What happened in climate-related financial regulation last month, and what’s coming up.
Americas
On January 19, the Federal Reserve released the plans for its first climate scenario analysis (CSA) exercise.
The exercise will assess banks’ abilities to withstand climate-related physical and transition risks, including extreme hurricanes and disruptive climate policies. The Fed will also use the exercise to gather data on banks’ climate risk management practices.
The six largest US banks — Bank of America, Citi, Goldman Sachs, JP Morgan, Morgan Stanley, and Wells Fargo — are participating in the exercise. Each bank will have to test its real estate portfolios’ resilience to physical climate shocks and its commercial mortgage holdings and corporate loan portfolios against transition risks.
For the physical risk component, banks will use scenarios produced by the Intergovernmental Panel on Climate Change. The transition risk module will use narratives created by the Network for Greening the Financial System, a coalition of climate-focused central banks and supervisors.
The participants must submit their results by July 31. The Fed will publish aggregated data and insights from the exercise by the end of the year.
Federal Reserve staff also published a paper in January comparing large banks’ climate action plans and risk management capabilities. They concluded that “much work lies ahead to properly measure and disclose climate-related risks, and to better align financing activities with their net-zero targets.”
Among their findings, the Fed staff said big lenders are only just starting to count up their financed emissions. Of the 30 banks reviewed, only eight are measuring them, and most are only partly doing so. The paper also highlights the difficulties banks have identifying and measuring their climate risks accurately. It says this happens because of the lack of a global classification system for economic sectors that are highly exposed to the low-carbon transition.
The US Securities and Exchange Commission (SEC) intends to release a final rule on climate risk disclosure for public companies by April, according to a notice in the federal register.
The rule, first proposed by the SEC last March, would require all US exchange-listed companies to disclose their climate risks and discuss how they could impact their businesses, strategies, and future plans. It would also mandate disclosure of specific climate metrics and data on how climate risks could affect companies’ financial positions.
On January 27, Mark Uyeda, a Republican SEC commissioner, said he has “significant concerns” that proposed environmental, social, and governance (ESG) ratings standards may empower ratings agencies to influence companies’ strategies and practices. Speaking in a personal capacity, Uyeda said proposed ratings standards out of the International Organization of Securities Commissions “may be intended as a means for asset managers to engage with company management in a broader effort to drive companies to satisfy the criteria of a specific ESG rating service.”
The Kentucky state Treasurer published a list of 11 financial companies that it accuses of “energy company boycotts” on January 3.
The selected firms have 90 days to stop their alleged boycotts. If they don’t, Kentucky state entities will divest from them in line with a law passed last year. The blacklisted firms are BlackRock, BNP Paribas, Citigroup, Climate First Bank, Danske Bank, HSBC, JP Morgan, Nordea, Schroders, Svenska Handelsbanken, and Swedbank.
On January 30, lawmakers in the California state Senate introduced a bill that would force businesses to prepare and disclose annual climate-related financial risk reports that align with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).
Businesses would have to submit their climate risk reports to California’s Secretary of State and make them available to the public on their own websites. The law would apply to any entity formed in California and any entity formed in another US state that does business in California with annual revenues over USD$500mn.
If the bill passes, the first round of disclosures will have to be made by December 31, 2024.
EMEA
Members of the European Parliament killed an effort to increase the amount of capital that banks have to set aside for their fossil fuel exposures.
In a vote on January 24, the Economic and Monetary Affairs Committee (ECON) chose to block a proposal from certain left-leaning lawmakers to introduce a “one-for-one” rule into an updated package of bank regulations. The rule would have forced banks to set aside one euro in capital for every euro invested in new fossil fuel projects.
Though no provisions on climate-related capital charges were included in the voted-on package, the regulations call on the European Banking Authority to assess whether and how capital requirements should be changed in the future to account for physical and transition threats. It also proposed that lenders factor climate in their routine stress tests and publish transition plans with absolute emissions reduction targets.
The bundle of regulations will be negotiated over by ECON and representatives of the European Council before they advance to a full plenary vote of the European Parliament.
