion, ending a five-year downward trend and undermining global efforts to mitigate Climate Change. (Ref 2 OECD)

Summary of Risks to Financial Institutions from Climate Change

While Climate Change poses risks and opportunities across all industries for all organisations, Financial Institutions need to understand the impact of these risks to optimise profitability and mitigate loss.  

It is important that first and second order relationships are understood through effective risk management frameworks and strong portfolio management, ensuring balance is maintained between protecting capital and addressing shareholder interests.

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(Ref 3 BOE)

The Transition to Mandatory Climate Related Financial Disclosures

The Financial Stability Board, formed after the Global Financial Crisis to promote international financial stability, established the Taskforce on Climate Related Financial Disclosure (TCFD) in 2015. Consisting of 32 members from G20 nations, the initial focus was on voluntary climate-related financial disclosures. These disclosures have now become part of the UK regulatory framework with the PRA mandating climate risk disclosure to TCFD by 2025.

Core Elements of TCFD:

Governance: disclosures must specifically outline corporate governance structures defining board oversight and management responsibilities for climate-related risks and opportunities

Assessing Impact on Business Strategy: business strategy should be assessed against two climate-related risk drivers i.e., climate-related changes that will impact economies:

  • Physical Risk: a direct result from Climate Change, this relates to the uncertainty around the physical impact of Climate Change on a global and regional scale due to rising temperatures, rising sea levels and extreme weather events
     

  • Transitional Risk: relates to the various risks that arise during the transition to a more sustainable low carbon economy which could lead to changes in policy, technology, and market trends, for example, introduction of carbon taxes and changes in consumer preferences impacting supply chains

 

Risk Management: the climate risk drivers impact traditional risk categories used by financial institutions and as reflected in the Basel Framework. (Ref 4 BCBS)

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It is essential that Climate Change is incorporated into risk assessment templates and rating scorecards to ensure Potential Future Exposure for counterparties is accurately forecast. Climate Change should also be included as an economic risk factor within internal stress testing frameworks as part of the capital assessment process.

Metrics and Targets: financial Institutions must determine how to quantify climate-related risks and opportunities over short-, medium- and long-term horizons. Key metrics include Green House Gas Emissions, potential revenue generation from climate related opportunities and concentrations of credit exposure to carbon related assets and revenue streams.

Roadblocks on the path to a low carbon economy

Standardisation of Reporting: The Carbon Tracker Think Tank has identified that over 70% of listed companies, representing some of the world’s biggest corporate carbon emitters, have failed to disclose the effects of climate risk in their 2020 financial statements.  (Ref 5 Carbon Tracker)

Access to Relevant Data: the lack of commonly agreed and industry validated Climate Change risk metrics has resulted in a data gap. The Basel Committee on Banking Supervision conducted a recent survey that indicated a lack of relevant granular data that is not sufficiently reliable to support development of assessment models.  (Ref 6 BCBS)

Consistent standardised data is needed across jurisdictions and industry sectors to ensure accurate and comparable risk analysis, banks, for example, need to differentiate between counterparties in key sectors and identify strong performers in subsectors. Deeper analysis is required to enhance standard Industry and Country risk frameworks that support decision making in setting sector exposure limits, to identify vulnerable sectors and counterparties who generate cash flows from those vulnerable sectors.

How can FinTrU help?

FinTrU has a proven track record providing Risk Management support in the Financial Services industry. FinTrU can provide an end-to-end solution, with extensive experience in Risk Assessment, Data Analysis and Testing with Project Management and PMO support on a global basis.


We have a proven methodology that provides a lean, relevant, and valuable set of processes, tools and skills to uniquely deliver complex change and BAU to achieve stakeholder business objectives at scale.


FinTrU has extensive experience in migrating client processes and delivering complex regulatory change projects from our UK delivery centres. Flexible engagement models from staff augmentation through to fully managed service allows FinTrU to provide a skilled, efficient, and cost-effective solution to regulatory change challenges. 

 


References:

   1. Ipcc 6th Assessment report https://www.ipcc.ch/assessment-report/ar6/

   2. OECD: https://www.oecd.org/climate-change/

   3. BOE Transition in thinking: The impact of climate change on the UK banking sector (bankofengland.co.uk)

   4. Basel BCBS Climate-related risk drivers https://www.bis.org/bcbs/publ/d517.pdf

   5. Carbon Tracker Think Tank Flying blind: The glaring absence of climate risks in financial reporting - Carbon Tracker Initiative

   6. Basel BCBS Climate-related financial risks: a survey on current initiatives (bis.org)

Kevin McElroy.jpg

Kevin McElroy

Senior Vice President - Regulatory and Risk Management

  • Linkedin - Kevin McElroy
  • Facebook - FinTrU
  • Twitter - FinTrU

Kevin is a Chartered Banker and Prince II Practitioner with over 10 years’ experience in Financial Services.

 

Kevin graduated from University College Dublin with an MSc in Financial Services and holds a degree in Business Studies from University of Ulster.
 
Prior to joining FinTrU, Kevin worked within the Portfolio Management team for the National Asset Management Agency, Dublin and Allied Irish Bank specialising in Credit Risk Management. Project delivery includes Risk and Regulatory Reporting covering Basel II, CCAR and commercial real estate financing and structured debt.
 
At FinTrU Kevin is a member of the senior management team with responsibility for a Risk Management project for a London based Tier 1 investment bank client.

About FinTrU

 

FinTrU is a multi-award-winning company, specialising in the areas of KYC, Compliance, Legal, Risk & Controls and Operations. Working with Investment Banks around the globe, the company designs technology-enabled solutions to help its clients meet their regulatory obligations.

 

FinTrU currently employs over 900 people worldwide across Belfast, Derry/Londonderry, London, Dublin, Maastricht and New York.