Weekly round-up: November 2-6

The top five climate risk stories this week

My apologies for the late running of today’s newsletter. **Programming note** next Monday’s subscriber-only newsletter will instead be sent Tuesday, November 10

Climate Risk Review’s Monday newsletter, and Wednesday’s ‘Inside Climate Disclosures’ series, are for paying subscribers only. This week, why political risks matter for banks’ transition scenarios and a deep-dive into RBC’s TCFD disclosure. You can upgrade your subscription here:

1) EU supervisors’ bank risk assessments have ESG blindspots — EBA

Current methods of evaluating capital adequacy may ignore those ESG perils, including climate risks, that could undermine banks’ resilience over time, a European watchdog writes.

A discussion paper on ESG risk management published by the European Banking Authority (EBA) said the process used by regulators to assess banks’ vulnerabilities and set the amount of capital needed to cover them “might not sufficiently enable supervisors to understand the longer term impact of ESG risks, its breadth and magnitude, on future financial positions and related long-term vulnerabilities”.

European watchdogs subject lenders to an annual Supervisory Review and Evaluation Process (SREP) to identify the risks they face, estimate the losses they could suffer, and set capital add-ons as appropriate.

The EBA said this exercise may need an add-on of its own to properly assess “whether credit institutions sufficiently test the long term resilience of the business model against the time horizon of the relevant public policies or broader transition trends”, meaning beyond the three-to-five year horizons most commonly used.

2) SEC official makes case for financed emissions disclosures

Financial institutions should publicise the emissions they fund under a specially-tailored reporting regime, an official at the US Securities and Exchange Commission has said.

Allison Herren Lee, one of five serving SEC commissioners, said the agency should work with market participants to build climate risk disclosures that include the scope 3 emissions linked to their financing portfolios.

“There is a concentration of risk in the financial sector that is not readily ascertainable except through Scope 3 emission disclosures,” said Lee. “Some level of regulatory involvement is needed to achieve standardized, comparable, and reliable disclosure in this critical area”. Lee was speaking at the PLI annual institute on securities regulation on November 5.

She added that the SEC needed to be “cultivating the relevant expertise” by “hiring climate and sustainability experts in various roles and by enhancing training opportunities for staff”. 

In addition, Lee said the SEC might consider rules that compel fund advisers to “implement policies and procedures governing their approach to ESG investment”, and use its authority to push credit ratings agencies to disclose more on how they incorporate ESG factors in their assessments of securities issuers.

3) Giant Australian fund pledges action on climate risk following lawsuit

Australia’s Rest Super, an A$57 billion superannuation fund, will incorporate climate risk in its investment strategy after settling litigation with a member who alleged it was neglecting his best interests by not considering the effects of global warming on its portfolio.

Twenty-five-year-old Mark McVeigh brought the case to federal court in 2018, the first time a super fund member had sued on the issue of climate risk. The trial was due to start this week. As part of an out-of-court settlement, Rest Super said it would decarbonise its portfolio to meet a net zero financed emissions goal by 2050, publicly disclose its fund holdings, measure and report its climate-related risks in line with recommendations laid down by the Task Force on Climate-related Financial Disclosures (TCFD), and gauge the resilience of its investment strategy under two climate change scenarios.

The fund also said it would work with investees to align their business activities with the goals of the Paris Agreement.

4) Fed is evaluating climate risks — Powell

The Federal Reserve is in the “early stages” of assessing the risks of climate change to the US financial system, chair Jerome Powell explained on Thursday.

“The public will expect and has every right to expect that in our oversight of the financial system, we will account for all material risks and try to protect the economy and the public from those risks. Climate change is one of those risks,” Powell said at a press conference on the US economy.

He added that the Fed is keeping tabs on the work of the Network for Greening the Financial System (NGFS), the club of green central banks and supervisors set up in 2017, and “very much working with and monitoring the things” these agencies are doing on climate change.

In January, Powell said the Fed would “probably” end up joining the NGFS. Officials from other central banks have previously told Central Banking that under the climate change-sceptic Trump administration, the Fed has likely faced political pressure not to align with the network.

5) Fitch warns of yawning protection gap for physical climate perils

Insurance-linked securities (ILS) and similar products aren’t growing fast enough to cover the protection gap between insured and uninsured climate-related losses to property assets, ratings agency Fitch says.

In a new report, the firm cites data showing how in 2019, more than 400 natural catastrophes produced losses of $232 billion. However, only 31% ($71 billion) of this amount was insured, meaning the remaining losses fell directly on property and business owners.

Issuance of ‘catastrophe bonds’, a subset of ILS that transfer insurance risks to capital markets participants, hit $12.5 billion as of September, according to the Artemis deal directory — falling well short of the amount needed to bridge this protection gap.

Fitch added that underinsured climate risks negatively affect the credit ratings it assigns issuers. For example, the credit risk of a mortgage pool underpinning a residential mortgage-backed security may be adjusted “to reflect geographical concentration if the pool is heavily concentrated in areas prone to natural disaster types that are typically underinsured, such as inland flooding and storm surges.”

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