Financial institutions lowballing climate risks, and more.

July 7, 2023

The top five climate risk and disclosure stories this week.

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Financial firms lowball climate risks — report

Banks, insurers, and investment firms may be underestimating climate-related financial risks due to a disconnect between climate scientists, economists, model builders, and financial institutions, according to a report out of the Institute and Faculty of Actuaries (IFoA) and the University of Exeter. 

The study reveals that companies often use models that produce “implausible” outputs and have significant blindspots when it comes to estimating potential hazards, exposures, and vulnerabilities under different climate scenarios. This ultimately limits their usefulness in assessing the true extent of financial institutions’ climate risks.

For example, the report says current modeling techniques exclude many of the most severe impacts expected from climate change, such as the emergence of climate tipping points and second-order effects, like global food supply shocks and mass migration. As a result, they generate overly benign outcomes, which can mislead financial institutions on the full extent of their risks and potentially delay action on decarbonization.

To improve financial firms’ climate risk assessments, the paper’s authors recommend that model users become climate literate and use these tools alongside narrative scenarios that qualitatively describe the potential risks and their impacts. Additionally, institutions should incorporate out-of-model adjustments and error margins in their analyses to account for uncertainties that the models fail to capture.

Net Zero Insurance Alliance dumps emissions targets

The United Nations-backed Net Zero Insurance Alliance (NZIA) will no longer require its members to set and publish targets for reducing the emissions associated with their underwriting portfolios.

In a statement Wednesday, the group said individual members are under “no obligation” to publish decarbonization targets, adding firms that choose to do this act “unilaterally and independently.” The statement follows the departure of more than half of the NZIA’s members amid allegations of antitrust violations by US Republicans.

The decision raises concerns among climate advocates, who argue that the change weakens the NZIA and opens the door to further greenwashing in the insurance industry.

The Insure Our Future campaign said the announcement “reduces the Alliance to an empty shell” and suggests the NZIA has caved to pressure from the fossil fuel lobby. The group adds that regulators must force insurers to adopt science-based transition plans and urges the International Association of Insurance Supervisors (IAIS) to integrate this requirement into its Insurance Core Principles. It also says the IAIS should put the topic on the agenda for its annual meeting in Tokyo in November.

Canada, Singapore take steps to adopt ISSB

The Canadian Securities Administrators (CSA) has expressed its support for the climate and sustainability rules published by the International Sustainability Standards Board (ISSB) and plans to consult on implementing them in Canada.

CSA members, which include Canada’s provincial and territorial securities regulators, are responsible for developing climate disclosure requirements for public companies. These regulators are waiting on the Canadian Sustainability Standards Board (CSSB) to make decisions on adapting the ISSB standards for the Canadian market before they start drafting binding reporting mandates. On June 26, the CSSB announced it appointed enough members to start deliberating over the standards.

Separately, Singapore signaled its intention to adopt the ISSB standards. On Thursday, the country’s Accounting and Corporate Regulatory Authority (ACRA) and the Singapore Exchange Regulation (SGX RegCo) announced a consultation on rules that would require publicly traded and privately held companies to produce ISSB-aligned climate disclosures. The authorities plan to mandate the disclosures for listed companies beginning 2025 and for large, non-listed entities beginning 2027.

“Trusted and consistent climate reporting is essential to drive accountability and decisive actions by companies,” said Kuldip Gill, ACRA’s assistant chief executive. “It will also rally companies towards contributing to Singapore’s net zero emissions commitments, expediting our transition to a green economy.”

Investors urge EU to require climate metric disclosures

More than 90 major investors and responsible finance groups have called on the European Commission to roll back proposed changes to the first set of European Sustainability Reporting Standards (ESRS). 

In a Thursday statement, signatories urged the Commission to ensure the ESRS require companies to disclose key climate indicators, including Scope 1, 2, and 3 emissions, as well as the necessary metrics for gauging the credibility of decarbonization plans. They also pressed for the mandatory disclosure of environmental and social indicators that are relevant to the Sustainable Finance Disclosure Regulation (SFDR), the EU Climate Benchmark Regulation, and other investor reporting regulations.

The statement follows the European Commission’s publication of draft regulation that would water down the ESRS — the rules that underpin the European Union-wide Corporate Sustainability Reporting Directive (CSRD). Among its proposals, the Commission recommends shifting all climate and environmental indicators that were initially classified as mandatory into the scope of a materiality assessment. This means they would only need to be reported if a company determines that a sustainability factor is important and relevant. A consultation on the Commission’s draft closed on Friday.

“The first set of the European Sustainability Reporting Standards … fails to address investors’ needs and risks undermining the effective implementation of the EU sustainable finance regulatory framework,” said Aleksandra Palinska, executive director at Eurosif, a European sustainable investment group. “The European Commission is now presented with a final opportunity to correct its course and find a compromise that would truly reflect all industry and stakeholders’ needs and better match the ambition of EU climate neutrality targets and the EU Green Deal.”

UK backs ESG data code of conduct

The UK’s Financial Conduct Authority (FCA) has welcomed a voluntary code of conduct for environmental, social, and governance (ESG) data and ratings providers.

Published Wednesday, the code is intended to “foster a trusted, efficient and transparent market” through clear standards. These aim to bolster the availability and quality of ESG information offered to investors, enhance market integrity, and improve competition. 

Compliance with the code is not mandatory, and the code does not “prescribe a singular approach” for implementing specific provisions. Instead, it lays out expectations for meeting five principles on good governance, securing quality, conflicts of interest, transparency, and confidentiality. 

The code was developed by the International Regulatory Strategy Group (ISRG) and the International Capital Market Association (ICMA) under instruction from the FCA. A consultation on the code is open until October 5.

Chris Hayward, interim co-chair of the IRSG Council said the code “will help ensure this [ESG data] market is fit for purpose, in turn supporting market practitioners to assess the risks more accurately.”