Climate risk regulation rundown: December

January 10, 2022

What happened in climate-related financial regulation last month, and what’s coming up

The US Office of the Comptroller of the Currency (OCC) published draft principles for large banks on dealing with climate-related financial risks.

The principles, released December 16, are intended to help lenders identify and manage climate threats to their safety and soundness. For example, the principles say that bank boards and managers should devote appropriate resources to climate issues and assign climate-related financial risk responsibilities throughout their organizations. They further recommend that banks use tools like heat maps, climate risk dashboards, and scenario analysis in order to get a grip on potential vulnerabilities. 

The principles are open for public consultation until February 14, 2022. If finalized, they would apply to banks with more than $100 billion in total consolidated assets. The OCC said the feedback to the consultation could inform “any future guidance” it issues on climate-related risks.

The US Financial Stability Oversight Council (FSOC) voted to establish the Climate-related Financial Risk Committee (CFRC) on December 17 to coordinate federal regulators’ efforts to guard the financial system from climate risks.

The creation of the CFRC was one of the recommendations included in the FSOC’s report on climate-related financial risks, published last October. As described in that report, the CFRC would “identify priority areas for assessing and mitigating climate-related risks to the financial system and serve as a coordinating body, where appropriate, to share information, facilitate the development of common approaches and standards, and facilitate communication across FSOC members and interested parties”.

The committee will update the FSOC twice a year on the state of the Council’s and its member agencies’ work to address climate-related financial risks, and include a summary of this progress in the FSOC’s annual report.

A lack of clarity on how companies’ net-zero pledges will be achieved underlines the importance of decision-useful climate metrics, an official at the US Securities and Exchange Commission (SEC) said on December 14.

In a speech before the Center for American Progress and Sierra Club, Caroline Crenshaw — an SEC Commissioner — said: “it is sometimes unclear to me how companies will achieve these [net-zero] goals. Nor is it clear that companies will provide investors with the information they need to assess the merits of these pledges and monitor their implementation over time.” She said this uncertainty makes the cases for metrics created using “reliable and comparable” methodologies “that enable investors to decide whether the companies mean what they say”. Crenshaw added that this is “a core purpose” of the SEC’s disclosure obligations.

Crenshaw also said the rise of net-zero pledges has put a spotlight on companies’ political spending and the ways in which this could contradict their climate ambitions: “Without disclosures on political spending, executives may spend shareholder money in ways that contradict their public commitments and statements. After the Paris Climate Accords, a number of public companies went on the record in support of the Accords. However, questions remain about whether those companies continue to make political contributions that support opposition to the Accords”.

The SEC is currently working on climate risk disclosure rules for public companies. A draft was expected before the end of 2021, but as of the time of writing this has yet to materialize.

The Government of Canada confirmed it would mandate climate-related financial disclosures and net-zero plans for financial institutions, pension funds, and government agencies.

In separate mandate letters sent to the Deputy Prime Minister and Minister of Financeand Minister of Environment and Climate Change, Prime Minister Justin Trudeau said the government would “move toward” compulsory climate-related disclosures based on the Task Force on Climate-related Financial Disclosures (TCFD) recommendations.

However, Trudeau did not specify the timeline over which these disclosure requirements would come into effect or describe what should be covered in the mooted net-zero plans.

The European Union (EU) passed into law the Taxonomy Climate Delegated Act (DA), its first set of rules on what investments can be considered climate-friendly.

The DA details the ‘technical screening criteria’ through which economic activities that contribute to climate mitigation and adaptation can be identified as such. The DA had been adopted by the European Commission in April and approved by the European Parliament in October, but only became official with the expiry of the European Council’s extended scrutiny period on December 9.

The rules in the DA oblige investors to explain how much of their ‘green’ investments can be accounted for by the EU’s sustainable finance taxonomy from January 1, 2022. The taxonomy sets out a ‘common language’ through which the climate-friendliness of different assets can be assessed, based on their contribution to at least one of six sustainability objectives and the degree of harm they do to the others. Only the rules governing the climate mitigation and adaptation sustainability objectives have passed into law.

Investors will have to start reporting the taxonomy alignment of their portfolios from January 2023.

