Category: Financial Services

2019 picks from the Acclimatise article archive – Financial Services

2019 picks from the Acclimatise article archive – Financial Services

The start of a new year is a time for setting new resolutions for the year ahead, whilst giving consideration to moments that shaped us over the past year. With that spirit of reflection in mind, we sifted through our network’s article archive and selected some of our favourites from the past year. We’ve sorted our favourite articles by topic, to make up a six-part series throughout the month of January.

We kick off with six articles related to climate adaptation for the financial services sector. 2019 was another important year of progress with momentum continuing to grow behind the recommendations of the Taskforce on Climate-related Financial Disclosure (TCFD). The noises from central banks including Bank of England Governor, Mark Carney, indicate that they are prepared to take further action, if banks and investors are perceived to be dragging their heals on the issue. The Bank of England and the French financial regulator have both indicated that they will begin climate stress testing of banks this year.

In the meantime, there remains a need for more standardisation of approaches for climate risk disclosure in the industry. Acclimatise continues to work with leading banks and investors to develop methodologies to help them understand, measure and manage the physical climate risks to their loan portfolios and investments.

Advancing climate-related financial risk discourse in the financial sector

By Laura Canevari

The financial sector must play a fundamental role in the transition to a low carbon and climate-resilient future. To do this, there is a need for a systemic shift in the way the financial system operates and in the way investment decisions are made. Through the release of the TCFD Recommendations in 2017, financial institutions, along with corporates, have been given a robust compass with which to navigate climate disclosures.

Read the full article here.

Bank of the England plans to test climate resilience of UK banks

By Acclimatise news

Mark Carney, governor of the Bank of England, said the central bank has plans to include the impact of climate change in its UK bank stress tests. Since 2017, the Bank of England assesses on a yearly basis how well the UK’s biggest lenders could withstand a shock without needing a bailout from taxpayers. This announcement comes after a survey completed by the Bank of England in 2018 showed that only 10% of banks were considering their long-term climate change risks.

Read the full article here.

Climate change adaptation is the “biggest investment opportunity of this generation,” says new UNEP FI report

By Will Bugler

In September 2019, the UNEP Finance Initiative launched a technical background paper on adaptation finance, identifying barriers and opportunities for scaling up financing for climate change adaptation and resilience building. The paper, ‘Driving Finance Today for the Climate Resilient Society of Tomorrow’ refers to adaptation as “the biggest investment opportunity of this generation’.

Read the full article here.

Investor portfolios failing to account for climate risk says BlackRock

By Acclimatise News

A report by the BlackRock Institute accuses investors of under-pricing the impact of climate-related risks and advises a restructuring of assessments of asset vulnerabilities. The report, ‘Getting physical: Scenario analysis for assessing climate risk’ marks an important next step.

Read the full article here.

Climate poses direct risk to real estate investment says ULI report

By Will Bugler

In a recent published just last year, the Urban Land Institute and real-estate investment management firm Heitman assess the potential impacts of climate change on real estate assets and give some direction as to what investment managers and institutional investors might do to understand and reduce their climate risk disclosure.

Read the full article here.

COP 25 signals public and private sectors coming together to green the financial system

By Caroline Fouvet

Multiple side events involving green finance emerged at the 2019 UNFCCC climate negotiations this past year. One common thread was the importance of collaboration between public sector-led efforts and financial institutions’ (FIs) initiatives to build a sustainable low-carbon and climate resilient financial system.

Read the full article here.


Bank of England unveils climate stress test

Bank of England unveils climate stress test

by Kieran Cooke

The warming world means climate stress now permeates every part of society. And so an entire financial system which has underpinned the growth of a global economy largely dependent on fossil fuels must be reoriented to deal with what is fast becoming a full-blown crisis.

A campaign to halt or withdraw multi-million dollar investments from industries associated with fossil fuel use is gaining momentum. And the central banks – the institutions responsible for regulating countries’ financial systems – are now taking action.

Leading the charge is the venerable Bank of England (BOE), one of the oldest such institutions in the world. In December it became the first central bank to announce what it terms a banking stress test on climate change.

Under the BOE’s stress test framework, banks and insurance companies will be required to go through their books to evaluate their exposure to the impacts of climate change.

If, for instance, a British bank has loaned money to a company building a coal-fired power plant, the BOE will require the bank concerned to hold a substantial amount of additional capital to cover the risks of the project being abandoned because of new regulations or other climate change-related factors.

