Climate risk is redefining business as usual for financial services

The number of companies effectively managing climate-related risks remains relatively small. There is a tendency to view the impacts of climate change as long-term and inherent, resulting in delayed decision making. Companies must examine the impact of climate change on their business strategies and operations. Investors will play a key role in financing the transition and unlocking opportunities.

With the recent announcement from the European Investment Bank that it will be phasing our lending for all fossil fuel projects, it is clear that change is coming.

Signals of change

Interest in how companies will tackle climate change is mounting and showing no signs of slowing down. This is a clear signal from across the industry that this heighted interest must be factored into how financial services organisation do business.

Green Finance

The UK’s Green Finance Strategy was launched in July 2019 and sets out how the UK plans to accelerate the growth of green finance. It calls for collective action “to deliver the urgent and far reaching change required for a greener, more sustainable and prosperous future”. Not just about funding green projects, to transform the financial system climate and environmental factors must be fully integrated into financial decision making across all sectors and asset classes.

TCFD

The Task Force on Climate Related Financial Disclosures (TCFD) recommendations have been backed by over 250 businesses worldwide representing more than $6.5 trillion in market capital. Investors are more keenly monitoring climate risk to ensure the long-term stability of their portfolios against the worst-case scenarios such as emerging regulations leading to non-compliance, increasing insurance and liability costs and stranded assets. The disclosures are now supported and used by governments across the world as well as being spearheaded by the largest pension funds globally.

Earlier this year Mark Carney, Governor of the Bank of England, advocated for increased mandatory disclosure against the recommendations set out by the TCFD. Rumblings from the UK Green Finance Strategy and the World Economic Forum’s Global Risk Report echo this.

There is widespread support from UK government and regulatory bodies for the TCFD to become mandatory by 2022. Integration of the TCFD recommendations into legislation seems inevitable, however what this looks like in practice is uncertain.

CDP

Financial institutions avoided the sector-specific restructuring of the CDP in recent years, however 2020 will see the introduction of the Financial Services questionnaire. CDP is moving from an operational focus and beginning to look outwards, encouraging companies to understand the climate-related impacts of financing, particularly in relation to emissions from investments.

The 2020 CDP Financial Services questionnaire will cover Banking, Insurance, Asset owners and Asset managers.

It is likely that the introduction of this questionnaire will have a significant effect on results as not all companies will be prepared to disclose the additional sector-specific information required.

The changes made to the CDP questionnaires in previous years occurred alongside an 11% increase in number of companies disclosing but a 14% decrease in the number of companies achieving an A.

Of the 12 Climate Change questionnaire modules most have had specific Financial Services questions added.

The new Financial Services questionnaire includes a new module on Portfolio Impact which examines emissions from investments and alignment to a well below 2-degree world.

There have also been a number of questions removed from the questionnaire, including the requirement to breakdown emissions from own operations showing the shift from an internal to an external focus.

PRI

The United Nation’s Principles for Responsible Investment (PRI), the world’s largest network on responsible investment, has integrated the TCFD into its voluntary reporting framework. However, from 2020 it is expected that several indicators will become mandatory. The three strategy and governance indicators cover climate-related risks and opportunities, how these are managed, responsibility for climate-related issues and scenario analysis.

What does best practice look like for financial institutions?

There is increasing pressure on financial institutions to ensure they are effectively managing climate risk and respond to investor requests for information. As a result, it can be difficult to understand what actions financial institutions can take that will have the most impact.

Assess risk through a TCFD Gap Analysis

Businesses should evaluate climate-related risks and opportunities and assess whether they have the resources required to effectively manage these. The TCFD recommendations provide a framework to do this however businesses may not yet be prepared to fully report in line with these recommendations.

Undertaking a gap analysis helps businesses understand what steps to take to improve understanding, management and disclosures of climate risk and impact in order to meet the recommendations of the TCFD framework. The TCFD recommends a three to five year journey for implementation so a gap analysis is the best first step to develop a strategic roadmap with simple, clear steps to build and embed climate risk mitigation and adaptation into business-as-usual operations.

 Scope 3 portfolio carbon footprinting

Reporting on emissions from investments is not a widespread practice amongst financial services organisations. Recent research conducted by CDP shows that if all institutions reported on their whole portfolio the sectors emissions would increase by 78 times.

Investors and stakeholders are keen to understand overall risk exposure, this means reporting on emissions from the whole portfolio and not just operations.

Portfolio carbon foot printing is a key tool to address the highest carbon emissions intensity businesses with a portfolio, highlighting any key risks for the portfolio allowing organisations to adjust investment strategies to align with lower carbon businesses.

Financial institutions SBT methodology

The Science-Based Targets Initiative (SBTi) is currently developing a target-setting methodology for financial institutions to set science-based targets. These methodologies are being road-tested by 29 financial institutions with the launch of the new methodology and criteria expected in 2020.

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