Banks and financial powerhouses map out climate risks

A day after the hottest Double Ninth Festival on record in Hong Kong, experts gathered at Asia Risk Live at the Ritz-Carlton to explore how banks can manage climate risk for a net-zero economy

A net-zero economy may be years away, but the climate crisis feels all too current. The Double Ninth Festival (Chung Yeung) is believed to be a day with excess yang. This year, it was marked by excess heat when the mercury climbed to a scorching 33.5º Celsius on October 4 – the hottest Chung Yeung Festival since records began in 1884.

Banks and regulators wake up to climate risks

For banks, the transformation begins now. Those that fail to navigate the path to a low-carbon economy could be slapped with billions of dollars in fines and settlements, warned Stuart Lewis, group chief risk officer at Deutsche Bank, earlier this year at the Risk Live conference in June.

Financial regulators are all too aware of this ticking time bomb. Dr Stan Ho, adjunct associate professor of finance at Hong Kong University of Science and Technology, chaired a panel discussion on climate risk management for banks for a net-zero economy at Asia Risk Live.

Dr Ho said: “High temperature is one of many phenomena associated with climate risk changes. Global regulators, including the HKMA [Hong Kong Monetary Authority], have been rolling out a series of measures to promote green and sustainable banking as a means to address climate risk.”

Banks face growing pressure from regulators to manage the financial risks that arise from climate change, such as soaring temperatures and raging typhoons, both of which are experienced in Hong Kong. The main focus around climate risk management has been credit risk, said Efe Cummings, head of operational risk for Japanese investment bank Nomura, Asia ex-Japan.

Credit risk manifests from the physical and transition risks associated with climate change; however, banks are failing to adapt fast enough. Collectively, the world’s 60 largest banks have $1.35 trillion invested in fossil fuel assets. These are at risk of falling sharply in value over the coming years, new research from Finance Watch shows. Fossil fuel financing from the world’s largest lenders reached$4.6 trillion in the six years following the signing of the 2015 Paris Agreement on climate change. Three of the largest American banks – Citigroup, Wells Fargo and Bank of America – rejected shareholders’ proposals to align lending practices with climate targets earlier this year.

Looking beyond credit risk

Credit risk is only the tip of the melting iceberg, however. According to Cummings, transition and fiscal risks can have impacts beyond credit portfolios. He explained: “For Nomura, we’ve identified risks in the operational, reputational and strategic risk [space] as being impacted significantly by climate risks, as well as a transition to net zero. The cost of insuring our physical assets and the potential uninsurability of digital assets is a huge topic.”

Increasing disclosure requirements give rise to potential regulatory fines and litigation if not done accurately and comprehensively. Banks that embrace green lending find themselves under scrutiny for greenwashing, mis-selling and mislabelling of green products. If found guilty, this poses a risk to their reputations and raises the risk of fines.

Cummings said: “It’s a trade-off between achieving the heightened expectations for the market but, at the same time, impacting your current book of business.

“A great deal of uncertainty arises from these risks. The potential timelines can be long but, in some cases, non-linear, so they could jump to a significant event. Lack of consistent data makes it difficult to make decisions.

“If we have a scenario that maybe the River Thames is going to flood pretty soon, what are we supposed to do? Move all our operations from the City to the Midlands? It is challenging to act around these risks, given the level of uncertainty.”

TCFD template helps to model climate risk

This uncertainty means organisations such as banks and insurers need comprehensive, high-quality information on the impact of climate change. The Financial Stability Board created the Task Force on Climate-related Financial Disclosures (TCFD) to help companies improve and increase reporting of climate-related financial information.

Rodney Gollo, head of risk at Bupa Asia, said: “I think it’s a very useful framing mechanism to take what is otherwise a quite complex and high-level concept of climate risk, and really distil it down into buckets and language that stakeholders in the business are more familiar with, such as governance, strategy, risk management, and targets and metrics.”

He continued that the TCFD guidelines are a useful signalling tool to demonstrate the extent to which a company and its management team have embedded and thought about climate risk within their business.

Still, they are far from straightforward. Gollo said: “The fourth part of TCFD – the targets and metrics part – is where it’s often more challenging because it’s around either settings – group one, two or three emissions – or trying to set net-zero targets to decarbonise investment or underwriting portfolios. But still, it’s a very useful mechanism in that regard.”

He continued: “TCFD is a standard bearer among regulators, not only within Asia, but globally. It’s something that is here to stay, and I think it’s a useful tool to be leveraged.”

How can banks align climate risk exposure with their risk appetite? The key is building in flexibility without compromising stable and sustainable results, said Katriona Ho, director in credit risk solutions, Asia-Pacific, at S&P Global Market Intelligence.

She said: “It has to be a pathway. It can’t be a completely radical change. So, starting [with a] top-down approach where you set your credit risk policy [and] facilitate awareness in the company back to the frontline to allow you to continue to collect this useful information to enhance your existing approach.”

Ho identified two schools of thought. Some companies opt for a service provider to do much of the heavy lifting as they lack in-house expertise. The challenge is then developing that expertise within the company.

She said: “Or [companies] take that heavy task on [themselves] and try to develop it. And then, six months down the line, there are new scenarios that come up and then everything has to change.”

Ho continued: “At the moment, we think the way to handle all this change is by going with a primary approach, as well as a challenger model approach. So, you would have a way to continue to monitor your risk exposure [and] set your risk appetite, but then again you’re not losing that ability to understand the emerging change from the market and region.”

How much faith can be placed in stress-testing and scenario analysis in climate risk management, given many of the dangers are unprecedented and history cannot provide a guide? Cummings said: “It is certainly something Nomura grapples with.” A good starting point is the Network on Greening the Financial System’s (NGFS’s) range of six scenarios.

He continued: “You can take elements from that which are useful. Certainly, when we were doing it ourselves internally, we looked at the main [physical climate] risks that would be relevant to ourselves as a company. We did a stress test with regard to the possibility of consecutive T10 typhoons within Hong Kong and how that would impact our insurance and health businesses, which have a series of clinics there.

Cummings said: “We sought to take elements from the NGFS scenarios and factor that into what we felt was more relevant to ourselves to build out our scenario, and that really helped to make it a bit more realistic for stakeholders. It is a worst-case, extreme scenario, but it was quite relevant to our day-to-day, whereas at times the NGFS scenarios are very good, but can feel quite abstract for certain companies, given they might not be exposed to the same pathways necessarily.”

Cummings advised businesses to combine standards or frameworks such as the NGFS scenarios into their stress tests, to see the impact of climate risks. It gets trickier to compute, however, when banks and financial institutions are indirectly exposed to climate risks through their client portfolios, such as oil and gas giants.

Gollo said: “There’s a body within the UN at the moment – the [Principles for Sustainable Insurance] was really trying to build up underwriting parameters to try to do this precise thing. I think it’s an area of significant opportunity going forward. Maybe that is a useful gap in the market to address.”

Nevertheless, the panellists agreed that stress-testing and scenario analysis are useful in helping to identify the climate risks and opportunities that a company can and cannot control.

Gollo said: “As a result, understanding whether you’re comfortable or uncomfortable with the exposure you have to those risks and opportunities is key because, in reality, time is precious and budgets are often constrained. I think prioritisation is one of the key things to focus on from a risk management perspective to help companies know where to prioritise their time, efforts and resources.”

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