- Despite the lack of response by the G20 to the TCFD recommendations, there is still an important role to be taken by global, regional and national standard-setting and regulatory institutions in ensuring that the Paris target is met.
- There is no international consensus on material climate risk at the sector, subsector and asset-class level.
- Internationally accepted, integrated accounting standards incorporating climate-change-related risks would reduce investor and financial stability risks.
- Standardised and regulated scenario analysis is needed to understand climate change effects on investment return.
- Banks, asset managers, industry, and government – including state governments in the US – will continue to need to work with regulators to ensure that investors have sufficient knowledge of the risks affecting their portfolios.
LONDON, JULY 10 - Despite the Paris agreement last year there is still no agreement on financial disclosure related to climate change risk for governments, industry or financial institutions, according to a new report published today by The Economist Intelligence Unit (EIU) and sponsored by Aviva.
The report, Road to Action: Financial regulation addressing climate change, reviews ten international, EU and UK standard setting and supervisory institutions to consider what role they play, or could play, in supporting climate-related financial risk reporting and standard setting.
Six institutions — (the IMF, the World Bank, the Financial Stability Board, the European Insurance and Occupational Pensions Authority, the Bank of England and the UK Prudential Regulatory Authority)—were found to to have mandates that cover risk and stability - implicitly covering climate change. However three institutions —the International Organisation of Securities Commissions (IOSCO), the International Association of Insurance Supervisors (IAIS) and the Bank for International Settlements (BIS)—were found to be failing on their mandates in terms of setting climate-related risk standards.
The report’s findings indicate that persuading asset owners and asset managers to consider the long-term viability of their portfolios in terms of the financial risks posed by climate change is vital. With consistent disclosure of material risks, both the business and the investor community should be able to make more informed decisions to take steps to reduce their emissions and create greater business resilience.
Renée Friedman, the editor of the report, said: “It should be considered part of the fiduciary responsibility of any institution with a remit to promote financial stability to also address climate-related financial risks”.
“Our research shows that although not currently explicit in many institutions’ mandates, there is definite scope for expansion of these mandates to include climate-change risk because it is considered by many, including the FSB, to be a financial stability risk.”
The Road To Action: Financial Regulation Addressing Climate Change
I. The Institutional Response To The Increasing Pace Of Climate Change
If nothing is done, the world may have, according to some estimates, as little as 3 years,4 and certainly less than 20 years until its carbon budget is spent or, in other words, global warming goes beyond the 2°C level agreed in Paris in December 2015. However, management of the climate is not only an environmental but also a financial matter, because finance fuels climate impact. Despite this relationship, there are still no binding international agreements or standardised directives for financial regulators, stock exchanges and institutional investors to incorporate climate-change risk into their financial risk models. There are no international agreements on what constitutes a material climate-related financial risk, no formal accounting standards that integrate environmental and social risk with financial risks either quantitatively or qualitatively, no harmonised climate disclosure standards, and no established reference scenario analyses that allow for comparable stress testing and reporting. Given the entry into force of the Paris Agreement on Climate Change on November 4th 2016, following its ratification by 55 countries that signed it far earlier than the originally envisioned 2020 deadline, there is even greater pressure for countries and regulatory bodies to develop climate action plans and disclosure standards that are comparable across geographies, asset classes and industry sectors.
The need for the disclosure of potential climate-related financial risks was first reported in The cost of inaction: Recognising the value at risk from climate change, a study published by The Economist Intelligence Unit (The EIU) in July 2015. It calculated the potential impact on the value of assets from unchecked climate change and benefited from the October 2006 Stern Review, The Economics of Climate Change, which stressed that a delay in acting on climate change would lead to considerably greater expense in response to the actual manifestations of climate change. The Stern Review also formed the basis of our calculations, when we estimated that “warming of 5°C could result in US$7trn in losses, more than the total market capitalisation of the London Stock Exchange, while 6°C of warming could lead to a present value loss of US$43.2trn of manageable financial assets, roughly 10% of the global total”.
