This blog was published on 09 December 2021.
On Finance Day at COP26 last month, finance ministers and regulators set out their plans for accelerating the transition of financial services firms and the economy to Net Zero. However, throughout the course of COP26 and in the weeks leading up to it, policymakers and regulators in the UK, EU and internationally took the opportunity to progress a number of initiatives.
To help navigate these developments, the report attached to this blog takes stock of what happened, focusing on what we learned and what has changed.
Finance ministers and regulators have clarified and extended their expectations and requirements, signalling a marked shift in the intensity of the work firms must do – even if the direction of many initiatives remains unchanged. Most notably, there is a new regulatory focus on net zero commitments and the scrutiny of transition plans.
For firms, there is a lot of material to digest and to factor into existing investment plans. Overall, the framework for managing climate-related risk is increasingly complex and is developing rapidly.
In our report we draw out four themes:
- Net zero commitments and scrutiny of transition plans | A step change in regulatory expectations. To date, firms’ net zero commitments have been voluntary but in future for many firms transition plans will have to be disclosed. Once plans are published, from next year banks – and in the UK, insurers – should expect increased supervisory scrutiny of the credibility of their plans and the implications for business model resilience and viability.
- Finance and risk disclosures on sustainability | Global cooperation, but unclear whether different regimes will converge. Several regulatory bodies set out new or updated climate-related disclosure requirements or recommendations, with the aim of further enhancing transparency for investors and mitigating greenwashing. And the UK Government provided an update on the development of its Taxonomy. The establishment of the International Sustainable Standards Board and the BCBS' intention to review the Pillar 3 disclosure framework for banks are important examples of efforts to establish globally consistent disclosure standards, but it is too early to conclude that national regimes will converge.
- Supervisory expectations for climate-related risk management | Growing commitment and intensifying supervision. The direction of travel on expectations for risk management for banks (and in the UK, insurers) is well established in Europe. Recent publications add further detail and examples of good practice but have not fundamentally changed course. However, in 2022 firms should expect heightened supervisory scrutiny of their management of climate-related risks.
- Capital requirements and scenario analysis | ICAAP and Pillar 2 remain key but increasing supervisory interest in Pillar 1. In 2022, banks and insurers are expected to incorporate climate risk and the results of climate stress tests into their ICAAP or ORSA, building on work already done in 2021. Supervisors will begin to examine whether climate risk considerations should also be incorporated into Pillar 1 capital requirements.
It has been clear for some time that even as firms work towards deadlines for meeting regulatory and supervisory expectations related to climate risk, they will in fact be locked into a longer-term process of developing frameworks and toolkits, as methodologies and the availability of data improve, and requirements become more stringent. Recent developments have emphasised this and underscored the importance of firms keeping pace with the increasing complex landscape of requirements.