Weekly round-up- June 27 – July 1

Weekly round-up: June 27 – July 1

July 1, 2022

The top five climate risk stories this week

1) US agencies making headway on climate risk — Ceres

Nine US financial regulators have made “tremendous progress” addressing climate risk over the last 14 months, sustainability nonprofit Ceres says.

In an updated scorecard released Monday, Ceres showed that the agencies have collectively taken 230 public actions on climate risk to date. All nine have publicly stated that climate change poses a systemic risk to the financial system and are producing research and data to analyze this risk.

The nine regulators are: the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the National Credit Union Administration (NCUA), the Securities and Exchange Commission (SEC), the Municipal Securities Rulemaking Board (MSRB), the Commodity Futures Trading Commission (CFTC), the Federal Housing Finance Agency (FHFA), and the Department of the Treasury.

Certain agencies have made more progress than others, however. For example, the SEC has made “notable progress” in five of the six action categories evaluated by Ceres, whereas the Fed and OCC have made progress in just two. The Fed is the least advanced on climate risk, having so far made no progress on including climate risk in supervision and regulation or improving climate-related financial disclosures.

While acknowledging the positive steps taken, Ceres says that US regulators still lag their international peers on climate-related rulemaking.

2) Banks, asset managers fall short of carbon accounting standards

Not one financial institution member of the Partnership for Carbon Accounting Financials (PCAF) is in line with its standards on calculating and disclosing portfolio emissions, research from think tank 2 Degrees Investing Initiative (2DII) shows.

The group analyzed 70 PCAF-aligned disclosures featured on the Partnership’s website out of 82 total (12 were discarded because of language barriers). This review found that PCAF’s reporting standard, set out in 2020, are not fully adhered to by any of the assessed firms.

Many firms do not make clear what share of their loans and investments are included in their financed emissions reports, 2DII said, and half do not provide sectoral-level disclosures. 

Furthermore, only 49 companies describe the underlying data sources for their financed emissions disclosures, with just 38 of these providing information granular enough to infer the degree of data quality. 2DII concluded that more than 70% of companies use sector-regional emissions averages to populate their financed emissions disclosures, which means they “effectively provide no meaningful insight into lending and investment strategies of the disclosing entities beyond their regional focus and their sector splits.” 

In addition, just one institution was found to comply with PCAF’s requirement to define a “baseline recalculation policy”, which is meant to establish how a firm revises the initial carbon footprint of its portfolio in response to an investee company’s restructuring or the transfer of emissions inventories between entities.

In a LinkedIn post, 2DII Co-Founder Jakob Thomä wrote that PCAF members “relaxed approach to disclosures bears significant risks to financial institutions.”

3) UK, EU agencies share ESG raters’ shortcomings

Financial watchdogs in the UK and European Union shed light on the wild west of ESG rating and data providers in separate publications this week.

In a feedback statement on ESG in UK capital markets published Wednesday, the Financial Conduct Authority (FCA) reported that a majority of respondents to a recent consultation agree that ESG ratings and data providers lack transparency, have poor governance, and burden companies with extensive data requests.

The FCA concluded that there is a “clear rationale” for regulatory oversight of certain providers, as well as a need for “a globally consistent regulatory approach” like that drafted by the International Organization of Securities Commissions. The agency added that it is supportive of efforts by policymakers to bring the supervision of ESG rating agencies into its regulatory orbit. “[W]e consider that ESG data and rating services should be transparent, well‑governed, independent, objective, and based on reliable and systematic methodologies and processes,” the agency wrote.

The European Securities and Markets Authority (ESMA) published the findings of its own call for evidence on ESG ratings on Monday. From an assessment of 154 responses, ESMA found that the most common problems with ESG ratings are “a lack of coverage of a specific industry or a type of entity and insufficient granularity of data.” Respondents also cited the complexity and opacity of ratings methodologies as issues. The findings were sent to the European Commission to inform their work deciding whether ESG ratings require “regulatory safeguards.”

4) ICMA revises green securitization standards

Updated standards on “green securitization” published by the International Capital Markets Association (ICMA) look to clarify how these instruments should be structured in order to benefit from climate-friendly labeling. 

The standards set out four types of green bond. A “Standard Green Use of Proceeds Bond” is an unsecured debt which is sold to fund investments in climate and environmental projects. A “Secured Green Bond”, in contrast, is a securitization, asset-backed security, or similar structured product where the net proceeds are used either to finance the specific projects that underlie the instrument or other green projects outside the structure. This definition means that a green securitization could be based on non-green collateral, so long as the cash raised from its sale is used to fund climate-friendly activities.

The other two types of green bond ICMA define are a “Green Revenue Bond”, a debt secured by the cash flows of a green project, and a “Green Project Bond”, where the investor has direct credit exposure to the risk of specific green projects.

On green securitizations, ICMA warns issuers against the double counting of green projects. This could happen if a firm uses a green project which has already been assigned proceeds from a green bond issuance as collateral for a securitization. The association also says firms should not typically use the proceeds of a sold green bond to invest in another green bond, citing the same double counting concerns.

ICMA also released tools and data to tighten standards for sustainability-linked bonds (SLBs) and Climate Transition Finance, plus new metrics issuers can use to report the impact of the green projects they finance. A recommendations paper for providers of green, social, and sustainability bond index services was also published.

ICMA is a nonprofit made up of over 600 members that are active in debt capital markets around the world. Though not a regulator, the association produces rules, principles, and recommendations that members use to facilitate the smooth trading of bonds and other credit instruments.

5) Finance Watch sets out net-zero blueprint

Aspiring net-zero banks should embed “climate covenants” in their lending and investment deals and roll out climate-linked financial products, a European nonprofit says.

In a new report, Finance Watch argues that efforts by so-called net-zero financial institutions to decarbonize their asset portfolios are misguided, since investors that don’t care about climate risk or ESG will simply hoover up the carbon-intensive assets that they discard. Furthermore, traditional lenders and asset managers are unlikely to surrender market share in profitable climate-harming activities to “shadow banks” and other unorthodox financial firms.

Instead, net-zero institutions should develop and sell climate-friendly investment products. Finance Watch recommends three kinds: products aligned with the European Union’s sustainable taxonomy; investment funds engaged with carbon-intensive activities that are implementing credible transition plans; and financial products investing in instruments subject to climate covenants.

These climate covenants would be tied to the transition plans of companies a bank invests in or lends to. If breached, they could trigger changes in the agreed financing terms. For example, a bank could craft a climate covenant in a loan deal that would force the borrower to pay more in interest or pay back their debt early if they failed to meet certain thresholds outlined in the EU taxonomy. 

Finance Watch also urges supervisors to police net-zero disclosures and banks’ carbon-neutrality claims. Specifically, supervisors should mandate that disclosures contain absolute greenhouse gas emissions data, account for Scope 1, 2, and 3 emissions, and take into account only actual, rather than hypothetical, emissions removals.

Financial watchdogs should also be empowered to prohibit banks and asset managers from promoting themselves or their products as net-zero aligned if they do not meet certain standards, Finance Watch says.