Our 2015 report also stated that financial regulators, stock exchanges and institutional investors needed to provide better information and establish strict disclosure rules for all market participants and investors on the financial risks emanating from climate change. The report identified a price on carbon emissions, disclosure of carbon footprints, and accurate assessment and quantification of future climate risk to portfolios as vital components of the debt, equity and capital markets’ response to the climate-change challenge.
These looming financial and physical risks from global temperature increases were implicitly acknowledged by the international finance community in November 2015, when the Financial Stability Board (FSB) established its Task Force on Climate-related Financial Disclosure (TFCD) with a mandate to “develop voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders”. The TFCD put forward its initial recommendations in December 2016. The final recommendations were published on June 29th 2017, in time for the G20 summit on July 7th-8th 2017 in Hamburg, Germany. The Paris Agreement, the TCFD recommendations and other calls for more action to be taken on climate change raise the question of which organisation or organisations at national, regional and/or supranational level should be held responsible for the development of reporting requirements so that they are standardised and suitable for adoption by regulators. In this paper we not only consider which organisation should be held responsible for standardisation, but given their very different remits, we also consider the role that regulators themselves can play in incorporating climate-change risk into their own work. Questions about the real effectiveness of voluntary standards, best practice and actual regulatory requirements led The EIU to examine the mandates of globally important regulatory and standard-setting institutions to see whether they cover—explicitly or implicitly—rules related to financial disclosure of climate-related risk.
The groups of institutions included are:
- International Monetary Fund (IMF)
- World Bank (WB)
- Financial Stability Board (FSB)
- International Organisation of Securities Commissions (IOSCO)
- Bank for International Settlements (BIS)
- International Association of Insurance Supervisors (IAIS)
- European Insurance and Occupational Pensions Authority (EIOPA)
- Bank of England (BoE)
- Prudential Regulatory Committee (PRC)
- European Markets and Securities Authority (ESMA)
We used a number of indicators to determine whether the mandates of the institutions could be considered to have explicit or even implicit requirements with regard to climate-related financial risks. We developed the indicators listed below to act as a benchmark by which actions and commitments taken by these institutions in relation to climate-change financial risk could be measured. The indicators include:
- Lending: We examine whether the primary mandates of institutions providing or facilitating loans to governments or private entities to undertake sustainable development include climate-related considerations in their lending requirements and project-evaluation criteria.
- Financing: Institutional strategies and efforts to raise finance for climate-risk mitigation and adaptation investments.
- Standard-setting: We investigate where the institution is mandated to play a role in developing and/or maintaining industry standards and whether these have been extended to include climate risks.
- Policy development: Activities assisting the processes of climate-risk-related policymaking and adaptation at the sovereign level.
- Inter-agency partnerships: Initiatives where the institution is engaged with peer organisations, international, regional or supranational bodies in fostering discussion on climate-related risk disclosures.
- Knowledge and analytical assistance: Development of research and analytical resources in the areas of sustainability, stability and risk analysis for the financial sector.
- Industry outreach/consultations: Outreach and consultative processes that advance discourse in the area of financial risk (climate risk by extension).
View the full report here.
About the research
The report, sponsored by Aviva, explores the issues relating to climate-related financial disclosure and investigates the mandates of ten different international, EU and UK supervisory and standard-setting institutions in terms of climate-related financial risk reporting.
The findings are based on significant desk research and 22 in-depth interviews with recognised, independent experts from around the world, all of whom are highly familiar with the topics covered and the institutions reviewed.
Ross Jenkinson, Global Head of Marketing – Thought Leadership
Renée Friedman, Managing Editor– Thought Leadership
About The Economist Intelligence Unit
We deliver vital business intelligence to executives the world over. With access to over 650 expert analysts and editors across 200 countries worldwide, underpinned by an unrivalled in-house survey panel that bolsters the qualitative and quantitative analysis, we uncover novel and forward-looking perspectives. We apply the same rigor of our editorial heritage to design content that goes beyond the expected. And our reputation for authority and independence ensures access to elite contributors in every market in the world, providing truly distinctive viewpoints. More information can be found at https://www.eiuperspectives.economist.com or https://twitter.com/EIUperspectives