Category: Financial Services

NGFS publish their guidance on scenario analysis for central banks and supervisors

NGFS publish their guidance on scenario analysis for central banks and supervisors

By Laura Canevari

The Network for Greening the Financial System (NGFS) has released a set of high level and harmonised Reference Scenarios in June, 2020. Central banks and supervisors have the responsibility to prepare for the potential impacts from climate change. Yet, there are great uncertainties regarding what climate change impacts may look like in the future, as the way that climate risks will take shape is dependent on the carbon-intensity development pathways that countries decide to take. The use and application of foresight tools such as scenario analysis allows organisations to test the robustness of their strategies against a number of plausible and coherent future storylines.

The use of scenario analysis as a tool for robust decision-making is already being promoted in the private sector through the efforts of the Task force on Climate-related Financial Disclosures (TCFD). Organisations can face many challenges when trying to develop and apply scenario analysis for financial planning. In particular, it is difficult for non-experts to penetrate the technical parameters and assumptions behind climate change models, ultimately to decide which climate and emissions scenarios to use in order to explore a good range of plausible futures. Set out in the publication, ‘NGFS climate scenarios for central banks and supervisors’, the Reference Scenarios are therefore well-placed to help organisations (central banks, supervisors, other financial institutions and corporates) explore the impacts of transition and physical climate risks to the economy and the financial system in a consistent and transparent way.

Apart from setting out Reference Scenarios, the new NGFS climate scenarios guide offers a four-step process for scenario analysis, which are briefly described in Figure 1. (Source: NGFS, 2020)

In Step 1, central banks and supervisors should first consider how the exercise will relate to their objectives and define whether the scenarios are going to be used to:

  • Assess specific risks to financial firms,
  • Assess financial system-wide risks
  • Assess macroeconomic impacts
  • Assess risks to a central bank’s own balance sheet

As part of this first step, central banks and supervisors need to define what are the most material risks to the institution’s objectives, which can help in the identification of physical and transition risks that are likely to have the greatest impact. At this stage, it is also important that central banks and supervisors consider how different stakeholders (e.g. financial institutions, financial standard setters, governments) will be involved in the scenario analysis.

In Step 2, central banks and regulators are suggested to make a number of informed choices on the climate scenarios assumptions they will use for scenario design (e.g. Greenhouse Gas (GHG) concentration and socio-economic pathways as well as policy, technology and market trends). At this stage, central banks and supervisors should consider the types of climate risks that they want to explore and the NGFS strongly encourages the use of multiple scenarios in order to explore a range of futures in order to unveil the broad spectrum of transition and physical risks that could emerge under different economic development pathways.  As noted in the guidance report, “The number of scenarios that central banks and supervisors choose to analyse will depend on the objective of the exercise, the materiality of the macro-financial risks, and resources available.” (p. 14). This also applies to the choice of scenario granularity and choice of time horizons.

For the NGFS Reference scenarios, multiple models were used to capture a range of uncertainty in the results, although they were all build against the assumptions of the same socio-economic pathways (namely the SSP2 “middle of the road” pathway). But each varies according to how policy and technology are assumed to evolve.  A number of scenarios are thus developed according to these assumptions, namely:

  • Three orderly transition scenarios: One which is representative and assume immediate action is taken to reduce emissions in alignment with the Paris Agreement and that all CDR technologies needed to reach net zero carbon are available; and two additional ones which are even more ambitious;
  • Three disorderly transition scenarios, which assume delayed policy action and limited access to CDR technologies but differ in the extent of dependence on Carbon Dioxide Removal (CDR )technologies;
  • Two “Hot house world” scenarios [i.e. the current trajectory]:
    • One scenario which assumes only current policies are implemented and the goals of the Paris Agreement are not met, leading to substantial physical risks over time and another that accounts for all; and
    • One scenario which incorporates all pledges from Paris  (even if not yet implemented) and leads to substantial, yet less, physical impacts.

In Step 3, central banks and supervisors will use the scenarios to assess economic and financial impacts. There are many challenges for doing this. For example:

  • It is difficult to anticipate and model the extent of macro-financial impacts caused by physical impacts due to tipping points in the Earth system that we are just starting to understand (e.g. loss of ice sheet, permafrost and forest loss).
  • Current economic models are ill-suited to study climate risks so central banks may need to deploy a combination of approach to tackle limitations of existing models.
  • The channels through which economic impacts translate to financial impacts are complex
  • Additional variables may be needed due to the limited number of macro-financial outputs available from climate models underpinning the scenarios.
  • There is limited data and research to support scenario analysis

To refine the scenarios, the NGFS also encourages central banks and regulators to revise scenario assumptions, address more comprehensively systemic risks, further elaborate on transmission channels, and perform a second round of the exercise. This recommendation is already being taken forward, for example, by the Bank of England (BoE) in its 2021 Biennial Exploratory Scenario (BES) exercise.