“A question for every company, every financial institution, every asset manager, pension fund or insurer is what’s your plan on climate change”

In the same way, if an insurance group has granted cover to houses on a flood plain, or to coastal properties which could be subject to rises in sea level – or if a bank has granted mortgages on such properties – the BOE will require additional capital to be held to cover the financial risks involved.

Other financial institutions are examining ways in which their activities can be protected from the more serious impacts of a warming world.  Several insurance groups have announced plans to withdraw cover from fossil fuel projects.

Central banks are following the BOE’s lead: a body with the somewhat cumbersome title of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) now has more than 40 members – all involved in monitoring the risks climate change poses to the finance sector.

The BOE’s action has two aims. One is to ensure the financial system can withstand the considerable financial costs posed by climate change. The other is to encourage financial institutions to invest their funds in more sustainable, environmentally friendly projects.

Mark Carney, the outgoing BOE governor who is soon to take up a post as UN special envoy for climate action and finance, describes the BOE stress test as the first comprehensive assessment of whether the financial system is on track to help deliver a transition to a sustainable future.

Worthless assets possible

“A question for every company, every financial institution, every asset manager, pension fund or insurer is what’s your plan (on climate change)”, Carney told the BBC.

He says that unless the finance sector and large companies wake up to the scale of the climate crisis, many of the assets they now hold in fossil fuels and other enterprises will become worthless.

Some financial institutions are taking action, says the BOE governor, divesting from investments in fossil fuels and becoming involved in more sustainable projects, but progress is still far too slow. Time is of the essence.

“The climate emergency continues to build. The next year will be critical”, says Carney.


This article was originally published on the Climate News Network.
Cover photo by Markus Spiske on Unsplash
COP 25 signals public and private sectors coming together to green the financial system

COP 25 signals public and private sectors coming together to green the financial system

By Caroline Fouvet

The work of the financial services sector in addressing climate change was high on the agenda at COP 25 in Madrid this year. Indeed, this December, the 2019 UNFCCC climate negotiations saw multiple side events involving green finance, and one common thread that emerged was the importance of synergies between public sector-led efforts and financial institutions’ (FIs) initiatives to build a sustainable low-carbon and climate resilient financial system.

The impact of the Task Force on Climate-Related Financial Disclosure (TCFD) recommendations is one of the main underlying factors to these common endeavours aimed to tackle climate-related issues. As it stands, several countries are implementing both compulsory and voluntary measures for the financial sector to take into account transition and physical risks, including the UK and France. Launched at COP, the 2019 Investor Briefing of the Global Adaptation & Resilience Investment (GARI) Working Group, to which Acclimatise contributed, urges investors to pay attention to this growing regulatory trend. While there are a number of ways that the public and private sector will have to work together on climate action, the need for standardisation, increasing green bonds, and macroeconomic analysis of climate impacts were in sharp focus at COP25.

A call for standardisation

One of the main reasons FIs are working hand-in-hand with governments on green finance is the need for standards to consistently address climate-related risks and opportunities. The European Union sustainable finance taxonomy was, for instance, referred to in multiple instances during panel discussions and praised as an efficient tool providing clarity as to what constitutes sustainable finance.

Financial regulators present at COP 25 mentioned their work on standardisation and methodologies. The Colombian financial regulator Superintendencia Financiera de Colombia (SFC) issued a mandatory survey to take stock of the country’s financial institutions’ governance, risk management and opportunities consideration practices, in order to identify best practices and provide common definitions. The Bank of England explained that it was currently working with scientists and FIs to develop four standardised scenarios that will be published in the spring 2020 and trialled by members of the Network for Greening the Financial System (NGFS). The NGFS chair Mr. Frank Elderson also announced that the Network was undertaking detailed technical work on scenarios, stress-testing, environmental assessment methodologies and guidance on integrating environmental risks in supervision.

Increasing green bond growth in developed and developing countries

In the wake of standardisation initiatives, several side events at COP 25 focused on the emergence of green bonds methodologies and the collaboration of governments with FIs to enable their take up. Both developing and developed countries are proactive on the issue, as shown by Nigeria and Ireland. The former issued the first African green bond in 2017 that was successfully subscribed to, thanks to efforts from the Nigerian federal government in giving confidence to investors regarding the green projects the proceeds would be invested into. The country set up the Green Bond Private Public Sector Advisory Group, which brings together capital markets, private corporates, the Government and external development partners to support the green bond programme and enable cross-sectoral dialogue. In Ireland, the government engaged with banks and investors in developing the Irish green bond framework, which underpins the issuance green bonds and use of the proceeds to finance projects that promote Ireland’s transition to a low-carbon, climate-resilient and environmentally sustainable economy.