The European Central Bank (ECB) is considering buying more bonds sold by climate-friendly companies and less from carbon-intensive firms as part of its efforts to support the EU’s Green Deal.
In a January 10 speech, ECB executive board member Isabel Schnabel said “actively reshuffling” the ECB’s corporate bond portfolio may be needed to ensure it aligns with Paris Climate Agreement goals. The ECB is already greening this portfolio by reinvesting the proceeds of matured bonds into climate-friendly issuances. However, since the bank is slowing reinvestments, it may need to actively sell carbon-intensive debt in order to buy more green instruments. Schnabel added that the ECB should not expel all bonds from companies that are “particularly important in managing the green transition,” even if they are carbon-intensive.
Schnabel also proposed that the ECB add more green bonds issued by supranational bodies, like the World Bank, to its portfolio, and limit its acceptance of certain carbon-intensive bonds as collateral for cash loans to financial institutions.
On January 24, the ECB published three sets of climate-related indicators to plug data gaps on the financial sector’s climate action.
The indicators contain data on EU financial institutions’ sustainable debt holdings, the emissions financed through their lending and investing portfolios, and their exposures to physical climate risks. The central bank says the indicators are intended to aid with the analysis of climate issues that are related to the financial sector.
It warned that patchy data and methodological issues mean some of the indicators may not be as reliable as some of its other financial and economic datasets. However, the ECB expects the quality to improve as better data sources become available.
The three European Supervisory Authorities (ESAs) published feedback on the initial set of reporting standards that EU companies will have to use to meet climate and other environmental, social, and governance (ESG) disclosure requirements.
The European Financial Reporting Advisory Group (EFRAG), an independent body that advises the European Commission, submitted a first batch of 12 reporting standards for EU bodies to consider last November. If adopted, the standards will be used by over 50,000 companies to disclose sustainability-related information as required under the EU’s Corporate Sustainability Reporting Directive (CSRD). The directive will go into effect for large companies in 2024.
The European Securities and Markets Authority (ESMA), one of the ESAs, said the standards could help protect investors and maintain financial stability. However, it recommended that some “technical issues” be fixed to improve their overall quality. These include clarifying certain terms and definitions and providing additional guidance on how companies should determine what ESG and climate issues are material to them.
Fellow ESA the European Insurance and Occupational Pensions Authority (EIOPA) said the standards should support the reporting of “high-quality material sustainability information.” It recommended that the European standards align with those under development by the International Sustainability Standards Board (ISSB) where possible, so that EU companies using the former automatically comply with the latter.
The third ESA, the European Banking Authority (EBA), affirmed that the reporting standards dovetail with its own disclosure framework for EU lenders. But the regulator said further guidance would be useful on what constitutes a bank’s “value chain” in the context of identifying and reporting material sustainability risks and opportunities.
The European Commission will evaluate the ESA’s feedback and comments from other public bodies before formally adopting the reporting standards by June 30.
Data out of the European Banking Authority (EBA) shows banks use the EU Sustainable Taxonomy most widely when it comes to defining what counts as “green” lending and investing.
As part of its quarterly Risk Dashboard, the regulator published the results of a questionnaire covering 60 EU banks. It revealed the mix of standards lenders use to define “green” activities and the variety of climate-friendly financial products they sell. Most banks said they are selling green loans, with 88% providing them to large companies and 78% to small- and medium-sized enterprises. Sixty percent are supplying “sustainability loans” and/or “sustainability-linked loans” to large corporations
The questionnaire also showed banks are most likely to supplement their categorization of “green” activities using their own internal metrics.
The European Securities and Markets Authority (ESMA) held an open hearing on its proposed ESG fund labeling guidance on January 23.
Last November, the regulator published recommendations stating that funds should only include ESG terms in their names and marketing materials if at least 80% of their investments have environmental or social characteristics or sustainable investment objectives that they’ve disclosed under the Sustainable Finance Disclosure Regulation (SFDR). The regulator also said the term “sustainable” should only be used by funds that have half of their assets invested in sustainable investments that have been disclosed under the SFDR.
