Earlier in May, Deloitte co-sponsored the 2019 Spring conference of the International Association of Credit Portfolio Managers (IACPM), a leading industry forum at which credit portfolio managers and risk executives exchange notes on the latest developments and trends in portfolio management.
This year one of the popular conference streams, which threaded the entire duration of the 2-day conference, focused on climate change and sustainable finance. It was good to see credit portfolio managers track and discuss business opportunities arising from climate change. Identifying and pursuing responsible investment opportunities at financial attractive terms is key, if business and consumer behaviours are to be changed at speed as the world strives to transition to a low-carbon environment both locally and globally.
At the same time, delegates also appreciated the growing importance of measuring and managing the financial risks associated with climate change. Attendees discussed a range of topics: financing green bonds, scenario planning for a (dis)orderly transition, implications for forward looking credit risk measurement and management, including limit-setting and sector concentration risk, as well as the setting of Board-level Environmental, Social and Governance (ESG) risk appetite. It was clear that several aspects of enterprise-wide risk management would need to be redesigned if fuller consideration is to be given to climate change.
Back in December 2018, Deloitte flagged climate change regulation as a key area of regulatory focus for 2019. It is indeed proving the year in which central banks are imploring governments and financial institutions to adequately address the financial risks from climate change and reassess their strategic resilience to climate change policy.
A lot will need to be done to stop the market failure induced by climate change from resulting in "Minsky moments". Risk managers at financial institutions have much to review and redesign before they are comprehensively climate change-inclusive in their approach to risk management. It's a journey, but this Deloitte blog offers some initial guidance, drawing on the PRA Supervisory Statement 3/19 (SS3/19).
Several open questions remain. For example, it's not clear for an institution that's an early mover whether giving greater regard to its climate change financial risks would translate to holding less or more capital compared with its peer group. Are point-in-time focused metrics, such as carbon-emission trackers, the best choice? Could these be gamed and lead to greenwashing allegations in banking? It is also not clear how the significantly longer horizons of climate change scenarios and responsible investment planning (typically decades out) can be easily reconciled by a Board with the typical shorter-term performance expectations of investors. Also, when sustainable is only inconsistently profitable, will the financial institution's resilience to the ESG agenda be tested? Would regulatory incentives be provided? The financial community would need to gradually resolve such uncertainties, with each institution charting its own course. Despite the many open questions, as we roll forward towards the second half of 2019, what is certain is that climate change will no longer be the elephant in the board room.
We need collective leadership and action across countries and we need to be ambitious. The NGFS is the core of the response of central banks and supervisors. But climate change is a global problem, which requires global solutions, in which the whole financial sector has a crucial role to play.