Step 4, the final step set out in the guidance, helps central banks and supervisors define their communication strategy of scenario analysis results. It includes guidance on the type of information that should be disclosed, the intended audiences and methods to communicate the results.

As noted by Frank Elderson (Chair of NGFS) and Sarah Breeden (BoE and Chair of Macrofinancial workstream) in the Foreword of the report, “Challenges and shortcomings remain. Indeed, we are close to the start of this intellectual journey not at its end.” The effort to harmonise scenario approaches and provide relevant guidance to central banks and regulators achieved in this document, however, is commendable and offers a good foundation for future developments in climate scenario analysis. Not only are the Reference Scenarios and guidance relevant for central banks and regulators, they can in fact be instrumental for financial firms and corporates that want to explore their exposure to these emerging risks.  


Cover photo by Annie Spratt on Unsplash.
Climate Financial Risk Forum releases ground-breaking guide for financial firms

Climate Financial Risk Forum releases ground-breaking guide for financial firms

By Robin Hamaker-Taylor and Georgina Wade

On 29 June 2020, the UK’s Climate Financial Risk Forum (CFRF), co-chaired by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), published their guide to climate-related financial risk management. The guide draws on good practice examples from industry as well as guidelines set by relevant and respected industry bodies, including the recommendations of the Taskforce for Climate-related Financial Disclosures (TCFD).

The new CFRF guide aims to help financial firms understand the risks and opportunities that arise from climate change and provides support for how to integrate them into their risk, strategy and decision-making processes. As part of this, the guide considers how firms can plan for the impact of climate policies over different time horizons and assess their exposure to climate-related financial risks so that they can adapt their businesses in response.

Written by industry, for industry, this guide is based on CFRF discussions that have been convened and facilitated by the PRA and the FCA. The forum, similar to the Task force on Climate-related Financial Disclosures (TCFD), has brought together expertise from both financial firms and corporates to develop this guidance. Over the course of 2019 and 2020, the forum’s four working groups (Disclosures, Innovation, Scenario Analysis and Risk Management) have shared good practice and analysis to advance thinking on how firms can better manage the risks posed by climate change and support the transition to a net-zero carbon economy.

Each of the four working groups wrote a chapter of the final guide, and a summary document was co-produced by the FCA and PRA. The PRA and FCA have convened and facilitated CFRF discussions but the views expressed in this guide do not necessarily represent the view of the regulators and does not constitute regulatory guidance.

Access the individual chapters of the guide here:

Acclimatise is proud to be featured in the Risk Management Annex: list of data and tools providers. We are a specialist advisory and analytics company, providing world-class expertise in climate change adaptation and resilience. With experience in more than 90 countries, our work plays an important role in shaping the international adaptation agenda. We work closely with corporates and financial institutions on their physical climate risk analysis, by interpreting climate science and information in the context of their own strategies, processes, capacities.

Click here for more information on Acclimatise’s TCFD-aligned disclosure services.

Click here to learn more about Acclimatise’s corporate climate risk and adaptation services.


Delivering a virtual training course on GCF project requirements in Belize

Delivering a virtual training course on GCF project requirements in Belize

Acclimatise’s Climate Finance team, in partnership with the Caribbean Community Climate Change Center (CCCCC), has designed and launched a five-week virtual training course on GCF project requirements as part of Belize’s Green Climate Fund (GCF) Readiness 2 Support – “Building Capacity for Direct Access to Climate Finance”. One of the objectives of this Readiness support is to strengthen the capacity of Belize’s National Designated Authority (NDA) – the Ministry of Economic Development (MED) – to effectively mobilise, manage and monitor climate finance with a view to achieving national development and climate change priorities.

This course was specifically tailored to members of Belize’s National Climate Change Committee (BNCCC) which is the committee that sits under the NDA, and designed so they can perform their GCF responsibilities, which includes appraising projects received from project developers and providing constructive feedback to national and international stakeholders.

