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At a glance, Climate-related Disclosures are grounded in greenhouse gas accounting and climate physical and transition risk exposures to lending or investment portfolios, supported by quantitative models, while fair conduct principles are to be embedded in company culture throughout all aspects of the financial services and product lifecycle.
Those obligations look very different in how they will impact financial institutions – but are they?
Climate-Related Disclosures aim to be data-driven: as much as possible, statements of impacts need to be supported by quantitative analysis and backed by documented assumptions and methodologies; along with explaining how the financial institution is supporting readiness for the transition to a net zero economy such as investing in or supporting the funding of electric vehicles on the roads or the evolution of the energy mix. That said, the core motivation of the disclosure is to have the still emerging climate risk and its components embedded in each of the business’ strategic layers, from integration into strategy development and execution, and ongoing board and executive oversight through to day-to-day risk management.
Climate risk will need to join other risk factors in the inventory of risks to be considered for management and control.
However, climate risk has a key characteristic that sets it apart from other risks: the time horizon considered; Climate risk has a few key dates of significance for the transition to a net zero economy: 2025, which is when global greenhouse gas emissions would need to peak and 2030 when emissions need almost to halve from 2005 in order to have a good chance of meeting +1.5C in 2050 [2]. 2050 is also when projections of the future start to diverge more clearly on global mean temperatures, ocean acidity, and ice-sheet coverage. The evolution of those metrics is much more pronounced in the second half of the century [3].
As noted before in Mark Carney’s historic speech [4], climate change is the tragedy of the horizon; which can be addressed through better understanding of the risks, better decisions and a smoother transition to a low-carbon economy.
The challenge for financial institutions (in fact, all businesses) will be to genuinely think, plan and act now with respect to managing climate risk (including supporting their customers to manage climate risks). This will require acceptance that higher costs and difficult decisions must be incurred and made now, but the real ‘pay back’ for taking action may not be obvious (at least from a financial perspective) until after 2050.
In our view, to meet the combined intent of these new legislative regimes, there needs to be a genuine and demonstrable commitment by financial institutions, first to understand how their products and services impact the climate or support their and their customers’ achievement of the climate objectives; and secondly to disclose those facts to their customers or prospective customers in a manner that enables them to choose whether to ‘use their services or not. If this is not done then regardless of whether or not CoFI requirements have been met, financial institutions may be in danger of being seen as simply providing ‘lip service’ to both CRD and CoFI in relation to climate risk.
So what can financial institutions do now?
Addressing climate risk (and later on, its close relations nature and biodiversity risks) will need to be about more than crunching datasets and determining a value-at-risk figure to capture a measure.
Ultimately, navigating the complexities of climate risk is a challenging journey. At Mosaic, we understand that and have the expertise and pragmatism to support you.
[3] Climate Change 2021: The Physical Science Basis - IPCC Working Group Ii contribution to the Sixth Assessment Report (fig 8 & 10)
[4] Mark Carney: Breaking the tragedy of the horizon - climate change and financial stability (bis.org)