The comment period for ESMA’s guidance closes February 20.
The Bank of England (BoE) published the results of its 2022 stress test of insurers, which asked firms to gauge their resilience to certain climate-related natural catastrophes.
The 54 participants were asked to estimate how their capital ratios would change under eight scenarios, including an extreme US hurricane and a UK wind and storm event. Other scenarios tested the insurers against cyber attacks and financial market turbulence.
The results show insurers should be able to withstand extreme weather-related shocks, though the participants rely heavily on the global reinsurance market to mitigate financial impacts.
The Financial Reporting Council (FRC) — the UK regulator of accountants, actuaries, and auditors — plans to release guidance on climate-related metrics and targets for certain industries later this year to complement the work of the country’s Transition Plan Taskforce.
In a Statement of Intent on ESG matters, the regulator described the ongoing challenges that UK firms have reporting ESG and climate-related issues in their public financial disclosures. It also laid out its plans for overcoming them.
Along with the plan to release a “thematic report” on metrics and targets, the FRC said it would develop guidance and best practices on the use and distribution of ESG data. It also said it would investigate how companies approach the question of financial materiality when it comes to ESG disclosure and introduce requirements for actuaries to factor climate and ESG issues into their work.
Deutsche Bundesbank and BaFin, Germany’s central bank and primary financial regulator, published the findings of a review of small and medium-sized banks’ climate readiness. Of the 17 firms assessed, the review shows most have “room for improvement” when it comes to their climate governance and risk management. They also could do better on integrating climate issues with their risk appetite processes and credit risk analysis.
Five of the banks received a “red flag score” for each of these areas, meaning their practices weren’t up to scratch. In addition, only a few institutions provided “concrete key performance and key risk indicators” on strategically managing their climate risks.
The review also said updates to BaFin’s risk management rules, due this year, will require all firms to address material ESG risks and consider them “at the strategic level,” including when assessing their internal capital adequacy.
Asia-Pacific
The Central Bank of the Republic of China, Taiwan’s central bank, said it would factor climate issues into its economic modeling and forecasting and alter its monetary policy to support sustainable development.
It also pledged to “establish an overall model related to climate change at the industry level” to better understand how climate risks could impact the economy and financial system.
Taiwan committed to a target of net-zero emissions by 2050 last year.
The Bank of Thailand and the Thai Securities and Exchange Commission released a draft sustainable taxonomy to help investors identify climate and environmentally friendly activities.
The draft categorizes activities using a “traffic light system” in which environmentally harmful activities are coded red, transition activities amber, and climate-friendly activities green. As an initial step, the two authorities are applying this system to energy and industrial activities and asking for stakeholder feedback.
The draft’s consultation period closed January 26.
The Reserve Bank of India (RBI) placed the country’s first green sovereign bond on January 25.
The offering raised 80 billion rupees (USD$981mn) and was mainly sold to local banks and insurance companies. The proceeds of the sale will be channeled into climate-friendly investments, including renewable energy projects. India’s government has pledged to reach net-zero emissions by 2070.
International
The International Sustainability Standards Board (ISSB) met in Frankfurt between January 17 and 19 to debate aspects of its forthcoming sustainability- and climate-related standards.
Some of the issues raised at the meeting include the standards’ sustainability-related metrics and targets requirements, the setting of climate-related targets, and how reporting companies should disclose the judgements, assumptions, and estimates they make when applying the standards.
The ISSB “tentatively decided” to require entities using its climate standards to disclose how any of their climate targets have been “informed by the latest international agreement on climate change, including how such targets have been informed by the jurisdictional commitments that arise from that agreement.”
The board also discussed how reporting entities should produce disclosures that are based on uncertain measurements or outcomes, like those concerning their climate-related scenario analyses. Board members “tentatively decided” to introduce a concept of “reasonable and supportable information that is available at the reporting date without undue cost or effort” to its two disclosure standards. This concept would apply when reporting entities use the disclosure standards for topics with “a high level of measurement or outcome uncertainty.”