About the course

The course was developed by Acclimatise’s Virginie Fayolle, Caroline Fouvet and Maya Dhanjal, with facilitations support from in-country expert Ann Gordon. Since commencing the course on 29th June 2020, we have had a successful first three weeks of the course which will continue until 7th August 2020. Overall, the course equips BNCCC members to:

  1. Understand GCF project requirements and what a good GCF project looks like;
  2. Grasp key GCF or general project preparation concepts, such as climate rationale, theory of change, logical framework, paradigm shift, and gender mainstreaming;
  3. Align a project with the GCF’s six investment criteria to appraise concept notes; and
  4. Provide constructive feedback on GCF concept notes received by the Belize’s NDA.

Adapting to a post-pandemic world

This training was originally designed for a face-to-face format where our instructors would travel to Belize to deliver it over a 2-week period. However, in response to travel restrictions due to coronavirus, Acclimatise adapted the format into a virtual training, following a human-centric design approach. This conversion required an understanding of the constraints faced by both parties including availability of and access to technology, using web-based products that allowed for collaboration and real-time communication, and lastly, a sense of what life is now like for BNCCC members who may be working from home, have children to home-school or dependents to take care of, and have religious observances to attend to.

Through a set of interactive plenary presentations from guest speakers, recorded videos that are accessible at participants’ own pace, as well as quizzes and live calls with featured polls to gauge participant knowledge, understanding and comfortability with the topic, the training course has been successfully re-designed for participants into a blended learning classroom where we are currently holding some “live-on-air” events as well as asynchronous activities so participants could tackle the content at their own pace. The live sessions in particular brought a range of participants together to exchange and share meaningful experiences across a broad group of stakeholders, including multiple regional government agencies and private sector organisations.

Future trainings on GCF project requirements under Readiness Support

Acclimatise has a wealth of experience designing and executing training services for clients looking to access, manage and utilise funding from the GCF. Although typically done in a face-to-face format, Acclimatise has now successfully approached adapting this training into a virtual format that maximises the potential of the participants to absorb knowledge and strengthen their success of securing funding from the GCF.

Some topics covered in the training include:

  1. Climate Change in Belize and Belize’s relevant climate-related national priorities – two presentations by Colin Mattis, Deputy Climate Change Officer at NCCO
  2. Challenges and opportunities for demonstrating the climate rationale of a GCF project and related data needs – a panel discussion with Olivia Avilez from Belize Sugar Industries, Ryan Zuniga from CCCCC and Ronald Gordon from National Meteorological Services
  3. The relevance of adaptation in Belize: the business perspective – a presentation by Olivia Avilez at Belize Sugar Industries

You can find more information about how Acclimatise can help you mobilise, catalyse, and leverage public and private capital to deliver your climate investment strategies and financing for climate-resilience solutions on our website.

If you are interested in our training offering on the topic,  contact: Ms. Virginie Fayolle


Cover photo of Belize flag from Wikimedia Commons.
Video: Introducing Acclimatise’s Special guidance report ‘Understanding Physical Climate Risks and Opportunities’

Video: Introducing Acclimatise’s Special guidance report ‘Understanding Physical Climate Risks and Opportunities’

Acclimatise’s special guidance report “Understanding Physical Climate Risks and Opportunities” is designed to help investors assess physical climate risk assessments to their portfolios.

Developed with the Institutional Investors Group on Climate Change (IIGCC), the guidance collates good practice for physical risk assessments across the stages of a typical risk assessment process. The guidance was published in June 2020. It was developed in close conjunction with IIGCC staff, leading investors, and Dr Rory Sullivan of Chronos Sustainability.

In this video, report author and Acclimatise consultant Robin Hamaker-Taylor talks through what the report covers.

Download the full guidance here.

Top 5 considerations for climate-related corporate governance released in new analysis

Top 5 considerations for climate-related corporate governance released in new analysis

MinterEllison, a commercial law firm in the Asia-Pacific, has published new analysis which indicates that companies have not been prioritising their surveillance of their climate change risk disclosures. In their analysis of annual reports for the 2019 financial year, MinterEllison found that only 21 (7%) of ASX300 companies had ‘meaningful’ climate change risk disclosures, compared with 137 (45.5%) of reports containing little or none.

            This does not bode well for many listed companies in light of the Australian Securities & Investments Commission’s (ASIC) recent announcement that it will prioritise this in the 2020 financial year. So how do boards assure themselves that they are having meaningful climate change risk disclosures? To answer this question, MinterEllison has set out their top 5 climate change-related governance issues for directors to consider this reporting season.