On December 8, the European Central Bank (ECB) updated its ‘fit and proper’ questionnaire to gather information on prospective bank executives’ level of knowledge and experience on climate and environmental risks.

For the first time the questionnaire asks prospective appointees whether they have ‘high’, ‘medium’, or ‘low’ knowledge and experience of climate-related and environmental risks, and requests details on any climate risk training they have received. 

This questionnaire acts as a guide to the information the ECB and European financial watchdogs expect to receive on prospective appointees to C-suite positions at supervisee banks. Appointees may be rejected if they do not meet certain standards. The ECB is also able to apply conditions to the appointment of managers before granting its approval.

On December 10, the European Insurance and Occupational Pensions Authority(EIOPA) launched a consultation on how re/insurance companies should apply guidance on incorporating climate change in their routine ‘health checks’. 

Specifically, the consultation covers the operationalizing of climate change materiality assessments and the use of climate change scenarios in European re/insurers Own Risk and Solvency Assessments (ORSA) — the internal processes they run to judge the quality of their risk management. This follows an Opinion issued by EIOPA last Aprilwhich set out its expectations on the integration of climate change risk scenarios by re/insurers in their ORSAs.

The consultation closes on February 10. EIOPA is slated to issue final application guidance in June this year.

On December 13, EIOPA published its December 2021 Financial Stability Report, which is used to communicate the key risks facing the EU insurance and pension sectors. Among its findings, the report said that environmental risks are the “top risk” to insurers and pension funds in terms of which has the highest expected increase in materiality. This is because of the “increasing intensity and frequency of excessive weather circumstances”, the report said.

On December 16, the UK’s workplace pension regulator finalized guidance on helping trustees meet governance and reporting standards in relation to climate risks and opportunities. 

The Pensions Regulator (TPR) guidance lays out what trustees have to do and report on in their schemes’ annual climate change reports. One of their responsibilities is making sure they get advice from “appropriately skilled and competent” experts.

The guidance also details the penalties that apply to trustees who fail to meet the governance and reporting standards. Where a climate change report is not published, the mandatory penalty will be at least £2,500. In other cases, penalties may rise to £5,000 for an individual and to £50,000 for other circumstances.

Today, the rules apply to authorized schemes and those with £5 billion or more in assets. TPR said these would extend to schemes with £1 billion or more in assets from October 1. The UK Department for Work and Pensions is currently considering whether to roll the rules out to smaller schemes in 2023.

The UK Financial Conduct Authority (FCA) finalized two policy statements on climate-related disclosures covering listed companies and asset managers, asset owners, insurers, and pension providers.

Published December 17, the statements advance the UK’s commitment to implement mandatory TCFD-aligned disclosure obligations across the economy by 2025. The first statement describes how, as of January 1 this year, all issuers of standard listed shares — or equity shares represented by certificates — have to explain in their annual financial reports whether their disclosures meet the recommendations of the TCFD, and if not, why not.

The second statement outlines for asset managers, life insurers, and FCA-regulated pension providers their obligations to report how they take climate-related risks and opportunities into account when managing their investments. It also details how these financial institutions have to put out product-level disclosures, including a core set of climate-related metrics, on their websites or cross-referenced in appropriate client communications.

The policy statements follow a consultation by the FCA that closed on September 10.

The UK’s Climate Financial Risk Forum (CFRF) published details of its October meeting on December 20. Significantly, at this meeting the Forum supported a proposal to form a working group dedicated to the transition to net zero, and to broaden its overall focus to encompass a range of environmental and sustainability issues going forwards.

The CFRF also agreed to “pause” its work on risk management to allow time for the tools and guidance produced by the Forum’s Risk Management Working Group to be digested and implemented by firms.

The CFRF is jointly chaired by the Prudential Regulation Authority and Financial Conduct Authority, and includes representatives from major banks, asset managers, an insurance companies.

The Bank of Japan (BoJ) offered ¥2 trillion ($18 billion) in zero-interest loans to financial institutions on December 23 through a scheme intended to bolster financing for climate change responses.

The loan auctions, announced last September, are slated to take place twice a year and can be rolled until 2030. The first tranche of loans offered were disbursed on December 24 and mature on January 30, 2023. In November, the BoJ said 43 institutions had applied to the scheme.

