Climate change and banks: Questions Boards should be asking

The EMEA Centre for Regulatory Strategy has today published its latest report, Climate change and banks: Questions Boards should be asking. You can read the report here.

2020 will no doubt be remembered as the year when the COVID-19 pandemic swept the globe. Many regulatory initiatives for banks were put on hold as regulators sought to respond to the immediate demands of the crisis. But there was one other issue which not even COVID‑19 displaced from the top of government and regulatory agendas. That issue was climate change. This focus has implications for a number of different roles and responsibilities across a bank, but there are some specific considerations for the Board as it steers the bank’s strategy.

This year has seen an abundance of legislative and supervisory measures for financial services firms on climate change. This reflects the marked shift in society’s view of climate change and the recognition that meeting the target of net zero carbon emissions by 2050 requires action now. Politicians and policymakers have stated their ambition that the recovery from COVID-19 should be ”green” – with UK Prime Minister Boris Johnson calling for the UK to “build back better”, and the European Union recently having agreed a COVID-19 recovery package in which 30% of EU funds will be spent on fighting climate change. In the coming years, policymakers will focus on how funding can be channelled towards the transition to a fundamentally different and more sustainable economy. In tandem, supervisory attention will increasingly turn to how banks manage the risks which arise from climate change.

As banks look towards 2021, they face a number of key regulatory deadlines. In July, the UK Prudential Regulation Authority set an end-2021 deadline for UK banks (and insurers) to have embedded fully their approaches to managing climate-related financial risks. On 27 November, the European Central Bank similarly stated that it will require banks in the Banking Union to conduct a self-assessment in 2021 against its Guide on climate-related and environmental risks, ahead of a full supervisory review in 2022. Stress testing exercises are planned in both the UK and the EU. And in the US, which has so far lagged behind Europe and the UK in terms of regulatory action on climate change, key documents have been published by the Commodity Futures Trading Commission and the New York State Department of Financial Services.

In addressing climate change, Boards must establish a strategy and risk appetite which accommodate and reconcile both the risks and opportunities arising from climate change and the transition to a greener economy. Moreover, Boards must ensure that the strategy and risk appetite are reflected in, and supported by, the bank’s risk management and governance structures. This is no easy task. Climate change presents challenges which are new, significant and complex.

Our paper, Climate change and banks: questions Boards should be asking, helps Boards navigate this difficult environment and meet regulatory expectations. We discuss five themes which Boards should prioritise in order to provide robust challenge and effective oversight of their bank’s approach to the identification and management of climate risk. The themes cover strategy and business model, governance and culture, risk management, scenario analysis and liability risk. We also provide examples of questions the Board can ask to challenge itself and the senior management team. For example:

• Is our strategy for managing the transition, physical and liability risks which arise from climate change aligned with our corporate goals on sustainability?
• Do we have access to sufficient breadth of knowledge, skills and experience to challenge senior management effectively on climate change?
• Are we comfortable that we understand the scale of uncertainties in climate risk exposure measures?
• Based on our scenario analysis, are we confident that the bank will have adequate access to financial resources and that the associated risk sits within our risk appetite?
• What gives us confidence that our bank has identified its material liability risks in relation to climate change?

This week, the UK began rolling out COVID-19 vaccinations, with other countries expected to follow soon. This offers hope that 2021 will be a better year for many. There is no vaccine though to halt the spread of climate change. Transitioning to a more sustainable economy needs to start now and will require prolonged and determined action and investments. In this, banks have a vital role to play, and bank Boards should aim to be a driving force for change.

This is more than a matter of corporate social responsibility. Banks that fail to take advantage of the opportunities arising in the transition to a greener economy, or deal with the challenges, are putting at risk the viability of their business model.