Narrative disclosures – TCFD and stress-testing move from gold standard to base expectation

An increasing proportion of mainstream institutional investors now expect investee companies to apply the governance, strategy, risk metrics and disclosure framework set out in the 2017 Recommendations of the Bloomberg Taskforce on Climate-related Financial Disclosures (TCFD). One of the key TCFD Recommendations relates to stress-testing and scenario planning of business strategies against a plausible range of climate futures, emphasising the inclusion of information on the impact of climate change on financial performance, position and prospects.

Consider how your business has made credible inroads on the journey towards compliance with the Recommendations of the TCFD in FY20.

‘Net zero’ emissions transition

Mainstream investors and large proxy advisors are increasingly voting in favour of activist shareholder resolutions that seek corporate disclosure of net zero emission strategies – often against the recommendation of management.

Consider how you envision your business will continue to thrive in a ‘net zero’ economy, and your strategy for transitioning your business.

…and a roadmap for achieving Paris Agreement goals

Bare pledges of ‘support for Paris Agreement goals’ are not enough. In FY20, investors are looking for a roadmap of short- and medium-term targets against which to assess a corporation’s net zero transition commitment, and evidence of credible progress on that journey.

Consider your business plans and their progression towards achieving emissions reduction commitments and your strategy for achieving these goals. 

Valuation and impairment – relevance of climate change-related assumptions to financial reporting and audit

Standard setters made clear that they expect climate change-related assumptions to be clearly stated, highlighting the potential to be a material accounting estimation variable, impacting on asset useful lives, fair valuation, impairments and provision for bad and doubtful debts.

What consideration has been given to the climate-related variables that may materially impact on your accounting estimates (financial position) and prospects?

Governance, executive remuneration and their relationship with climate change strategy.

Companies should benchmark their governance of climate change strategy and risk management against the recommendations of the TCFD and ensure that a portion of the discretionary remuneration of relevant senior officers is linked to progress against the business’ climate targets.

Consider your company’s governance structures and if they are benchmarked against the TCFD.

View a PDF version of this report here.

View the press release here.


Cover photo by Charles Forerunner on Unsplash.
Call for members of the EU Sustainable Finance Platform, new Taxonomy Regulation, and closing public consultations – EU sustainable EU sustainable finance update part 2

Call for members of the EU Sustainable Finance Platform, new Taxonomy Regulation, and closing public consultations – EU sustainable EU sustainable finance update part 2

By Robin Hamaker-Taylor

The European Commission is continuing to progress the implementation of their Action Plan for Financing Sustainable Growth. New reports have been published, regulations have been established, and more are on the way. Much of this recent activity has implications for financial institutions. This is the second of a two-part article series that aims to round up these developments.

This article narrows focus to newly adopted EU regulations on the Taxonomy, the European Bond Standard, the European Green Deal, and a consultation on the updated EU Sustainable Finance strategy. The first article looked at the developments relating to the EU Sustainable Finance Taxonomy and impending regulation, and is available here.

Be sure not to miss the calls and consultations linked throughout this article, several of which end in mid-July 2020.

EU Taxonomy Regulation is adopted and call for members of the Sustainable Finance Platform

On 18 June 2020, European Parliament adopted the EU Taxonomy Regulation (TR). The TR creates a legal basis for the EU Taxonomy and sets out the framework and environmental objectives for the Taxonomy. It will be supplemented by delegated acts*, due to be established in 2020-2021. These acts will contain detailed technical screening criteria for determining when an economic activity can be considered sustainable, and hence when activities can be considered Taxonomy-aligned.

To help the Commission prepare the technical screening criteria and develop the taxonomy further, the Commission has launched a call for applications for members of the Platform on Sustainable Finance. This platform will be an advisory body composed of experts from the private and public sector, according to a Commission press release. Platform members will also advise the Commission on the further development of the EU Taxonomy to cover other sustainability objectives and provide advice on sustainable finance more broadly.

The deadline for applications is 16 July 2020. For more information on the Platform on Sustainable Finance and how to apply, please visit: Register of Commission expert groups – Calls for applications.

*Delegated acts are legally binding acts that enable the Commission to supplement or amend non‑essential parts of EU legislative acts, for example, in order to define detailed measures. Read more about the proposed timeline for EU Taxonomy delegated acts and what they mean for climate risk disclosures in part one of this two-part series.

