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Weekly round-up: April 4-8

April 8, 2022

The top five climate risk stories this week

1) Green finance policies needed to tackle climate risk — IPCC

The “systemic underpricing of climate risk in markets” could be tackled through innovative financing approaches, the latest paper from the Intergovernmental Panel on Climate Change (IPCC) says.

The UN-backed body issued its report on climate change mitigation on Monday, which includes a chapter dedicated to investment and finance. This says that policies “to enhance the risk-weighted return of low emission and climate resilient [investment] options” are needed to promote financial products that support ‘green’ objectives. Such policies include “de-risking investments” — where governments step in to guarantee private institutions against losses on climate-friendly projects — as well as “robust ‘green’ labelling and disclosure schemes.”

The report’s authors also say there is “a persistent misallocation of global capital” in relation to climate goals, with “high levels of both public and private fossil-fuel related financing.” Part of the reason for this is the “current perceived risk-return profile of fossil fuel-related investments” — a function of public subsidies for oil and gas production.

Elsewhere, the report says that “uncoordinated transition risk” could affect financial stability at the institution level and system-wide, and notes that this is currently being discussed by financial regulators, including at the level of the Basel Committee on Banking Supervision.

Benoît Lallemand, Secretary General of the European nonprofit Finance Watch, said: “The latest IPCC report description of climate change as a systemic financial risk is a breakthrough which mandates more ambition from financial regulators and supervisors around the world. It highlights how private financial institutions have an incentive to minimise the risk — in a context of moral hazard where taxpayers are likely to pick up the bill when risks materialise, as happened with the 2008 financial crisis. It also underlines that a qualitative, precautionary approach to prudential regulation is needed. With insurance and banking rules both under review, all eyes are now on EU financial policymakers. The IPCC is watching.”

2) EU leaders approve anti-greenwashing regulations

Rules setting out what investment firms have to tell the public about their products’ sustainability characteristics were adopted by the European Commission on Wednesday.

The rules flesh out the European Union’s Sustainable Finance Disclosures Regulation (SFDR), which is intended to prevent the ‘greenwashing’ of investment products and increase transparency around the climate-friendly claims financial institutions make about their funds. They are slated to come into effect on January 1 2023, but will first be scrutinized by the European Council and Parliament.

Under the rules, financial institutions will have to provide detailed information on how they handle and reduce the negative effects their investments have on the climate, as well as on other environmental and social factors. 

Though the SFDR was not intended to create a product labeling regime for EU investment funds, many firms have sought to align their products with certain aspects of the regulation. What have become known as ‘light green’ funds are those that comply with Article 8 of the SFDR, by promoting environmental and/or social characteristics and using sustainability indicators to measure their positive impacts. ‘Dark green’ funds are those that comply with Article 9 in having “sustainable investment” as a core objective. These funds must also do no significant harm to the myriad sustainability factors enumerated by the SFDR.

3) Climate disclosures to be mandated for Canada’s banks, insurers

Banks, insurers, and other federally regulated financial institutions in Canada will have to issue climate risk reports based on the Task Force on Climate-related Financial Disclosures (TCFD), the government’s budget proposal says.

Released Thursday, the budget says that Canada’s federal financial supervisor — the Office of the Superintendent of Financial Institutions (OSFI) — will require the disclosures from 2024. It will also expect firms to “collect and assess information on climate risks and emissions from their clients.” 

In addition, the proposal says the government will “move forward” with efforts to make pension funds produce ESG disclosures that also cover climate-related risks.

Separately, Canada’s budget earmarked dollars for the International Sustainability Standards Board (ISSB), which has set up an office in Montreal. The organization, which is overseeing the creation of a global baseline of sustainability reporting and published draft disclosure requirements last week, will get CAD$8 million over three years under the proposal.

4) Divestment won’t solve systemic climate risk alone — BoE official

Banks that exit carbon-intensive assets may lower their own transition risks, but may not reduce systemic climate risk if these continue to be financed outside the regulated financial system, an official at the Bank of England (BoE) has said.

In a speech on Thursday, Sarah Breeden, Executive Director, Financial Stability Strategy and Risk at the BoE, said that “anything one firm does to green its own balance sheet will be undermined where those emissions-intensive activities can continue to be financed by alternative sources that will not steward them toward net-zero.”

This could lead to “less transparency” over the activities of carbon-intensive companies and “deprive those firms that need to transition the most access to affordable finance.” However, Breeden added that this risk does not mean the BoE should not “take necessary actions” when it comes to banks’ climate risks.

She also warned of “green asset bubbles” pumped up by a rush of capital into climate-friendly investments, which could lead to “sudden price corrections.” On the flipside, she reiterated concerns raised by ex-BoE head Mark Carney of a climate ‘Minsky moment’ where the prices of heavy-emitting assets collapse “perhaps with wider financial and economic consequences.”

A third risk Breeden raised was the cutting back of finance for certain services and products before climate-friendly alternatives could replace them. “That might arise if limits on finance to corporates involved in the supply of high carbon energy runs ahead of replacement renewable sources. Or if there are restrictions on the provision of mortgages on energy inefficient buildings without finance available to improve them.”

Preemptively restricting financing could impact energy prices and the economy more widely, she said.

5) Investors press European companies on climate risk accounting

Major asset owners and managers are demanding big firms explain why they aren’t incorporating climate risks into their financial accounts.

Members of the Institutional Investors Group on Climate Change (IIGCC) representing more than $7.1 trillion in assets sent letters to 17 European companies — including BP, Glencore, and Volkswagen — criticizing them for failing to produce ‘Paris-aligned’ accounts that show their exposure to climate transition risks. The letters were also sent to each of the 17 companies’ auditors.

Without these disclosures, the investors said they “lack the required visibility to give us confidence that the economic impacts from climate change and associated policy action are being properly accounted for.” If the targeted companies don’t produce such accounts soon, they should “increasingly expect” to see investors vote against the reappointment of their Audit Committee directors, who oversee financial reporting.

“Investors cannot understand the true value of a company without knowing the embedded climate risks,” said Natasha Landell-Mills, Partner and Head of Stewardship at Sarasin & Partners, one of investors that signed the letters. “Company financial statements that leave out climate risks are thus not just potentially failing to meet statutory requirements but will drive too much investment into carbon-intensive activities.”

The IIGCC sent 36 companies their expectations for Paris-aligned accounts last November. To meet these expectations, companies must affirm that the goals of the Paris Agreement have been factored into their accounts, explain how critical accounting judgements are aligned with achieving net-zero emissions by 2050, and describe the sensitivity of their accounts to changing judgements and assumptions on the climate transition.