Macroeconomic analysis of climate impacts

Another area for collaboration was the analysis of climate change impacts on the economy, undertaken by Central Banks. A representative of the Central Bank of Costa Rica explained how 2016 hurricane Otto hit the country for the first time and impacted the inflation rate and GDP growth, leading to repercussions on the financial sector. This pushed the Central Bank to undertake analyses from a risk perspective of what climate-related events such as El Nino meant in terms of inflation, and to communicate on this topic to financial stakeholders. The Central Bank of Chile is also involved in analyses of the climate impacts on the macroeconomy.

Financial sector alignment with the Paris Agreement’s mitigation and adaptation objectives continued at COP 25

Each COP provides a platform for dialogues across continents, sectors and institutions. COP 25 reflected this collaborative spirit between FIs and government-led work to green the financial system. Climate action is now an established concept within the financial sector, as evidenced by the conversations at COP 25, which constitutes an essential step in addressing the climate emergency.

Note: COP = Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC)


Cover photo taken by Caroline Fouvet at COP25.
Climate risk stress test for banks and insurers in France to begin next year

Climate risk stress test for banks and insurers in France to begin next year

By Will Bugler

Banks and insurance companies in France will undergo climate risk stress tests to ensure they are adequately managing their exposure to both the transition risks and physical risks of climate change. Speaking just before the start of COP25 in Madrid, France’s central bank governor Francois Villeroy de Galhau announced that France’s financial regulator would begin the tests from next year.

Banks and insurance companies in France have been required by law to disclose climate risks for over three years. “We will run climate stress tests for French banks and insurance next year,” Villeroy told a green finance conference in Paris. “This will be very important progress in order to assess the kind of climate risks that are already nascent in banks and insurers’ balance sheets”.

The financial services industry has come under increasing pressure to understand and manage its climate risk exposure. In 2015, the Bank of England Financial Stability Board’s Taskforce on Climate Related Financial Disclosure (TCFD) released recommendations to encourage the banking sector to manage its climate risk.

The financial sector has responded by beginning to grapple with its climate risk exposure. Last year for example, sixteen leading banks, UN Environment Finance Initiative (UNEP FI) and Acclimatise, published new methodologies that help banks understand how the physical risks and opportunities of a changing climate might affect their loan portfolios.

The methodologies, published in the report “Navigating a new climate”, were piloted across three climate-sensitive industry sectors: agriculture, energy and real estate. Using the methodologies, banks can begin to assess physical climate risks in their loan portfolios, evaluating the impacts on key credit risk metrics – Probability of Default (PD) and Loan-to-Value (LTV) ratios. The forward-looking assessments offer longer-term insights that go beyond the usual stress-testing horizon of 2-3 years.

The move by France’s financial regulator comes on the back of similar moves from other countries. The Bank of England said in October it would stress test the financial system under various climate “pathways” and the European Central Bank said earlier this month it was also considering it. Last month, Mark Carney, the governor of the Bank of England, warned major corporations that they have two years to agree rules for reporting climate risks before global regulators devise their own and make them compulsory.

Download a copy of Navigating a New Climate here.


Cover photo from Flickr by The Jacques Delors Institute 
New UK Stewardship Code requires reporting on ESG factors including climate change

New UK Stewardship Code requires reporting on ESG factors including climate change

By Robin Hamaker-Taylor 

The UK Financial Reporting Council (FRC) has issued a revised Stewardship Code this November, following a public consultation in March 2019.  The new Code takes effect from 1 January 2020 and now takes into consideration the fact that since the last revision in 2012, climate change, environmental, social and governance issues have all become material issues for investors to consider when making investment decisions and undertaking stewardship.

The Code does not prescribe a single approach to effective stewardship. Instead, it allows organisations to meet the expectations in a manner that is aligned with their own business model and strategy. Stewardship is defined in the new Code as: ‘the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society’. Asset owners, managers, and service providers can demonstrate their good stewardship by using the Code to voluntarily report against a set of Principles.

The Code sets out “apply and explain” Principles for asset managers and asset owners, and for service providers. Reporting expectations are included for each Principle, pointing to information that the FRC expects should be publicly reported in order for the relevant organisation to become a signatory.