European Bond Standard

The European Commission is exploring the possibility of a legislative initiative for an EU Green Bond Standard in the context of the public consultation on the renewed sustainable finance strategy. That consultation is running from 6 April to 15 July 2020. A targeted consultation on the establishment of an EU Green Bond Standard, that builds and consults on the work of the TEG, and is running for an extended period of 16 weeks between 12 June and 2 October 2020.

Based on the outcome of these two consultations, as well as ongoing bilateral stakeholder dialogues, the Commission will take a decision in Q4 2020 on how to take the Green Bond Standard. Read more about the EU Green Bond Standard here.

European Green Deal and sustainable finance

The European Green Deal is the EU’s roadmap for making the EU’s economy sustainable and make the EU climate neutral by 2050. It includes actions to boost the efficient use of resources by moving to a clean, circular economy and restore biodiversity and cut pollution, according to the European Commission’s dedicated Green Deal website.

The Green Deal outlines investments needed and financing tools available, and explains how to ensure a just and inclusive transition. Climate Action is one of nine policy areas of the Green Deal. Under the Climate Action umbrella, the Commission is proposing to establish the first European Climate Law which makes it a legal requirement for the EU to become climate-neutral by 2050. On the adaptation and resilience side, the Commission will adopt a new, more ambitious EU strategy on adaptation to climate change in early 2021, according to the Commission. The aim will be to strengthen efforts on climate-proofing, resilience building, prevention and preparedness, ensuring that businesses, cities and citizens are able to integrate climate change into their risk management practices. A public consultation will inform the design of the new adaptation strategy.

The EU recognises that Climate Action will require alignment of many key areas, including sustainable finance. While the EU will fund climate action itself, it expects that its efforts in establishing the Taxonomy Regulation and implementing the will also boost private sector investment in green and sustainable projects. So while the Green Deal may seem like a parallel initiative, it is very much intended to align with the EU’s current efforts to make finance and the wider economy sustainable.

Consultation on the renewed sustainable finance strategy

The European Commission is currently consulting on an update to the 2018 sustainable finance strategy. Building on the 2018 Action Plan on financing sustainable growth, the renewed sustainable finance strategy will provide a roadmap with new actions to increase private investment in sustainable projects and activities to support the different actions set out in the European Green Deal and to manage and integrate climate and environmental risks into our financial system. The initiative will also provide additional enabling frameworks for the European Green Deal Investment Plan. The public consultation is open until 15 July 2020.


Cover photo by Marius Badstuber on Unsplash
European Central Bank issues consultation on guidance for banks on managing and disclosing climate risks

European Central Bank issues consultation on guidance for banks on managing and disclosing climate risks

By Robin Hamaker-Taylor

On 20 May 2020, the European Central Bank (ECB) published a draft guide setting out its expectations for banks on managing and disclosing climate-related and environmental risks under the current prudential framework. The ECB wants banks to account for these risks given that they drive existing prudential risk categories and can substantially impact the real economy and banks.

The ECB issued this new guidance to clarify how ECB Banking Supervision is expecting banks to consider these risks in their in their governance and risk management frameworks and when formulating and implementing their business strategy, according to the ECB press release. Apart from setting out expectations around climate risk management, the guide also outlines expectations on enhancing banks’ climate-related and environmental disclosures. The ECB is pursuing transparency, with increased disclosures as a main route for this.

In issuing this guide, the ECB is moving in step with other central banks around the world. The guide was developed in close cooperation with European national authorities and aims to ensure high supervisory standards are applied consistently across the euro area. The ECB’s guidance, for example, echoes the Bank of England’s 2019 BoE Supervisory Statement (SS) on banks’ and insurers’ climate risks – read more about the BoE SS here. Importantly, the ECB’s guide is designed to fit within the boundaries of applicable European Union and national law. It aims to foster banks’ preparedness for managing climate-related and environmental risks under current prudential rules, in accordance with the European Commission’s Action Plan on financing sustainable growth and the European Banking Authority’s Action plan on sustainable finance. Click here to read our recent summary of the current status of the Commission’s Action Plan.

The ECB is now seeking feedback on their draft guide, with the consultation running until end of 25 September 2020. The guide itself and a list of frequently asked questions (FAQs) are available on the ECB’s Banking Supervision website. Following the end of the public consultation, the ECB will publish the comments received together with a feedback statement.


