Weekly round-up: August 16-20

The top five climate risk stories this week

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1) Many EU banks’ climate plans “inadequate” — ECB

Two in three European banks’ plans for improving their climate and environmental risk management practices are not up to scratch, a preliminary analysis by the European Central Bank (ECB) shows.

The central bank’s latest supervision newsletter includes data on lenders’ efforts to align their approaches to climate risk with its expectations, as laid out in guidance published last November. This data shows that two-thirds of banks “have failed to sufficiently tailor their plans to the supervisory expectations” and that one-fifth of these banks “have (somewhat) inadequate plans”, which imply their climate risk practices will improve only slightly, if at all.

Source: ECB

The ECB also found that the quality of banks’ climate risk efforts varies across the 13 supervisory expectations. When it comes to operational risk management, liquidity risk management, reporting and disclosures, less than two-fifths of banks have adequate plans. On the flipside, over 60% of banks factor in expectations on the management body, organisational structure and stress testing to a “reasonable degree”.

Many banks expect it will take a long time to complete implementation of their plans, too. Less than 35% of banks think their credit and liquidity risk management practices will be aligned with the ECB’s climate expectations “in a timely manner”.

Back in June, Frank Elderson, a member of the ECB Executive Board, said that banks are “a long way off” from meetings the supervisor’s expectations.

2) Swiss to mandate climate-related disclosures

Switzerland will move ahead with binding climate-related disclosure requirements for large companies, banks and insurance firms, the country’s Federal Council confirmed Wednesday.

The Federal Department of Finance has been charged with writing draft requirements based on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) by summer 2022. These will cover all companies with 500 or more employees, more than CHF 20 million in total assets or more than CHF 40 million in turnover. Mandatory disclosure is scheduled to begin from 2024, covering the 2023 financial year.

Significantly, the Federal Council — Switzerland’s executive body — said that companies must disclose both the climate-related financial risks they face and the impacts their activities have on the climate and environment. This “double materiality” approach has also been adopted by the European Union through its Corporate Sustainability Reporting Directive.

In contrast, the UK’s mandatory TCFD-aligned reporting rules, which start coming into force from 2022, have not adopted “double materiality”. In the US, the Chair of the Securities and Exchange Commission has said climate disclosure rules for large companies will be drafted by year-end, but has not opined on what materiality approach these will endorse.

3) Financial regulators’ climate scenario focus misguided — think tank

Climate risk management approaches built around scenario planning may blind the financial sector to the real impact of climate change, a report by an Australian think tank says.

Financial regulators should instead “move beyond” scenarios and embrace a “precautionary approach” to supervision — meaning actions and initiatives focused on preventing high levels of warming.

‘Degrees of Risk’, published by The National Centre for Climate Restoration (Breakthrough) on Monday, says that the climate scenarios cooked up by the Network for Greening the Financial System (NGFS), and today in use by financial authorities and institutions around the world, underplay the effects associated with temperature rises of 3-4°C. At this degree of warming, “the impacts may be so great as to be potentially infinite and unquantifiable, making model-based scenario testing largely irrelevant”, the authors explain.

The NGFS in June released six scenarios: four calibrated to a below 2°C by 2100 outcome, one to plus-2°C and another to plus-3°C. The report’s authors accuse the two above 2°C scenarios of being “poorly developed” and argue that the quantification of climate damages is “grossly underdone”. They also say the four below 2°C scenarios are all anchored in one set of Paris Agreement-aligned assumptions, and thereby neglect other alternative futures.

The authors add that by privileging scenario analysis over different approaches to climate risk management, regulators are in danger of repeating their mistakes in the run-up to the global financial crisis — when they focused on individual institutions rather than “systemic risks to the financial system that were created endogenously”.

4) Commercial real estate investors should upgrade asset models — UNEP FI

Institutional investors should develop “climate-adjusted” financial modelling for commercial real estate (CRE) assets that accounts for how physical hazards could upend their valuations, a new report recommends.

‘Climate Risk & Commercial Property Values’, published by the UN Environment Programme Finance Initiative (UNEP FI) on Monday, says there are many variables that may be influenced by climate risks which “could ripple through [CRE] cash flow modelling or calculation of exit or terminal values”. For example, cash flows from CRE assets could be reduced by spiralling capital costs linked to repairing and restoring climate-damaged properties. Higher insurance premiums required to protect against worsening physical hazards could also impair asset performance.

To capture these climate-related effects, the report says a group of asset owners and managers should agree on an expanded range of input variables for asset-level valuation models. This group should also run sensitivity testing of these variables against future climate scenarios, and find out how the decisions of other financial institutions — like banks and insurers — may influence them.

The UNEP FI authors further recommend that current and projected climate hazard data “be catalogued and shared between market setters and participants”.  They also propose an “engagement and dialogue exercise” involving different levels of government and financial institutions to enhance understanding of the links between public sector “strategic resilience investment” and individual CRE asset values.

5) US urges development banks to refuse fossil fuel projects

Multilateral development banks (MDBs) face US opposition to their financing of most overseas coal-, oil- and natural gas-based energy projects, new guidance from the Treasury Department explains. 

‘Fossil Fuel Energy Guidance for Multilateral Development Banks’, published on Monday, states that the Treasury will push MDBs — which include the World Bank and African Development Bank — to prioritise funding for clean energy, innovation and energy efficiency, and only consider fossil fuel projects if these options prove impractical. The US is the largest shareholder across the MDB system.

The US will continue to support midstream and downstream natural gas projects if they meet strict conditions, the guidance says. It will also consider funding for coal decommissioning efforts “so long as they do not expand the capacity of a plant or extend its life”. This opens the door to US support of efforts like the Asian Development Bank’s scheme to buy out coal-fired power plants in the developing world and shutter them early.

The guidance follows recent efforts by Treasury Secretary Janet Yellen to convince MDBs to align their asset portfolios with the Paris Agreement and embed climate policy goals in their decision making.

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