It is a notable departure from the 2012 and other previous versions. In particular, it requires signatories to take account of material ESG factors, including climate change, when fulfilling their stewardship responsibilities. Asset managers, asset owners, and services providers (‘signatories’) are now required to port on their specific stewardship activities and outcomes over a period of 12 months, rather than just focussing on reporting on stewardship policies. Furthermore, the Code requires signatories to disclose more detailed information around their voting decision-making process and history, as highlighted by law firm Baker McKenzie.  

The 12 Principles for asset owners and managers are as follows:

  • Principle 1: Signatories’ purpose, investment beliefs, strategy and culture enable stewardship that creates long-term value for clients and beneficiaries leading to sustainable beliefs for the economy, the environment and society.
  • Principle 2: Signatories’ governance, resources and incentives support stewardship.
  • Principle 3: Signatories manage conflicts of interest to put the best interests of clients and beneficiaries first.
  • Principle 4: Signatories identify and respond to market-wide and systematic risks to promote a well-functioning financial system.
  • Principle 5: Signatories review their policies, assure their processes and assess the effectiveness of their activities.
  • Principle 6: Signatories take account of client and beneficiary needs and communicate the activities and outcomes of their stewardship and investment to them.
  • Principle 7: Signatories systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities.
  • Principle 8: Signatories monitor and hold to account managers and/or service providers.
  • Principle 9: Signatories engage with issuers to maintain or enhance the value of assets.
  • Principle 10: Signatories, where necessary, participate in collaborative engagement to influence issuers.
  • Principle 11: Signatories, where necessary, escalate stewardship activities to influence issuers.
  • Principle 12: Signatories actively exercise their rights and responsibilities.

The 6 principles for service providers, e.g. investment consultants, proxy advisors, and data and research providers, are as follows:

  • Principle 1: Signatories’ purpose, strategy and culture enable them to promote effective stewardship.
  • Principle 2: Signatories’ governance, workforce, resources and incentives enable them to promote effective stewardship.
  • Principle 3: Signatories identify and manage conflicts of interest and put the best interests of clients first.
  • Principle 4: Signatories identify and respond to market-wide and systemic risks to promote a well-functioning financial system.
  • Principle 5: Signatories support clients’ integration of stewardship and investment, taking into account, material environmental, social and governance issues, and communicating what activities they have undertaken.
  • Principle 6: Signatories review their policies and assure their processes.

Organisations must submit their first Stewardship Reports based on the 2020 Code by 31 March 2021, following which the FRC will publish a list of the first 2020 Code signatories in the third quarter of 2021.

The UK Stewardship Code 2020 is available via the FRC website, by clicking here.

The FRC is the UK’s regulator of auditors, accountants and actuaries, setting out UK Corporate Governance and Stewardship Codes and UK standards for accounting and actuarial work. It also monitors and takes action to promote the quality of corporate reporting and operates independent enforcement arrangements for accountants and actuaries.

More information about the 2019 Stewardship Code consultation and subsequent Feedback Statement are available from the FRC website, by clicking here.


Photo by Sweet Ice Cream Photography on Unsplash
US Commodity Futures Trading Commission moves forward on assessing climate-related financial risks and announces members of the new climate sub-committee

US Commodity Futures Trading Commission moves forward on assessing climate-related financial risks and announces members of the new climate sub-committee

By Laura Canevari and Robin Hamaker-Taylor

The US Commodity Futures Trading Commission (CFTC) Commissioner announced the members of the newly established Climate-Related Market Risk Sub-committee (aka the ‘Climate Sub-committee’) on 14 November 2019. The CFTC announced earlier this year that it will begin to assess climate-related financial risks, in line with actions announced by its counterparts around the world in recent years. Establishing this sub-committee signals ongoing commitment to this goal.

The Climate Sub-committee is sub-committee of the CFTC’s Market Risk Advisory Committee (MRAC), and it will have 35 members representing a range of expertise and industries. Representation will be from financial markets, insurance and banking sectors, data and intelligence providers, as well as academics with a range of knowledge on climate change, public policy and finance. among others.