Cover photo by Martin Krchnacek on Unsplash.
Understanding Physical Climate Risks and Opportunities: New practical guidance for investors launched

Understanding Physical Climate Risks and Opportunities: New practical guidance for investors launched

By Robin Hamaker-Taylor

Acclimatise has led the development of a new guidance document on physical risk assessments for investors. Developed with the Institutional Investors Group on Climate Change (IIGCC), the guidance collates good practice for physical risk assessments across the stages of a typical risk assessment process. The Understanding Physical Climate Risks and Opportunities guidance was developed over the last year, in close conjunction with IIGCC staff, leading investors, and Dr Rory Sullivan of Chronos Sustainability.

Download the full guidance here

The guidance helps investors understand physical climate risks and how they are measured. It also provides investors with practical guidance on how they can begin to analyse, assess and manage the risks and opportunities presented by physical climate hazards.

Written specifically with investors in mind, the guidance can be used without prior climate expertise. Examples of how peers have conducted physical risk assessments and processes are included throughout, and investors are provided with 20 key questions to help them to plan their assessments or sense-check what they have already done.

Report author and Acclimatise consultant, Robin Hamaker-Taylor talks through what the report covers.

Why does physical climate risk matter to investors?

The Earth’s climate has already warmed by approximately 1.0°C above pre-industrial levels, according to the IPCC. Current trajectories show temperatures are expected to rise by 3.2°C by the end of the century, even if all current unconditional commitments under the Paris Agreement are implemented, according to the UN Environment Programme.

More frequent and more extreme weather and climate events, as well as gradual shifts in rainfall patterns, temperature, sea levels, sea ice and glacial retreat, are some of the changes already underway. Physical risks are here now and will continue to unfold, with financial implications throughout the investment chain.

Many asset owners and managers recognise climate change as one of the largest systemic risks to their investment portfolios. To date, however, relatively little attention has been paid to how institutional investors might assess and report on the physical risks and opportunities arising from climate change. This is despite a growing evidence base demonstrating the economic consequences of increasingly severe climate change.

“As a changing climate alters the fabric of economies, societies and environments across the world, it pays to be prepared,” said John Firth, CEO, Acclimatise. “The investors that can act now to both manage physical climate risks and grasp the opportunities to invest in resilience stand to be in the most secure position in the long-term. This guidance acts as a first step to achieving this.”

What does the report cover?

The newly published guidance will help investors to:

  • Better understand the investment implications – both risks and opportunities – resulting from the physical impacts of climate change.
  • Take practical steps to identify, assess and manage climate-related physical risks across their portfolios, through the approaches covered in the guidance.
  • Identify ways to invest in solutions that support greater resilience to climate change as well protecting investments from physical-climate related risks. Both approaches are key to strengthening broader societal adaptation to climate change.
  • Draw on additional available tools and data sources in identifying and assessing specific risks, and opportunities, across different asset classes.

The guidance document provides a comprehensive overview of physical climate risk assessment and management, including the following chapters:

  • Review of physical climate risks and how are they measured;
  • Chapters which follow the steps of a physical risk assessment:
    • Understanding the context
    • Setting the objectives and scope
    • Physical climate risk assessment variable selection (timescale, scenarios);
  • Analysis of physical climate risk-related opportunities; and
  • Monitoring, management and reportingof physical climate risks.

Download the guidance here


The challenges of deploying complex financial products in the face of climate change

The challenges of deploying complex financial products in the face of climate change

By Laura Canevari

As countries respond to the COVID-19 pandemic, important lessons for climate action have started to emerge. In a recent article in Bloomberg Green, Kate Mackenzie reflects on the challenges of deploying complex financial products designed to attract investors and helping actors share the risks generated by large-scale disruptions.

Such is the case of pandemic bonds, a financial instrument inspired by catastrophe bonds and released by the World Bank in 2017 following the Ebola outbreak. These bonds are being triggered as a result of COVID-19; yet it seems that they are failing to provide the desired results in terms of rapidly mobilising resources to ensure an earlier, faster, better-planned and coordinated response.  In fact, it seems that the outbreak of the coronavirus pandemic failed to trigger pay-outs from these bonds in time to help countries avoid the worst outcomes. As noted by Tracy Alloway, former World Bank economist, “It has to be at least 12 weeks after the beginning of the outbreak before anything can be triggered […]. So that means it’s triggered much too late”. According to another Bloomberg source, due to their archaic structure, it has taken a total of 122 days since the start of the outbreak to unlock these bonds.

