Weekly round-up: April 26-30

The top five climate risk stories this week

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1) Few financial institutions disclose portfolio emissions –CDP

Almost half of financial institutions do not measure how their lending and investment activities aggravate climate change, a new report by the nonprofit CDP shows.

Forty-nine percent of the 322 institutions that responded to its recent questionnaire don’t conduct any analysis of how their portfolios impact the climate. Of those that do, just one in four disclose their financed emissions — 84 firms total. Among these, over half cover less than 50% of their assets in their financed emissions reporting. Thirty-four percent of all institutions said they plan to conduct climate assessments of their portfolios within two years.

Source: CDP

The findings show that investors currently have limited visibility on the true carbon footprint of banks, asset managers and insurers. Though many institutions do disclose their operational emissions from office use and executive travel, CDP found that the emissions linked to their investing, lending and underwriting are on average 700 times greater than these.

CDP said institutions are also underestimating their climate-related risks. Forty-one percent said they’ve identified climate-related operational risks, which include physical threats to their offices, data centers, and other buildings. But only 35% have identified climate-related credit risks and 25% climate-related market risks. Since the loss potential tied to op risks ($34 billion) is far lower than that linked to credit and market risks ($1.05 trillion), CDP says this proves firms are lowballing their climate-related exposures.

In contrast, a majority of institutions are focused on the financial upsides afforded by the transition to a low-carbon economy — with 76% saying they spy opportunities selling sustainable finance products and services, which CDP says could be worth up to $2.9 trillion.

2) Climate capital add-ons may result from ECB’s annual review of banks

The European Central Bank may impose extra capital charges and other sanctions on lenders for climate risk following its annual review of their financial resilience, a senior official at the agency has said.

Frank Elderson, vice-chair of the supervisory board at the ECB, in a speech on Thursday said the central bank has already started to incorporate climate-related risks into its Supervisory Review and Evaluation Process (SREP), which is used to assess lenders’ capital adequacy. Though this year’s assessments “will not be translated into quantitative capital requirements across the board”, the ECB could introduce “qualitative or quantitative requirements on a case-by-case basis”, Elderson said.

He added that the agency would also challenge banks’ self-assessments of their climate risk readiness. Last year, the ECB published a guide on climate-related and environmental risks, which included a series of supervisory expectations. A total of 112 banks were asked to judge their current practices against these expectations and submit reports to the ECB on how they plan to align their activities to them.

The central bank will benchmark these self-assessments and implementation plans ahead of a full supervisory review of firms’ practices in 2022.

3) SBTi, PACTA lowball transition risks – ShareAction

Popular methodologies for aligning bank portfolios to Paris Agreement climate targets underestimate lenders’ transition risks and may enable greenwashing, a new report by ShareAction says.

The nonprofit assessed two Paris-alignment approaches: the Paris Agreement Capital Transition Assessment (PACTA), developed by The 2 Degrees Investing Initiative, and the Science-based Targets Initiative (SBTi), as well as BlueTrack, an in-house methodology used by UK bank Barclays.

ShareAction said that SBTi and PACTA “dismiss important non-balance sheet items in banks’ portfolios”, including underwriting activities and the undrawn portions of credit lines. BlueTrack was found to cover only a “fraction” of capital markets underwriting. These shortcomings mean all three methodologies underestimate banks’ exposures to transition risks.

The nonprofit also said that because of their patchy coverage, banks have been observed to mix-and-match the open-source methodologies and adapt them to suit their needs. Though helpful in extending their utility, ShareAction warned that this “flexibility can come at the expense of transparency and methodological differences can increase the risk of greenwashing”.

To minimise this risk, the group suggested that 2DII, SBTi and users of their methodologies “abide by clear communications guidelines”. For example, ShareAction said Paris-alignment targets and underlying assumptions should be published in banks’ annual reports. It also recommended that 2DII tell banks to report on managing their fossil-fuel exposures “regardless of what can be technically allowed by the [PACTA] methodology” so that users don’t infer that PACTA alone is enough to get them on the path to Paris. “Adhering to a methodology should not be construed as a
certification of alignment,” the report said.

PACTA is in use at top European banks including Societe Generale, ING and Standard Chartered, among others, and is also being trialed by US giant Citi. SBTi counts HSBC, Credit Agricole and Axa Group among its users.

4) Physical climate risks could undermine diversification strategies – Fitch

Corporates that try to diversify their suppliers to manage their climate exposures may find this approach no match for physical risks, credit ratings agency Fitch has said.

In a new report, the company explains that systemic climate risks will restrict opportunities for risk diversification, as different suppliers will likely be similarly affected by acute and chronic physical hazards, and certain key industries are limited when it comes to supplier options.

“Diversification is the mainstay of most investment strategies to mitigate physical climate risk, but with projected increases in both the frequency and severity of extreme weather conditions and other environmental hazards, this will be tested to the limit in the coming decade,” said David McNeil, director, sustainable finance, at Fitch.

Fitch cites the example of rare earth producers in south-eastern China, a crucial source of battery metals. This region is prone to extreme rainfalls, which are expected to double in frequency by 2030. Users of these commodities could try to protect themselves from disruption in this region by changing suppliers, but “these will not address the wider systemic challenges posed by physical climate change”, Fitch writes.

In addition, the ratings agency says many companies have “limited coordination of sales, procurement, product development and manufacturing divisions,” meaning their ability to respond deftly to escalating physical shocks is inherently restricted.

Fitch says an effective response to these threats would be for the public and private sectors to collaborate on climate adaptation. Solutions could also be found to address the costs of insuring activities focused on risk mitigation.

Fitch also says the most common sectors investors feared for when it came to physical risks are sovereign bonds, municipal bonds, real estate, commercial mortgage-backed securities, infrastructure, utilities and oil and gas.

5) Investors urge Barclays to tighten coal, oil sands policies

Institutional investors including Amundi, Man Group and Nest, together with nonprofit ShareAction, on Monday lobbied Barclays to cut off new oil sands projects and companies developing new coal mines and coal-fired power plants.

Barclays set itself a ‘net zero emissions by 2050’ target for its lending and investing portfolio last year. However, data from climate activists the Rainforest Action Network shows it provided $873 million of financing to oil sands projects in 2020, up 49% year on year. It also extended $763 million of financing to coal-fired power companies and $181 million to coal mining entities. Overall, Barclays was found to be the seventh largest financier of the fossil fuel industry in 2020.

The letter from the investors, which together manage $4.3 trillion of assets, said that “decarbonisation across sectors is expected to accelerate with tightening regulations”, which will load climate risks onto banks, like Barclays, with high exposure to the fossil fuel sector. It added that Barclays also faces reputational risks from its continued involvement in the sector, citing survey data showing how its retail customers are more likely to switch banks when presented with information on its climate-harming financing record.

Besides a prohibition on new funding for coal and oil sands clients, the investors also asked Barclays to commit to a “clear, time-bound plan” to phase out existing exposures and to help clients draw up their own roadmap for exiting coal and oil sands activities. 

Similar demands made by investors and ShareAction of UK bank HSBC resulted in the firm pledging to zero out its financing of coal-fired power and thermal coal mining last month.

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