The sub-committee will provide a report to the MRAC detailing climate related financial and market risks and will proactively identify and assess the financial market impacts of climate change. A preliminary set of topics and issues the sub-committee will cover, to that end, were also released. Specifically, the sub-committee will aim to carry out the following activities, among others:

  • Identify challenges or impediments to evaluating and managing climate-related financial and market risks;
  • Identify how market participants can improve integration of climate related scenario analysis, stress testing, governance initiatives, and disclosures into financial and market risk assessments and reporting;
  • Identify policy initiatives and best practices for risk management and disclosure of financial and market risks related to climate change that support financial stability; and
  • Identify appropriate methods by which market participants’ data and analyses can enhance and contribute to the assessment of climate-related financial and market risks and their potential impacts on agricultural production, energy, food, insurance, real estate, and other financial stability indicators.”

The full list of the new committee members can be viewed via the CFTC website, by clicking here.


Cover Photo by Denys Nevozhai on Unsplash
New guide helps actuaries make physical climate risk considerations

New guide helps actuaries make physical climate risk considerations

By Robin Hamaker-Taylor

The Institute and Faculty of Actuaries (IFoA) published a guide this month (November 2019), titled ‘A Practical Guide to Climate Change for Life Actuaries’. The guide seeks to provide information to support actuaries to integrate climate change considerations into their work. It aims to help life actuaries respond to the 2017 IFoA Risk Alert on Climate-Related Risks, which stated: “Actuaries should ensure they understand, and are clear in communicating, the extent to which they have taken account of climate-related risks in any relevant decisions, calculations or advice.”

Climate change can impact health and mortality, physical assets, and financial markets, all of which could have implications for life insurers and actuaries working for them. As the new guide points out, the wide range of existing climate impact modelling outputs do not directly provide inputs to life insurance financial models. This new guide aims to bridge this gap by proposing approaches and frameworks to more directly link climate change considerations into typical insurance risk frameworks. This development could not come at a better time, as actuaries recently rated climate change as the number 1 risk in new survey, rating it as a bigger threat to insurers than cyber-crime, financial instability, and terrorism.

The guide provides a rich discussion on how life actuaries can integrate climate change considerations in their day to day work, covering information relating to physical, transition and liability risk. For example, the guide reviews how climate change risk can be linked with risk classifications typically included in an Enterprise Risk Management (ERM) framework. The guide also sets out some considerations specific to linking the implications of climate change to demographic modelling, and illustrates how climate change modelling may be appropriate for life actuaries. Beyond this, the guide covers other elements which could be useful to members of the financial services sector more generally; for example, it discusses how insurers can identify both existing explicit and implicit regulatory and disclosure requirements and how these may change in future. It is worth reiterating that this is a practical guide, and as such, it includes helpful ‘Practical Steps’ at the end of each chapter. 

This new guide is one of several other practical guides recently commissioned by the IFoA’s Resource & Environment (R&E) Board. Other guides commissioned by the R&E Board recently include guides on climate change targeted at general insurance (GI) practitioners and at actuaries advising on defined contribution or defined benefits pension schemes. A general introduction to climate change for all actuaries was also published in 2019 titled ‘Climate Change for Actuaries: An Introduction’. All R&E Board guides are available from the IFoA website, by clicking here. These guides, while not aiming to provide formal guidance, can help insurance firms and actuaries working for them start to include climate change into typical insurance risk frameworks.


Cover Photo by Gerrit Vermeulen on Unsplash
Training workshop: Integrating climate risk considerations into decision-making processes

Training workshop: Integrating climate risk considerations into decision-making processes

A three-day training workshop hosted by the Banking Association of South Africa (BASA) in collaboration with GIZ’s Climate Support Programme (CSP) in South Africa, will provide eight South African banks with the knowledge and tools required to take demonstrable action to embed climate risk into their existing risk management frameworks. The training will take place from November 27th to 29th at the Standard Bank Global Leadership Centre in Johannesburg.

            Through a set of interactive plenary presentations, practical exercises and contributions from guest speakers, the workshop is designed to provide training participants with an incremental understanding about the relevance of climate risk management and disclosure and its integration in existing decision-making processes, in line with the recommendations of the Task Force on Climate-Related financial Disclosure (TCFD). The training will aim to foster peer-to-peer learning between international and national banks that are at different stages of their journey in integrating climate-related risks into their governance structures, risk management processes and disclosure, as well as undertaking climate scenario analysis. Perspectives from South African companies that have been considering climate risks into their supply chains, business assets and operations, customers and other stakeholders will be also sharing their experience with the participating South African banks on the market needs and opportunities they foresee in their sectors towards a low carbon and climate resilient economy.