As noted by Tracy Alloway, the problem with the parametric risk financing mechanism is that “if it’s triggered earlier, the price of the insurance would be much higher because there is just so much uncertainty in the modelling”. This ultimately means delaying much needed early action in recipient countries and just as it is difficult to anticipate how an epidemic starts, it is also challenging to define when impacts triggered by climate change start being felt – especially in countries that lack adequate data on climate hazards.

Another problem presented by these bonds is that many resources that should be delivered as development money to the poorest countries ($115 million in total in the case of pandemic bonds) are being used to pay premiums, fees and interests to recipient investors; most (if not all) of which are in high-income countries. This means that the remaining resources have to be split between a large number of developing nations and will most likely be unable to satisfy their needs to respond to the outbreak.

Ultimately, mechanisms developed to share, mitigate and/or cope with certain risks (be it climate change or a pandemic) should not become a bottleneck; nor should they delay much needed early action. They need to be effective and speedy in delivering resources where these are most needed.

As countries continue to explore risk-sharing market mechanisms to deal with climate change, it will be important to closely examine whether these mechanisms truly deliver the results that they promise; and to consider what other investments are required in order to ensure that they can operate successfully. In the case of natural catastrophe bonds – which pay out in response to insurance claims from events such as hurricanes- it will be important to improve data collection and climate analytics in developing countries in order to reduce the levels of uncertainty of disaster risk models. Additionally, information systems that can assist a government’s ability to reach the most vulnerable during a crisis should also be strengthened. Moreover, building capacity at the local level for early intervention should be promoted alongside the deployment of any other risk management strategy. In the case of climate adaptation, we know that climate-proofing assets and infrastructure also means good business (e.g. it is estimated that for every dollar invested in climate-resilient infrastructure, six dollars are saved).  It is also unlikely that risk-sharing mechanisms will be able to cover losses from future (and more intense) climate events unless countries work on building their climate resilience, as these losses may become too unbearable.


Cover photo by NOAA on Unsplash.
Final EU Taxonomy report published, and regulation established – EU sustainable finance legislation Part 1

Final EU Taxonomy report published, and regulation established – EU sustainable finance legislation Part 1

By Laura Canevari and Robin Hamaker-Taylor

The European Commission is continuing to progress the implementation of their Action Plan for Financing Sustainable Growth. New reports have been published, regulations have been established, and more are on the way. Much of this recent activity has implications for financial institutions. This is the first of a two-part article series that aims to round up these developments.

This article narrows focus to the developments relating to the EU Sustainable Finance Taxonomy and impending regulation. The second part, to be published in May 2020, will cover new EU regulations on sustainability‐related disclosures in the financial services sector, the European Bond Standard, the ecolabel for financial products, and the European Green Deal.

Current status of the EU TEG and Sustainable Finance Taxonomy (‘EU Taxonomy’)

A final report on the EU Taxonomy was published in March 2020. Titled ‘Taxonomy: Final report of the Technical Expert Group on Sustainable Finance’, the report was developed by the EU’s Technical Expert Group (TEG) on Sustainable Finance, to share its final recommendations on the design of the EU Taxonomy. The final report takes into consideration feedback on the set of recommendation on the EU Taxonomy, set out by the TEG in a June 2019 technical report.

The March 2020 final report includes guidance on how companies and financial institutions can make disclosures using it, and its technical annex shares technical screening criteria for economic activities that can substantially contribute to climate change mitigation or adaptation. In addition, the TEG has prepared Excel-based tools to help with the implementation of the Taxonomy. The final TEG report and related outputs are available here.

Box 1 provides an overview of the EU Taxonomy.

Status of the EU Taxonomy Regulation and requirements

The Taxonomy Regulation (TR) was established in a political agreement of EU co-legislators in December 2019. The TR creates a legal basis for the EU Taxonomy and sets out the framework and environmental objectives for the Taxonomy. It will be supplemented by delegated acts* which contain detailed technical screening criteria for determining when an economic activity can be considered sustainable, and hence can be considered Taxonomy-aligned, according to the TEG final taxonomy report, Chapter 1.2.

As set out in the TEG final report, Chapter 3, the technical screening criteria will be issued as part of the explicit legal requirements from the European Commission by the end of 2020. Delegated acts containing technical screening criteria will be developed in two phases:

  1. Adaptation and mitigation environmental objectives- Technical screening criteria for activities which substantially contribute to climate change mitigation or adaptation:
    • adopted by the end of 2020, and
    • enter into application by the end of 2021.
  2. Other four environmental objectives – Technical screening criteria which cover economic activities substantially contributing to the other EU’s four environmental objectives (water, a circular economy, pollution prevention and control, and protection of ecosystems):
    • adopted by end 2021, and
    • enter into application by end of 2022.

