Weekly round-up: June 21-25

The top five climate risk stories this week

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1) Green bonds may not count as bank capital — EBA

Green bonds may be ineligible for use as regulatory capital by banks, a European watchdog has warned.

In a new report published Thursday, the European Banking Authority (EBA) said that popular features of green and other ESG-linked bonds prevent them from being counted as loss-absorbing debt, a part of bank capital, under EU rules.

For example, step-up rates and fees promised by green bonds if the issuer falls short of preset climate goals could encourage a bank to redeem the debt early. This conflicts with EU rules that say debt eligible as capital should be perpetual or callable only at maturity.

Issued bonds where the proceeds are ‘ring-fenced’ for investment in climate-friendly projects may also be disqualified, since regulatory capital has to be available to absorb all kinds of losses a bank could incur, not just those related to green assets.

EU banks have stepped up their issuance of green bonds in recent years, and are structuring them in ever more inventive ways. In July last year, Spanish bank BBVA became the first to issue a green bond that counts as Additional Tier 1 (AT1) capital. Unlike some other green bonds, this debt is perpetual, and BBVA only said it would “make an effort to dedicate a percentage of the proceeds … to finance green projects”, terms that would appear to make it eligible as regulatory capital. 

To ensure future green bonds do not fall afoul of capital rules, the EBA said banks should include in their documentation “explicit provisions” on how the proceeds “should cover all losses in the balance sheet”, and statements making clear that their climate-friendly label “ does not affect the status of the notes in terms of subordination, loss absorbency features and regulatory classification”, among other things.

2) EBA says banks should test plans against 10-year period to cover climate threats

European banks should examine the resilience of their business strategies to climate change over at least a 10-year time horizon, the bloc’s banking watchdog has said.

In a report published Wednesday on how banks and their supervisors should deal with ESG issues, the European Banking Authority (EBA) said because climate-related risks could unfold over decades, it makes sense for them to extend their planning horizons and use a variety of “environmental and social scenarios” to guide them. EU bank regulatory authorities should also use a 10-year horizon when analysing institutions’ business plans, the EBA added.

The watchdog said because quantitative projections would be uncertain and patchy out beyond the short- and medium-term, banks could assess their strategies out to the 10-year point in a qualitative manner. Today, the average time horizon used for business planning by EU banks is three to five years.

The EBA also said that ESG risks, including climate-related risks, should be incorporated in supervisors’ assessments of banks’ regulatory capital to determine whether additional loss-absorbing resources are needed on top of existing requirements. The watchdog pledged to embed ESG risks in an update to the Supervisory Review and Evaluation Process (SREP), which is used to set Pillar 2 capital requirements on a bank-by-bank basis.

3) FCA consults on climate disclosure rules

UK asset managers, life insurers and pension funds in the UK would have to publish the carbon footprint and intensity of their individual products and portfolio management services under a proposal drawn up by the Financial Conduct Authority (FCA).

The UK watchdog proposed enhanced climate-related disclosure requirements on Tuesday. The package of measures would require firms to publish product-level climate metrics on their website and in “appropriate client communications”. 

The core metrics to be disclosed include Scope 1, 2 and 3 emissions, total emissions, carbon footprint and weighted average carbon intensity (WACI). The FCA says these should be published as a historical time series so that users can compare the climate impact of products over time. 

The proposal also calls for additional metrics to be made available on a best effort basis, such as a product or portfolio’s climate value-at-risk or implied temperature rise. 

Institutions would also have to make other, entity-level disclosures aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). These firm-wide disclosures would have to be housed in a standalone TCFD entity report, though organisations could cross-refer to disclosures made elsewhere where those cover the relevant content.

The FCA proposal follows the publication of the ‘Roadmap towards mandatory climate-related disclosures’ released by the UK Treasury in November last year. This lays out a strategy for UK authorities to introduce climate disclosure mandates for all kinds of public and private organisations, starting with banks, large occupational pension schemes and premium listed companies.

The FCA rules would come into effect in January 2022 for the largest, most interconnected firms with the first disclosures to be published by end-June 2023. All asset managers and owners above £5 billion in size would be in scope from 2023 with disclosures required by June 2024.

The consultation on the proposal closes September 10.

4) Poor sustainability data assurance poses financial stability risk — IFAC

Only 51% of companies that publish sustainability information, including on climate change, provide any level of assurance on it, the International Federation of Accountants (IFAC) has found. Of those that do provide assurance, 37% use companies that are neither audit firms nor affiliated with audit firms.

“With investors increasingly incorporating sustainability matters into their asset allocation decisions, low-quality sustainability assurance is presenting a significant, global investor protection issue,” wrote IFAC officials Kevin Dancey and Susan Coffey in the foreword to the report.

“Low-quality sustainability assurance is emerging as a financial stability risk as well,” they added.

Source: IFAC

IFAC reviewed the reports of 1,400 companies across 22 jurisdictions to find out the current state of sustainability data disclosure and assurance. Of this total, 1,269 (91%) disclosed some sustainability data. The majority (57%) of these disclosures were made in sustainability reports, with just 18% housed in annual reports. Twenty-four percent of disclosing companies referenced the Task Force on Climate-related Financial Disclosures (TCFD) as a framework that informed their reporting.

5) US federal workers’ pension fund should account for climate risks, says watchdog

The Federal Retirement Thrift Investment Board (FRTIB) should factor climate change into its decisions managing the pensions of US government employees, the Government Accountability Office (GAO) has said.

In a report released publicly on Thursday, the GAO recommended the Board assess climate-related investment risks in the fund, known as the Thrift Savings Plan (TSP). The TSP is the world’s fourth largest pension fund, with $700 billion in assets as of November 2020.

“Taking action to understand the financial risks that climate change poses to the TSP is a useful first step that would help FRTIB be better positioned to consider, as part of its ongoing oversight activities, if any changes are needed to help ensure that the retirement savings of federal workers are protected,” the report said.

The FRTIB is required by statute to invest passively, and not focus on risks from a specific industry or company. However, it has in the past reviewed its investment policy in response to certain developments. For instance, in the 1990s it changed its policy to allow investment in an international equities fund and a small- and medium-capitalisation stock fund.

In response to the GAO recommendation, the FRTIB said its next investment consultant review is due in 2022 and that it would review any recommended changes to its fund offerings then. It also said it would evaluate the recommendations of the Securities Exchange Commission and the Federal Stability Oversight Commission on climate risks to “determine whether and how to apply those lessons to the TSP”.

The GAO report comes in the wake of President Biden’s executive order on climate-related financial risks, issued on May 20. The order directed the Labor Secretary to identify any actions that could be taken under current law to “protect the life savings and pensions of United States workers and families from the threats of climate-related financial risk” and prepare a report on the topic within 180 days.

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First Image: Andrii Yalanskyi / Shutterstock.com, Third image: kamilpetran / Shutterstock.com. All other images under free license through Canva.