            Over the course of the three days, Acclimatise’s own Virginie Fayolle will introduce participating banks to relevant climate change-related risks in South Africa, as well as help them navigate the suite of climate scenario-based tools available to them for evaluating climate risks based on their existing needs and capabilities.

Key events include:

27th November 2019

10:45-11:15 Climate change-related risks in South Africa / Virginie Fayolle

11:45-12:25 Key International regulatory and market related development on climate risk management, including the recommendations of the Task Force on Climate-Related financial Disclosure (TCFD) / Chiara Trabacchi

28th November 2019

9:15-09:45 Integrating climate risk considerations into decision-making processes in line with TCFD’s recommendations / Chiara Trabacchi

14:45-16:00 Mainstreaming climate scenario analysis in existing risk management frameworks / Virginie Fayolle

29th November 2019

9:15-9:45 Overview of climate scenario-based tools / Virginie Fayolle

9:45-11:00 Perspective from a provider and a user of climate scenario-based tools / Florence Palandri, George Harris, Jaco G. Swart, Lizette Perold, Simon Connell


Cover photo by Mark Jelley (CC BY-SA 2.5)
Training workshop in Mexico City helps strengthen banks’ capacities to govern and manage social, environmental and climate risks

Training workshop in Mexico City helps strengthen banks’ capacities to govern and manage social, environmental and climate risks

By Laura Canevari

Introduction

In late October, 2019, Acclimatise led a training workshop which aimed to strengthen the governance and risk management structures of Mexican banks, in relation to social, environmental and climate risks.  The training workshop was funded by the Inter-American Development Bank and the GIZ (the German Corporation for International Cooperation), with the support of the Asociación de Bancos de México (ABM) and was held in Mexico City. Facilitated by Laura Canevari of Acclimatise, and Dr Chiara Trabacchi, an independent consultant, the training was well attended by more than 40 representatives from over 20 banks. This included: Banco Azteca, Bancomext, Bancoppel, Banobras, Banorte Banregio, CIBanco, Fira, Nafin Santander and Scotiabank, among others. The Mexican banking regulator – Banxico – was also in attendance during the event which served as a reminder to participants that aligning to best governance and risk management practices and to the TCFD recommendations will help ensure their sustained viability and competitiveness and that of Mexico.

This article reviews the rich array of findings from this training workshop, including lessons drawn for important sectors of the Mexican economy, including tourism, real estate and agriculture. While these findings focus on the Mexican context, other banks may find them useful as they begin their own journeys with climate risk governance and management.

Getting started: understanding environmental, social and climate (ES&C) risks and current management systems

During the first day, drivers of environmental, social and climate (ES&C) risks were discussed and key factors that differentiate climate from other types of risks introduced (such as their far-reaching nature, irreversibility, dependence on short term actions and foreseeable nature). In addition, the training reviewed the various channels through which physical and transition climate risks transfer to the economy and to the financial system. Finally, market and regulatory trends in climate risk governance and risk management were reviewed.

Banks were provided with the opportunity, during the first day, to use a new self-assessment tool from IDB and Acclimatise, which allows banks to identify gaps in their governance and management systems for ES&C risks. The tool enables users to assess their existing systems against an international benchmark on best practices, in order to develop a roadmap on priorities and steps they need to take to improve their practices.

This first application of the self-assessment tool, and reflections stemming from the work with five pilot banks who completed their assessment in the previous weeks, showed that Mexican banks are at different levels of maturity in their development of ES&C governance and risk management structures. Most are still in the very early stages of this process. Few banks have consolidated ES&C governance and risk management best practices or have started to incorporate climate risks into their existing processes and procedures. Most participants lack direct oversight from the Board on ES&C risks, and have not yet assigned clear roles and responsibilities for the identification, evaluation and management of these risks and their integration at higher levels of strategy and financial planning. Several factors were found to have influenced the current status, in particular: lack of awareness on the financial implications of physical and transition risks on portfolio performance across different departments; lack of awareness around the potential benefits of incorporating ES&C risk management into existing processes; lack of resources and data to establish a baseline on portfolio risk exposure; short termism; and a lack of an established culture among Mexican banks to plan strategically and manage social and environmental risks.

