The world identifies climate change with extreme changes in weather patterns resulting in destructive effects of storms and floods, droughts, heatwaves, hurricane or wildfires on lives and property. Financial sector regulators have also identified the threats climate change pose to financial stability and seen the urgent need to adopt measures to manage those uncertainties.
In that regard, the Central Bank of France initiated together with eight (8) other central banks and established the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The Network was established as a coalition of the willing with voluntary membership and intention to “share best practices, contribute to the development of climate and environment–related risk management in the financial sector and mobilise mainstream finance to support the transition toward a sustainable economy.”
Since its formation at the Paris “One Planet Summit” in December 2017, the Network has grown to 34 Members and 5 Observers with representation from the World Bank, International Finance Corporation (IFC), Bank for International Settlement (BIS) and the Organisation for Economic Co-operation and Development (OECD).
In April 2019, the Network issued its First Comprehensive Report titled “A call for action: Climate change as a source of financial risk” with some key recommendations. Though its recommendations are not binding, they are aimed at encouraging all central banks and other stakeholders to take the necessary measures to foster a greener financial system or a low-carbon world economy. This script provides an insight into the subject matter of the 42-page report by highlighting excerpts regarding the key recommendations.
- Integrating climate-related risks into financial stability monitoring and micro-supervision
Important steps in this regard include:
1) Assessing climate-related financial risks in the financial system by:
- mapping physical and transition risk transmission channels within the financial system and adopting key risk indicators to monitor these risks;
- conducting quantitative climate-related risk analysis to size the risks across the financial system.
- considering how the physical and transition impact of climate change can be included in macroeconomic forecasting and financial stability monitoring.
2) Integrating climate-related risks into prudential supervision, including:
- engaging with financial firms:
- a) to ensure that climate-related risks are understood and discussed at board level, considered in risk management and investment decisions and embedded into firms’ strategy;
- b) to ensure the identification, analysis, and, as applicable, management and reporting of climate-related financial risks.
- setting supervisory expectations to provide guidance to financial firms, as understanding evolves.
- Integrating sustainability factors into Central Banks’ own-portfolio management (pension funds, own accounts and foreign reserves).
The expected benefits include:
- It can improve investors’ understanding of long-term risks and opportunities and thereby enhance the risk-return profile of long-term investments.
2.It can help Central banks to manage reputational risks by acknowledging financial risks related to the transition towards a carbon-neutral economy and by addressing these risks proactively in their own (risk) frameworks.
3.Central banks may decide to employ part of their investments to pursue non-financial sustainability goals in order to generate positive (societal) impacts, in addition to traditional financial return goals. In this way, central banks can also actively support the development of the market for green and sustainable assets.
- Bridging the data gaps
The Network recommends that appropriate public authorities share data of relevance to Climate Risk Assessment (CRA) and, whenever possible, make them publicly available in a data repository. The Network observed that a collection of data is critical to undertaking risk assessment and carrying out climate disclosure. The Network has, therefore, identified that there is the need for bringing together relevant expertise to gain a complete and integrated understanding of data needs, covering climate, environment and Finance. The Network is ready to initiate work with interested parties to mine the relevant data aimed at bridging the gaps.
- Building awareness and intellectual capacity and encouraging technical assistance and knowledge sharing.
The Network is encouraging central banks, supervisors and financial institutions to:
1) allocate sufficient internal resources to address climate-related risks and opportunities;
2) develop training to equip employees with the necessary skills and knowledge;
3) raise awareness by sharing knowledge within the financial system.
4) work closely together with academics and think-tanks to inform thinking. This calls for collaboration between financial industry players, NGOs (concerned about climate change or the environment), government departments and climate science experts with support from partners such as the Sustainable Banking Network (SBN), the International Finance Corporation (IFC) and the Task Force on Climate-related Financial Disclosures (TCFD).
According to the Network, recommendations 5 and 6 do not fall directly within the sphere of activities of central banks but point to actions that can be taken by other policymakers to facilitate the work of central banks and supervisors in the fight against climate change.
- Achieving robust and internationally consistent climate and environment-related disclosure.
The Network emphasises the importance of a robust and internationally consistent climate and environmental disclosure framework. The Members of the Network also collectively pledge their support for the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD recommendations provide a framework for consistent, comparable and decision-useful disclosure of firms’ exposures to climate-related risks and opportunities. The Network encourages all companies issuing public debt or equity as well as financial sector institutions to disclose in line with the TCFD recommendations.
- Supporting the development of a taxonomy of economic activities.
The Network wants policymakers to bring together relevant stakeholders and experts to develop a taxonomy (framework) that enhances the transparency around which economic activities (i) contribute to the transition to a green and low-carbon economy and (ii) are more exposed to climate and environment-related risks. Such a taxonomy would:
1) facilitate financial institutions’ identification, assessment and management of climate and environment-related risks.
2) help gain a better understanding of potential risk differentials between different types of assets.
Policymakers would thus need to:
1) ensure that the taxonomy is robust and detailed enough to (i) prevent green washing, (ii) allow for the certification of green assets and investments projects and (iii) facilitate risk analysis.
2) leverage existing taxonomies available in other jurisdictions and in the market and ensure that the taxonomy is dynamic and reviewed regularly to account for technological changes and international policy developments.
3) make the taxonomy publicly available and underline the commonalities with other available taxonomies. Eventually, it should strengthen global harmonisation to ensure a level playing field and prevent the dilution of green labelling.
The Network makes it clear that more work needs to be done in order to equip all central banks and supervisors with appropriate tools and methodologies that will help them to identify, quantify and mitigate climate risks in the financial system. To achieve this vision, the Network calls for a dialogue with other stakeholders for further technical work to translate the six (6) recommendations into operational policies and processes.
Thank you for reading. Your feedback is always welcome. God Bless!
This script was written by a Chartered Banker with a flair for feature writing. Apart from his work schedules, he edits or proof-reads corporate material for his colleagues, executive managers – including distinguished professionals working in various fields outside Banking. Through this column, his articles feature on third-party online media platforms in Ghana and outside. Email: Kwaku.Anumu@gmail.com