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July 2022 Horizon scanning
It has been six months since the UN’s climate change conference COP26 in Glasgow, which reaffirmed global leaders’ commitments to the Paris Agreement of limiting warming to 1.5 degrees Celsius above pre-industrial levels. In this fourth and penultimate blog in our climate risk series, we look back on the key implications of COP26 on the financial services industry, what progress has been made since then and what financial institutions should be watching out for ahead of COP27 in Sharm el-Sheikh later this year.
COP26 Key Takeaways
While some people have dismissed COP26 as being ‘more of a talking shop than an action shop’, there were strong indicators that decisions taken at COP26 will translate into new financial regulatory standards. The Financial Conduct Authority (FCA), for instance, announced measures to support the transition to a more sustainable economy, including setting up a dedicated ESG division.
Financial institutions will face as much scrutiny as, and potentially even more so, than the fossil fuel industry on their climate commitments. Much of that focus will be on how banks plan to reduce their funding of oil and gas companies. A Reclaim Finance report published last year revealed that the world’s 60 largest banks pumped $3.8 trillion into fossil fuel-related businesses between 2016 and 2020.
The creation of the International Sustainability Standards Board (ISSB) announced during COP26 will help establish a global benchmark for sustainability disclosure standards. That will increase transparency around a company’s ESG risks, giving investors and other market participants access to better information to identify potential investment opportunities and enable them to make more informed decisions.
The Basel Committee on Banking Supervision (BCBS) published its consultative document ‘Principles for the effective management and supervision of climate-related financial risk’ in the wake of COP26. It is the first comprehensive set of principles covering climate-related governance for banks to help them improve their risk management and supervisory practices for climate-related financial risks.
Central banks are taking climate risk far more seriously. For example, the Bank of England’s Prudential Regulatory Authority (PRA) annual Dear CEO letter in January outlined climate risk management as one of its key priorities for this year. It warned that the majority of financial institutions are still lagging on climate risk preparedness, adding that climate-related financial risks will now form part of its broader supervisory approach.
US regulators are also stepping up their focus on climate risk management. The Securities & Exchange Commission’s climate risk statement in March detailed the agency’s expectations for improved disclosure around governance, target setting, reporting and more detailed risk management for public companies to better inform investors about the climate-related risks those companies face.
The risks of misleading investors on carbon reduction claims could lead to potential lawsuits. In Germany, a fund manager was taken to court for omitting information on its website about claims relating to its green investments (the plaintiff said it was not sufficiently clear for investors that references to ‘potential positive effects’ were estimates that were not backed up by evidence).
Greenwashing has long risked causing reputational damage, now regulators are starting to hold financial institutions to account over potentially misleading claims. In April, HSBC was issued with a preliminary warning from the UK’s Advertising Standards Authority for two adverts that promoted the bank’s green credentials while failing to mention how it finances companies that are heavy carbon emitters, highlighting the risk of unintentional greenwashing.
The fast-moving pace of the climate risk backdrop means it is difficult to predict with any certainty what is likely to unfold over the next six months as we approach COP27. What is clear, however, is that regulatory scrutiny will only continue to intensify and financial institutions without a robust climate risk management framework in place will become increasingly exposed to reputational and legal risks. For more information on climate-related risk management, click here. Stay tuned next month for the fifth and final part in our climate risk series.