Appraising financial climate risks: a sectoral approach

Activities on the second and third days of the workshop raised awareness among participating banks to help overcome these barriers. Bank participants reflected on the implications of climate change to important sectors of the Mexican economy, and on financial portfolios. With facilitation from Acclimatise, working groups performed an initial analysis of climate risk exposure in the tourism, real estate, energy and agriculture sectors in order to identify and reflect on the types of credit, market and operational risks that could become material for each. The working groups also explored how climate scenario analysis can be used to better understand and plan for these risks. From these exercises, the following lessons were drawn for each sector:     

Tourism

Key climate hazards generating physical risks to tourism operations in Mexico include hurricanes and floods, as well as global warming, ocean acidification and an increased incidence of drought and forest fires. Transition risks facing Mexican banks, on the other hand, include the potential effects of new legislation on energy prices and changes in consumer behavior. These hazards can affect a bank’s clients through increased operational costs, reduced tourism volumes and earnings, increase of insurance premiums and losses in assets value. Reduced tourism rates and changes in consumer preferences could also reduce opportunities for new businesses and, in the worst scenarios, could lead to business interruption.

Real estate

Key climate hazards affecting Mexican real estate include; coastal erosion (caused by sea level rise and storms), drought and forest fires; increased residential cooling costs (due to increases in temperature and the incidence or urban heat islands); damage from hurricanes, tropical cyclones and flooding; and potential human migration. On the transition risk side, changes in regulation for water and solid waste management as well as new urban planning standards and the development of carbon markets were noted as key risks. Combined, these risks can increase the costs of construction and insurance, increase reputational risks, induce reductions in property prices and affect business continuity. For financial institutions, these risks can expose banks to credit risks through their effect on loan-to-value ratios and affect the mortgages market.

Energy

Physical climate impacts were found to affect the entire energy value chain in Mexico, from generation and transmission to storage. In particular, changes in rainfall patterns and associated floods and droughts were identified as a threat to energy generation and infrastructure. On the transition risk side, changes to the price of carbon and government reforms (particularly in relation to the CELs market (i.e. market for clean energy certifications) and the Energy Transition Law and the General Law on Climate Change) could affect the price of energy and the demand for oil and gas. Potential impacts to the sector could also diminish the ability of PEMEX, a Mexican oil company,  to repay the Mexican government and lead to default.

Agriculture

In terms of physical risks, participants identified key climate hazards affecting agriculture including: the potential reduction of yield productivity (due to changes in temperature and rainfall patterns); increased production costs associated to water shortages; the salinisation of productive soils due to both sea level rise and over extraction of groundwater resources; and increased damage in transport routes, storage facilities and equipment due to flooding. Transition risks also include: changes in regulation and the transition to low carbon technologies, which could lead to the potential increase in fuel prices (affecting the production cost of herbicides and fertilisers), as well as the increased cost of other key inputs, such as energy and water.

These risks can result in a reduction in revenue and EBITDA, due to reductions in the quality and volume of the produce, and increases in CAPEX and costs to adjust practices to new technologies and increased premium of parametric insurance. These impacts can result in greater price volatility of agricultural commodities and changes in the probability of default of a bank’s clients.

Formulating actions to overcome the challenges posed by physical and transition risks and to take advantage of emerging opportunities

During the sectoral working groups, several priority areas were identified as necessary to strengthen banks’ abilities to face emerging climate risks. The development of internal technical capabilities was found to be key: bank officials, starting with those handling client relations, must be able to identify and evaluate climate risks at the transaction level. Exclusion lists and contractual clauses can be updated to better account for ES&C risks and to support climate-proofing of future lending transactions. Banks also recognised the importance of developing cross-departmental working groups and bringing together the expertise and knowledge of different units (e.g. operational risk, credit risk, sustainability and new products) for the appraisal of climate risks and opportunities. They reflected on the opportunities that can originate from an adequate appraisal of client risks and how the banking sector can act as catalyzer of change through the development of financial products that respond to client’s need to adapt to a changing climate and to transit to a low carbon economy.

By exploring the saliency and utility of different tools available, the banks were able to compare different approaches to scenario analysis (for both physical and transition risks) and to debate how outputs from scenario analysis could inform financial planning. Several challenges that need to be tackled in order to mainstream scenario analysis into risk management processes were identified, including limited available data, resources and metrics. Banks agreed that greater foresight and understanding on the evolution of transition and physical risks and on the climate impacts to their clients can be important for the development of new products in the banking sector. Furthermore, banks agreed that client engagement can help determine the extent to which investments are already climate proofed. Several banks seemed reluctant to incorporate new ES&C risk management requirements and expressed a fear of losing clients if they were to reinforce their risk management practices. Their concern was that clients may perceive such requirements to be heavy handed in an environment where ES&C risk management is not being mandated or enforced by the regulator. Banxico, however, noted that it is in the best interest of banks to strengthen ES&C risk management practices and to work with their clients. Banxico also encouraged banks to extend their time horizons to match the long-term horizons of client investment needs.