To qualify for the loans, financial institutions have to publish metrics and targets on their green investments and loans, as well as the efforts they have made to make TCFD-aligned disclosures.

The Hong Kong Monetary Authority (HKMA) published the results of a pilot climate stress test exercise of top banks on December 30. 

The test covered 20 retail lenders and the branches of seven international banking groups. Participants assessed their portfolios under three scenarios: a physical risk assessment assuming a “worsening climate situation”, an “orderly” transition scenario, and a “disorderly” transition scenario. The HKMA concluded that banks would be able to withstand climate-related risks because of their strong capital buffers. However, it cautioned that under “extreme scenarios” the sector could suffer “significant adverse impacts”.

In light of the results, the HKMA said the participants “have developed plans to strengthen their climate strategies and risk governance frameworks”. These include steps to integrate a wider range of climate risk factors into their risk assessments and direct more capital to climate resilient activities, like ‘green’ financing.

On December 16, Hong Kong’s Green and Sustainable Finance Cross-Agency Steering Group, chaired by the HKMA and the Securities and Futures Commission, unveiled recommendations to progress the jurisdiction’s green finance agenda.

To action these recommendations, the HKMA said it would develop a new module on Green and Sustainable Finance under the Enhanced Competency Framework for Banking Practitioners, a set of voluntary standards designed to elevate the risk management capabilities of Hong Kong banks.

The Singapore Exchange (SGX) finalized rules on mandatory climate-related disclosures on December 15.

All securities issuers are required to produce climate reports based on the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) on a ‘comply or explain’ basis as of this year. Climate reporting will then become mandatory in 2023 for companies in three sectors: finance; agriculture, food and forest products; and energy. In 2024, it will become mandatory for firms in the materials and building and transportation industries, too.

A series of related rules came into effect on January 1, 2022. These include a requirement for issuers to submit their sustainability reporting processes to internal review and to issue sustainability reports together with their annual reports. All issuing company directors are also required to undergo a one-time training on sustainability.

The rules follow a public consultation on sustainability reporting by Singapore Exchange Regulation (SGX RegCo) which ended on September 27. As part of that consultation, SGX Regco issued a list of 27 “core ESG metrics” that companies should consider disclosing, including absolute GHG emissions and energy consumption. However, these metrics were not mandated in the final rules.

Bank Negara Malaysia (BNM) published draft requirements and guidance on climate risk management and scenario analysis for financial institutions on December 27.

The proposed measures are intended to bolster the resilience of banks and other financial firms in Malaysia against climate risks and help usher along a low-carbon transition in the country. Feedback on the exposure draft is welcome until March 31, 2022.

BNM and other Malaysian regulators also said they would issue a TCFD-aligned application guide for climate-related risk disclosures by financial institutions for consultation in January of this year.

The Network for Greening the Financial System (NGFS) has said central banks should “lead by example” by disclosing their climate-related risks.

In a guide on climate disclosure for central banks published December 14, the NGFS said that public reporting of climate risks by financial authorities “would promote disclosures by other market participants” and help “meet the growing public demand for transparency about climate-related risks on central bank balance sheets”.

The Financial Stability Board (FSB) appointed Lael Brainard, a Governor of the Federal Reserve and President Biden’s pick to be Vice Chair of the US central bank, to chair its Standing Committee on Assessment of Vulnerabilities (SCAV) on December 10.

The SCAV’s functions include monitoring and assessing vulnerabilities affecting the global financial system and putting forward actions to tackle them. The committee is also charged with observing and advising on “market and systemic developments, and their implications for regulatory policy”.

The FSB took steps in 2021 to address climate-related risks to financial stability, and is currently scrutinizing the data through which these risks could be monitored, as well as identifying data gaps. As part of its roadmap on addressing climate-related risks published last July, the FSB said it will “[c]arry out systematic and regular assessments of climate-related financial vulnerabilities and financial stability impacts”.

Brainard has been outspoken in support of climate scenario analysis and climate risk management guidance for banks. As SCAV chair, she succeeds Klaas Knot, President of De Nederlandsche Bank, who led the committee since 2016 and who became FSB Chair on December 2.