Weekly round-up: September 20-24

The top five climate risk stories this week

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1) ECB climate stress test shows ‘hot house world’ threatens banks

Banks “could be severely affected” in a world where climate change is not tamed, the European Central Bank (ECB) said as it published the findings of its first economy-wide climate stress test.

The results show that by 2050 the most climate-vulnerable loan portfolios held by EU lenders would be 30% more likely to implode under a ‘hot house world’ scenario — one which assumes no action is taken to curb global heating — than they are today. Expected losses to EU banks overall are projected to be 8% higher by 2050 under a ‘hot house world’ than under a ‘orderly transition’ scenario.

However, the ECB also found that banks would shoulder costs in the short term under an ‘orderly transition’ scenario relative to both ‘disorderly transition’ and ‘hot house world’ alternatives. These costs would be more than offset in the medium to long run relative to the ‘disorderly transition’ and ‘hot house world’ simulations, though.

The projected impacts on banks’ credit portfolios from climate change appear slight overall. The ECB calculated that average bank-level probability of default (PD) for corporate loan portfolios under the orderly transition scenario would be approximately 2.1% by 2050, and 2.3% under the hot house world scenario.

However certain banks, depending on the make up of their portfolios and the geographical spread of their assets, could prove especially vulnerable to a hot house world. Large banks — what the ECB calls ‘significant institutions’ — would have shakier loan books than their smaller peers as they lend more to companies exposed to extreme weather events. Those banks with lots of exposures in countries most vulnerable to escalating climate physical risks would also see their PDs spiral higher than the average.

Banks’ corporate bond portfolios are also projected to take a beating under a hot house world scenario. Average market losses on these assets between 2020 and 2050 from repricing could be over 35% greater than under the orderly transition scenario.

The climate stress test was conducted using a “top-down” approach — using models, data, and inputs devised by ECB staff. This is in contrast to “bottom-up” tests, which use banks’ own measures of their exposures to generate results. Four million corporates worldwide and 1,600 banking groups across the EU were included in the test’s scope.

The ECB will next apply a supervisory climate stress test to the banks it supervises directly in 2022, based on the results and methodology of this economy-wide exercise. 

2) Unchecked climate change could inflict $3trn of losses on Vanguard — think tank

Vanguard, the world’s second-largest investor, faces “enormous unhedgeable risk” from climate change and is doing too little to protect itself from losses, a new report by think tank Universal Owner says.

The money manager would lose $3 trillion from a 2°C temperature rise by 2050 on its US equity holdings alone, the group projected. Higher temperature increases would inflict proportionately more financial damage. Universal Owner arrived at the $3 trillion figure by applying a “middle-of-the-road” compound growth rate to this equity portfolio and subtracting 6.9% from the 2050 figure, an amount which aligns with the size of the drop in US GDP projected by Swiss Re because of climate change.

Vanguard is also doing little to shift its portfolio towards more climate-friendly assets, the think tank said. Its existing investment policies “fall well short” of those required to align its holdings with the goals of the Paris Agreement, with outstanding bond holdings to coal companies of $7.6 billion and debt financing to the oil sands sector of $8.6 billion.

Universal Owner said Vanguard’s blindspot on climate risk stems from a misunderstanding of its place in the market. Since the asset manager holds a “representative slice” of the equity and bond markets as a whole, it should be concerned about the systemic health of the economy. However, its climate-related actions to date have instead focused on the climate-resilience of individual companies, as evidenced by its focus on getting portfolio companies to produce climate-related financial disclosures.

To improve its response to the systemic risk climate change poses to its funds, the think tank recommended Vanguard dump the thermal coal and oil sands assets in its actively-managed portfolios and pressure the thousands of other carbon-intensive companies it has a stake in to decarbonise their operations.  

3) Reinsurers lowballing physical climate risks by 50% — S&P

Reinsurers may be understating their exposure to future natural catastrophes by half, and will have to fundamentally reshape their businesses to survive in a world transformed by climate change, new research by ratings agency S&P Global finds.

The firm arrived at this conclusion using the results of a “simple stress scenario” — based on the last 30 years’ worth of insured losses from natural catastrophes — which found that a $150 billion loss could be a one-in-ten-year event going forward. Top reinsurers, in contrast, are modelling this kind of loss to occur at between a one-in-20-year and one-in-30-year frequency, S&P said.

The ratings agency said the years since 1990 have witnessed “a significant increase in weather-related losses” by reinsurers, triggered by disasters that “have been made worse or more likely by climate change”. The top three years for annual insured losses over this period — 2005, 2011, and 2017 —  all came close to the $150 billion mark after adjusting for inflation and exposure changes.

If this loss frequency and intensity recurs over the coming decades, reinsurers will experience heightened earnings volatility and have to raise large amounts of capital — $21.7 billion in aggregate — to protect themselves from future catastrophes, either by increasing reinsurance premiums or issuing new equity into the market.

S&P also found that while the majority of reinsurers incorporate climate risk in their business strategies, most assign it “medium importance” in their property catastrophe decision-making processes. In addition, though almost three-quarters of reinsurers say climate change is priced in their policies implicitly through their use of third-party catastrophe models, S&P said just 35% “add an additional explicit load into pricing based on their own assumptions” and that such amounts are in the “low-single-digit percentage range”.

4) SEC lists questions to plug holes in climate-related disclosures

The US Securities and Exchange Commission (SEC) has published illustrative comments on the gaps in companies’ climate-related financial disclosures, as part of its efforts to enhance compliance with existing reporting requirements.

The sample letter, published Wednesday by the SEC’s Division of Corporation Finance, gives public companies an idea of the kinds of questions they could face from the regulator in relation to their climate-related disclosures — or lack of them. Though the comments included in the letter do not represent “a rule, regulation, or statement” of the SEC, it does evidence the Division of Corporation Finance’s attitude towards these kinds of filings.

The comments indicate that companies should: consider disclosing the material impacts of climate-related transition risks that may hit their businesses, financial condition, and results of operations; disclose any climate-related litigation risks; highlight those pending or existing climate laws, regulations and treaties that may affect their businesses; identify past and/or future capital expenditures on climate-related projects, and disclose the effects of physical climate risks on their operations and financial results.

SEC Chair Gary Gensler said in July that the agency would produce “a mandatory climate risk disclosure rule proposal” by the end of this year.

5) Carbon markets initiative debuts governance body

A coalition of businesses and other organisations set up by ex-governor of the Bank of England, Mark Carney, to promote the buying and selling of carbon offsets has formed a new governance committee to oversee its efforts.

The Taskforce on Scaling Voluntary Carbon Markets (TSVCM), first set up in 2020, will now be led by a 22-member governance body composed of market representatives and independent experts. Nineteen members form the Board of Directors, of which 16 were appointed by the TSVCM Advisory Board and three elected by the Member Consultation Group. An additional three Board Directors will be selected to represent indigenous peoples and local communities by this group.

Among the new directors are financial industry professionals including Chris Leeds, in charge of carbon markets trading strategy and product development at UK bank Standard Chartered, and Sonja Gibbs, the Managing Director and Head of Sustainable Finance, Global Policy Initiatives at the Institute of International Finance. Academia and non-governmental organisations are also well-represented on the Board.

The Board is to be supported by a senior advisory council made up of climate and finance heavyweights, including Mark Carney and Bill Winters — chief executive officer of Standard Chartered. An expert panel, co-chaired by leaders in carbon markets methodologies, will guide the Board on technical issues. Together, the various components of the governance body will finalise the TSVCM’s Core Carbon Principles establishing quality standards for carbon credits, and work to build healthy markets where these can be traded.


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