Learning from others in the sector

Across all three days of the workshop training, participating banks had myriad opportunities to learn from the experiences of their peers and to reflect on the steps required to help Mexican financial institutions strengthen their governance and risk management processes, in alignment with the TCFD recommendations. On the first day, representatives from several banks reflected on their experience using assessment tools to appraise and manage social and environmental risks. On the second day, another panel reflected on the business case of integrating ES&C risks into financial planning and the importance of having the support from high level officials. The panel suggested the Board of directors need to promote the integration of climate considerations into governance and risk management structures. On the second and third days, banks also benefitted from presentations by 2 Degrees investing initiative (2Dii) and from South American regional bank who is a known leader on the governance and risk management of climate-related financial risks. 2Dii provided a useful overview of the PACTA tool they developed in partnership with the Principles for Responsible Investing (PRI), which can be used to analyse different energy transition scenarios.

Conclusion

This training workshop has helped raise awareness on the relevance of climate risks to the financial sector in Mexico and strengthened the institutional capacity of banks around governance and risk management systems. The training has left participating banks with an increased ability to align with the TCFD Recommendations and implement them. These are crucial steps to help Mexican financial institutions be on par with international best practices. Acclimatise will continue to work with these institutions with the aim of strengthening their institutional capacities and improving their response to emerging realities of a changing climate.


Cover photo by Alejandro Islas on Flickr.
Acclimatise contributes to Risk Magazine on the pressures facing energy firms, driven by physical climate change

Acclimatise contributes to Risk Magazine on the pressures facing energy firms, driven by physical climate change

By Anna Haworth

Acclimatise’s Anna Haworth recently contributed to an article for Risk Magazine focused on the increasing pressure energy firms are facing to assess physical climate risks. In the article, Anna shares a number of insights, developed through our long-standing experience of helping corporate clients, particularly in the oil, gas and extractives sector, position themselves to effectively manage physical climate risks.

In the article, Anna highlights that climate change doesn’t necessarily create new risks, but instead acts to change existing risk profiles – by altering their frequency, severity and spatial distribution. She reflects that the energy sector, and others with large, fixed assets and complex supply chains (e.g. mining and metals), are very experienced and well-equipped to identify and manage risks. Future climate-related risks have been on companies’ radars for a long-time, particularly from an operational, business continuity and supply chain management perspective. “What they are struggling with a bit more is bringing in the longer-term dimension and understanding how those risks might change over time, driven by changes in the climate and evolving stakeholder expectations” reflects Anna.

Anna describes the step-changes in the last few years in the positions of many key stakeholder groups around the imperative to understand and manage physical climate risks, with associated calls for disclosure. Arguably the most significant recent development is the publication of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) recommendations, in 2017. The TCFD set out a framework for the voluntary disclosure of climate-related risk and opportunities (governance, strategy, risk management, metrics and targets). The TCFD identifies physical risk as one of two categories of climate-related risk, alongside transition risk to a lower-carbon economy.

Anna reflects that corporates are encouragingly viewing the TCFD’s recommendations as being more than just disclosure: meeting the recommendations is also changing corporate behaviour and driving action. “The TCFD’s recommendations have really created an impetus for companies to progress their climate risk and opportunity assessment and management,” says Anna. “Oil and gas companies are increasingly aligning their climate change activities with these recommendations,” such as improving governance, strategic planning, risk management and reporting on targets, including progress in meeting these. We are also witnesses a flow-through of this information into companies Integrated Annual Reports or the development of stand-alone TCFD-style climate reports.

Anna, and others in the Acclimatise team, are at the forefront of developing methodologies and metrics that help corporates to identify, quantify, and disclose physical climate risks and opportunities. Anna has been instrumental in the development of our bespoke TCFD benchmarking and audit toolkit, which we have successfully deployed for several of our FTSE100 and major corporate clients. If you would like to discuss your needs, Anna Haworth would be delighted to hear from you.

The full Risk Magazine article published on 10 October 2019 is available here


Photo by Raghu Nayyar on Unsplash