As global warming wreaks havoc across the world, there is a growing awareness that physical and transition risks threaten banks and the wider financial system. Banks have seen stakeholder awareness of these risks grow substantially over recent years, with regulators, policymakers, customers, employees, and civil society imploring them to improve and disclose their climate-related financial risk management capabilities.
Recent months have seen financial regulators, in particular, sharpen their focus on banks’ climate risks. In the US, the Office of the Comptroller of the Currency (OCC) — the country’s main bank watchdog — released draft principles for big banks on identifying and managing their climate risks. Meanwhile, in Canada, the Office of the Superintendent of Financial Institutions (OSFI) said it would introduce a draft guideline with its climate risk management expectations of federally regulated financial institutions later this year.
On the other side of the Atlantic, the European Central Bank launched its inaugural supervisory climate stress test for banks, which is intended to gauge banks’ preparedness for handling the financial and economic shocks of both physical and transition risks. Around the same time, the European Union’s banking regulator issued draft disclosure rules for firms that would require them to publish detailed information on their exposure to carbon-intensive companies and their funding of ‘green’ activities.
The Task Force on Climate-related Financial Disclosures (TCFD) provides a framework for banks to identify, monitor, and manage their climate risks. Since the TCFD has been used as the inspiration behind many financial regulators’ climate initiatives, it also offers banks a guide to fulfilling their growing expectations. Already, TCFD-aligned disclosure requirements are in place, or soon to be implemented, in New Zealand, Switzerland, the UK, and China. In Canada, Crown Corporations holding more than CAD$1 billion in assets have to start reporting in accordance with the TCFD as of this year. In the US, the TCFD framework may well underpin new climate risk disclosure rules currently being drafted by the Securities and Exchange Commission.
With the TCFD acting as the foundation for climate-related financial regulation, it makes sense for banks to get familiar with its four pillars: Governance, Strategy, Risk Management, and Metrics and Targets.
1. Governance: Starting at the top
Strong climate governance is essential if a bank is to put in place an effective climate strategy and risk management framework. To achieve this, the TCFD recommends that banks establish a formal climate oversight function, appoint senior officials to climate-specific roles, and apportion climate responsibilities at the board and senior management levels. This way, a bank can establish leadership at the top to drive its climate strategy and bring clarity to each part of the organization on its role implementing this.
Manifest Climate’s knowledge of common industry practices has revealed that key areas of advanced governance on climate change include: a corporate position statement (may also include a risk appetite statement), the implementation of ongoing education for all levels of the organization, and ensuring that the board and senior management levels have expertise related to climate risks and opportunities.
2. Showing a strategic approach on climate
The next pillar that banks must tackle is Strategy. This pillar advises organizations on identifying and assessing their exposures to climate risks and opportunities and putting together a clear plan in response. The TCFD carefully outlines specific risks and opportunities for banks and offers them a guide to exploring how these might impact their strategic and financial planning under different climate scenarios. These focus on the bank’s lending and other financial activities, but also apply to its corporate operations. The TCFD also recommends that organizations discuss their planned responses to these risks and opportunities.
3. Risk Management: Integrating climate into internal processes
The third pillar of the TCFD framework is Risk Management. This pillar focuses on the processes used to identify, assess, and manage climate-related risks and opportunities. It also speaks to how institutions should integrate climate into their established risk management processes, as well as engagement activities with clients and counterparties.
Manifest Climate’s database of industry best practices shows that climate-related data collection and research are critical to establishing a robust climate risk management approach. These elements are also frequently referenced by financial authorities, including the members of the Network for Greening the Financial System — a coalition of climate-focused central banks and supervisors. Banks require both internal data from their counterparties, as well as data from third-party providers, to allow them to effectively identify, assess, and manage climate-related issues.
4. Utilizing climate Metrics and Targets
The last pillar of the TCFD is Metrics and Targets. These recommendations cover how organizations should set climate goals and measure their progress against them. For banks specifically, the TCFD asks that they calculate and disclose the GHG emissions produced by their own corporate operations and, more significantly, by the businesses they finance through loans and investments. The TCFD also lays out a number of metrics to advance banks’ strategic climate objectives and manage their climate risk exposures.
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