* Delegated acts are legally binding acts that enable the Commission to supplement or amend non‑essential parts of EU legislative acts, for example, in order to define detailed measures. The Commission adopts the delegated act and if Parliament and Council have no objections, it enters into force, according to the European Commission.

The Taxonomy Regulation requires the European Commission to review all technical screening criteria regularly.

What does the Taxonomy Regulation stipulate, for who, and when?

The Taxonomy Regulation (TR) sets out legal obligations for financial market participants**, large companies, the EU and Member States. These entities will be required to do the following:

  • Financial market participants will be required to complete their first set of disclosures against the Taxonomy, covering activities that substantially contribute to climate change mitigation and/or adaptation. This is required by the 31st December, 2021.
  • Large companies will be required to disclose in the course of 2022.

An expanded set of disclosures covering activities that substantially contribute to all six environmental objectives will be required by the end of 2022.

In addition, the TR will introduce a new disclosure requirement for companies already disclosing under the Non-Financial Reporting Directive (NFRD). This is applicable to companies with more than 500 employees, including listed companies, banks and insurers. All companies subject to NFRD will include a description of how, and to what extent, their activities are associated with EUTaxonomy-aligned activities.

** Financial market participants are those firms offering financial products in the EU, including occupational pension providers.

The EU Taxonomy and climate adaptation

The EU Taxonomy sets out criteria specifically for adaption related activities. These are differentiated we “adapted activities” and “activities enabling adaptation”. The TEG has proposed three key guiding principles in order to identify economic activities that substantially contribute to climate adaptation:

  1. The economic activity reduces all material physical climate risks to the extent possible and on a best effort basis.
  2. The economic activity does not adversely affect adaptation efforts by others (it supports system adaptation).
  3. The economic activity has adaptation-related outcomes that can be defined and measured using adequate indicators.

The TEG have made available a list of 70 activities across eight sectors which are believed to make a substantial contribution to climate adaptation (see a summary in Table 1).

Table 1: Activities which make a substantial contribution to climate change adaptation , by sector, as shared in the final TEG report on the EU Taxonomy

The TEG’s final recommendations hold that the criteria for adaption related activities should ensure that an economic activity and its adaptation measures do not lead to increased climate risks for others, hamper adaptation elsewhere, and do not increase the risks of an adverse climate impact on other people, nature and assets. The criteria also ensure that adaptation measures consider the viability of “green” or “nature-based” solutions over “grey” solutions to address adaptation.

The report notes that the technical screening criteria to determine whether an economic activity makes a substantial contribution to climate change adaptation can be applied to any type of economic activity, but must necessarily comply also with the criteria for avoidance of significant harm to the other environmental objectives.

The full list of eligible activities is available here.

Next steps for the EU Taxonomy and how this relates to other taxonomy efforts

On 15 April 2020 the European Council adopted by written procedure its position at first reading with respect to the Taxonomy regulation.

The European Parliament will have to vote on the text pursuant to the “early second reading agreement” procedure. The Commission will only establish the actual taxonomy by defining technical screening criteria, in the form of delegated acts, as described above.

The taxonomy for climate change mitigation and climate change adaptation should be established by the end of 2020, in order to ensure its full application by end of 2021. For the four other objectives, the taxonomy should be established by the end of 2021 for an application by the end of 2022.

Further development of the EU Taxonomy will take place via a new Platform on Sustainable Finance, which is expected to be operating by autumn 2020. The first company reports and investor disclosures using the EU Taxonomy are due at the start of 2022.

Efforts to build green or sustainability taxonomies are proliferating across the globe. Within emerging markets, they are not all going in the same direction, as a recent IFC Sustainability Webinar Series highlighted. Harmonising some of these taxonomies on the climate mitigation side will be easier than doing so on climate adaptation side.  Taxonomies for adaptation related activities will have to happen in a context where not all of its elements can be applied or transferred across all geographies. For this reason, harmonisation of adaptation taxonomies globally is most likely going to be guided by principles with common interpretation across places. The IFC is building a green finance review protocol, for example, so that taxonomies from different countries can be compared. The protocol is due out in the second half of 2020.

Box 1: EU Taxonomy at a Glance (Source: Final report of the Technical Expert Group on Sustainable Finance, 2020)

Figure 1: EU’s six environmental objectives

Cover image from Wikimedia Commons, the free media repository.