Climate Change - Time is Running Out for Financial Systems to React

Climate Change brings unprecedented risks to Financial Systems and Global economies.

Thirty years after the first UN IPCC meeting, financial regulators globally have realised that not only is there a coupling between climate risk 'in the real world' and in the financial domain, but that the Financial System will be pivotal in enabling transitions to net-zero carbon economies.

Since Mark Carney's now famous speech 'Breaking the tragedy of the Horizon - Climate Change and Financial Stability' in 2015, Central Banks and Supervisors around the world have joined forces to help shape the next chapter in the response to financial risks as a result of climate change.

"While there is still time to act, the window of opportunity is finite and shrinking."

Though progress in this area feels like it's remained painfully slow, we're starting to see the green shoots of real action and formative change emerge.

Let's start with the basics.

There are three key types of risks that arise from climate change

• Physical Risk: what you probably imagine when you think of climate change; the impacts that arise from climate and extreme weather events, such as floods and storms that damage property or disrupt trade;
• Transition Risk: the financial risks associated with the cost of moving to a net-zero carbon economy for both consumers and businesses alike - the more disorderly the transition the higher the transition cost is likely to be;
• Liability Risk: the impacts to insurers and legal firms relating to both changes in policy but also increasing risk of loss claims, including failure to disclose significant risks that may impact market valuations

In reality, there could be any number of combinations by which these risks manifest - firms will need to be able to flex their strategies to accommodate a range of scenarios and possible outcomes in the real world.

Firms recognise the challenge ahead and are voluntarily mobilising action, before regulation drives them to do so

Climate change doesn't just represent unprecedented risk. But for those who identify them, there are significant opportunities. Opportunities for building a more resilient business as we head into an uncertain future, but also sustainable growth in new and exciting areas.

We can see evidence of firms' willingness to take action:

• Over 1,400 firms of all types, with significant representation from the Financial Industry, have voluntarily signed up to the FSB's Task Force for Climate-related Financial Disclosures (TCFD). They represent a market capitalisation of over US$12.6 trillion. New supporters are added on a continuous basis.
• This includes all 77 members and 13 observers who form part of the Network for Greening the Financial System (NGFS), mainly comprised of Central Banks and Supervisors.
• There is a noticeable absence from the USA in any of these forums. However, the US Financial System isn't standing still. A recently published report by the Climate-Related Market Risk subcommittee, an independent subcommittee of the U.S. Commodity Futures Trading Commission (CFTC), acknowledges that climate change poses a major risk to the stability of the U.S. financial system and to its ability to sustain the economy. Firms are taking note and voluntarily mobilising action.
• In a recent GARP survey, 80% of respondents advised that they expect climate change risk to cut across all areas of their business - Credit, Traded/Market, Ops, Insurance, Underwriting etc.

This is aside from the significant commitments already being made to shift and drive up funding towards sustainable and green initiatives. We've seen this pledge repeated by most major Banking Groups worldwide - just recently HSBC published their own commitment of up to US$1 trillion of finance and investment by 2030 to help with their business customer's transition.

Central Banks are working together on a global response

Each country will have their own unique challenges, risks and opportunities as a result of climate change.

However, there are common elements that exist regardless of where firms are:

• Agreeing common reporting standards (TCFD is looking more and more likely to be the de facto standard)
• Determining appropriate, urgent but proportionate responses to mitigate emerging and potential risks; smaller firms will not be exempt as they could be disproportionately impacted due to concentration risk and lack of geographical diversity where physical risks could otherwise be balanced or offset
• As is often the case, the UK regulators are taking a leading role in setting policy. The Climate Financial Risk Forum (CFRF) is an industry forum jointly convened by the PRA and FCA to build capacity and share best practice.
• This includes clear expectations that firms should report climate change risk as part of future ICAAP returns
• Stress testing frameworks will also be amended to recognise potential impacts of climate change risks spanning 50+ years; this goes far beyond the usual business cycles of 3-5 years used in today's forecasts
• Having released initial, useful guidance and reference scenarios during Summer 2020, UK Regulators are working to refine and build towards clear policy
• Strengthened guidance and the first foray into providing usable stress testing scenarios (though, not contributing to CET1 initially) is expected to be ready in 2021
• Similar actions are in flight across other markets - wider Europe and Asia being front runners, with the USA ready to join the call to action imminently
• The UN's Finance Initiative (UNEP FI) is working closely with Financial Institutions to make sure emerging markets aren't left behind. A great example where this collaboration has come to life is between The Making Finance Work for Africa (MFW4A) and Africa Development Bank (AfDB) who recently explored the risks, opportunities and responses to their local market. The discussion continues.

This is bigger than just Banking

Climate Change is also an issue of social and economic justice, that if left unchecked, will disproportionately hurt the poorest members of society.

By acting now, we can help protect those who are most vulnerable from costs that come with a disorderly transition to net-zero; rising food costs, housing shortages, rising insurance premiums, and mass unemployment to name a few.

Questions you should be asking of yourself and the firm you represent

1. Are you and your leadership teams providing Climate Change the right level of attention within your business? This should include clear strategy and investment plans to match.
2. What type of modelling approach will you be using to quantify the risk exposure to your assets and business?
3. Do you have the right teams in place to support a strong, robust delivery?

Having spoken to representatives of some of the biggest firms and associations that represent them, the answer to the questions is almost always 'not enough'.

And if you're in the same camp, then don't worry. We know that it's usually driven by a few things like

• uncertainty in regulatory expectations (regulators are still working hard with firms to bring clarity and reasonable next steps to the market)
• lack understanding of what climate change is and how it'll manifest into risk types we talked about earlier
• other urgent and immediate issues that have taken up bandwidth, such as Covid-19 and Brexit which looms again

What next?

Nobody really knows what the future holds when it comes to climate change. But what we do know is time is running out and we have to take action now.

There are practical, immediate steps that you can take to start that journey and we can help.

Kube Risk have partnered with some of the UK's leading Climate Change scientists and economists to bring you thought leadership and a best-in-class modelling capability.

Here's how:

1. Thought leadership in Climate Change Risk and what it means for you

2. A best-in-class modelling capability that will enable you to respond to regulatory requirements with confidence; using credible and quantifiable risk outputs - all powered by AI

If you think you or your firm will benefit from advice, guidance or direct support in this deeply complex but exciting area, we'd love to talk.

Schedule a call with us today, with a few simple clicks, by visiting our website https://www.kuberisk.com/schedule.

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Lukky