As the regulatory drumbeat around climate risk preparedness grows louder, financial institutions are scrambling to keep pace. The challenge: all of this is new. Best practice is still evolving. The broader operational impacts of climate change can be hard to quantify. Against this fast-moving backdrop, risk managers are trying to cut through noise and ensure their institutions are on track with their climate risk response. For this third part in our climate risk series, we’ve been talking to senior risk professionals at various events, roundtables and customer advisory boards over the past few months to better understand the key issues that are impacting financial institutions as they seek to improve their climate risk management.

Here are four common themes that risk managers have identified:

  1. The reusable cup paradox
    Tackling climate risk is a complex process and knowing where to start can be daunting. Oftentimes this can cause firms to be distracted by the low-hanging fruit, such as introducing reusable cups in the staff canteen. While such gestures are symbolic and can encourage people to start thinking more broadly about sustainability, banning disposable cups will only have a very trivial impact on reducing an institution’s exposure to climate risk. Instead, risk managers say institutions need to focus more on ensuring their employees are actually making a difference when they get back to their desks. There is little point sipping a latte from a reusable cup if they are not actively seeking to minimize the environmental impact of the deals on which they are working.

  2. Opportunity vs risk
    Understanding how climate risk will impact a financial institution’s operations is critical for ensuring they are not exposed to adverse environmental events. Regulators have been dialing up their messaging around climate change to ensure firms are ready to meet the challenge. Many financial institutions still have significant work to do in order to improve their climate risk preparedness. Yet in today’s ultra-competitive operating environment, financial institutions shouldn’t lose sight of the need to balance those risks with the opportunities created by climate change. Given the constantly shifting backdrop, financial institutions can’t afford to stand still and miss out on emerging business areas, be it new products or serving different markets and businesses that are being created as the green economy develops.

  3. Outside-in vs inside-out
    Oftentimes financial institutions frame climate risk in terms of what they can do to help limit their impact on the environment—whether it is working with clients on cutting emissions or avoiding certain sectors or simply reducing their own carbon footprint. In other words, tackling climate change from the inside-out. Yet a number of firms are starting to find it more effective to articulate their climate change agenda to stakeholders by focusing on the outside-in. That means highlighting the external factors that will impact a firm’s long-term ability to do business. For instance, physical risks (such as increased adverse weather incidents that result in flooding, drought or wildfires) and transition risks (such as consumer pressure to stop financing heavy polluters).

  4. Greenwashing
    Financial institutions will already be aware of the dangers of greenwashing and the potential reputational and regulatory risk of falsely claiming products are greener than they actually are. Yet a number of senior risk managers are beginning to worry that while firms may in good faith label certain products green today, in the future regulators could take a backwards-looking view that those claims were wrong—particularly if investors are left shortchanged. As more and more products are labeled green, ostensibly to help investors make more informed choices about their exposure to climate change, there is a risk that some will be mislabeled. To avoid any potential future mis-selling accusations, financial institutions need to tread more carefully about how they label products.

For more information on climate-related risk management, click here. Stay tuned next month for the fourth part in our climate risk series looking at how the financial industry is responding to the climate challenge six months on from COP26.

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