Posted by Michael McKee, Bryony Widdup, Marina Troullinou and Jinu Choi on 26 October 2021
Tagged to CFRF, Climate Change, Climate Finance, Innovation, Risk

On 21 October 2021, the Climate Financial Risk Forum (CFRF), co-chaired by the FCA and PRA, published its second round of 10 new guides (the Session 2 Guides) to assist the financial sector in developing its approach to climate-related financial risks and opportunities.  

The CFRF originally published their guide to climate-related financial risk management on 29 June 2020 (2020 CFRF Guide). The guide was prepared by four working groups that each prepared chapters on risk management, scenario analysis, disclosures and innovation.

The Session 2 Guides build on the 2020 CFRF Guide and provide more guidance on risk management, scenario analysis, disclosure, innovation and climate data and metrics.

Risk management – risk appetite statements

The climate risk appetite statement (RAS) is a vital part of managing climate risk. The purpose of this guide is to offer advice on writing, implementing and maintaining an effective RAS.  This guide focuses on a few of the specific risks that may affect climate risk appetites, namely:

  • the impact of climate change on the firm through physical and transition risk;
  • the impact of the firm on the climate through net zero (or other) alignment; and
  • the most widely applicable financial risk categories, (e.g. credit risk).

This guide also suggests that climate RAS should consider transition risk, physical risk and alignment (to either net zero or some other science based climate-related objective).

This guide encourages the adoption of a mechanism to ensure that there is a holistic view of climate risk, either a designated individual or a full team with formal responsibility so that ownership for climate risk is clearly established.

Risk management – use cases

The purpose of the Use cases guide is to provide further guidance on how to integrate risk appetites into the firm’s risk management processes. This guide contains separate use cases for insurers, asset managers, retail banking and corporate banking.

Risk management – climate risk training

The Climate Risk Training guide aims to offer practical advice on the development and implementation of an effective climate risk training programme. The guide focuses on 3 key elements:

  • key topics that form the basis of a climate risk training curriculum;
  • importance of conducting detailed learning needs analysis to tailor training materials to effectively embed climate risk management across a firm; and
  • factors needed to ensure success of a firm’s climate risk training programme.

This guide suggests that it would be good practice to ensure that such training is linked to the firm’s climate strategy, purpose and values.

Scenario analysis – implementation guide

The implementation guide builds on the Scenario Analysis Chapter in the 2020 CFRF Guide and provides further guidance for specific bank, insurance, and asset management use cases on identifying potential exposures to climate-related risks and assessing their financial impact. This guide also explains how scenario analysis can be used to measure portfolio alignment with the Paris Agreement and to aid portfolio construction. The guide advises that all of the approaches set out in the various case studies may be useful regardless of the specific industry.

Scenario analysis – data and tools providers spreadsheet

The Climate Risk Product Providers database is a list of current climate risk offerings that highlight the variety and scope of what is currently available. The database is designed to simplify research and decision making around climate risk product procurement. The database presents information about the following specific climate risk products:

  • Models
  • Datasets
  • Ratings
  • Hazard maps
  • Frameworks

The database is organised into the following searchable fields:

  • Product format
  • What risks are covered
  • What geographies are covered
  • A summary of input data sources
  • A summary of outputs
  • Information regarding product costs
  • External links for further information

Disclosure – case studies

This guide collected case studies from different types of organisations that would be of interest to financial institutions that are developing their own approaches to climate risk.  These case studies suggest that climate concerns are increasingly integrated in risk management practices, investment research, stewardship, governance and policies and new approaches to investment portfolios and products. It was concluded that enhancing a firm’s climate approach is an ongoing iterative process. Organisations will need to meaningfully involve their staff and adopt an integrated approach in order to develop credibility and coherence.

Disclosure – managing legal risk

Financial institutions in the UK are expected to start facing legal and regulatory obligations to make climate-related financial disclosures from 2022. While financial institutions acknowledge the value and need for climate-related reporting there are concerns about the current weakness of available climate-related data to support disclosures from the reporting institution’s counterparties and data providers. There are concerns that disclosures will attract litigation and liability risks. This guide covers the areas of concern and potential litigation risks. The guide also provides guidance on managing risk of litigation and liability and offers best practice options for disclaimer wording that may be included in respect of disclosures.

Innovation – commentary report

The Innovation Working Group (IWG) noted that the opportunities and upside potential of moving to a net-zero resilient economy have generally been underappreciated. The IWG concluded that firms need to have a capital allocation framework as well as a climate risk management framework. In relation to this issue, there needs to be actionable and scalable innovation which will require regulators to work closely with industry.

The IWG analysed and provided commentary on 11 innovation case studies that each could be categorised into three broad categories:

  • Expand financing into the real economy
  • Actions to finance transition assets
  • Improve use of data and metrics

The case studies serve to demonstrate examples of innovative activities in the financial system that can be scaled and replicated by others.

Innovation – case study videos

The IWG produced a series of videos on some of the case studies in the Commentary report.

  1. Local climate bonds

Local climate bonds are an important financial innovation because they let ordinary people invest in local green projects such as solar, wind or biodiversity projects. If every local council raised money, they could raise billions. They also encourage discussion between communities and their local councils about the climate and potential solutions.

  1. Net zero neighbourhood funding model

Local authorities and cities have an important contribution to make to the net zero agenda. This funding model helps local authorities fund retrofitting housing and making energy and transport improvements. The programme can also contribute to the health and regeneration of the neighbourhoods.

  1. New asset allocation model

Investments of GBP2.7 trillion are necessary to enable the UK to transition to a low carbon economy. Currently, investors’ models do not allow them to make the necessary investments so institutional investors set up the Institutional Investors Group on Climate Change (IIGCC) that delivered the Net Zero Investment Framework. This framework provides the tools for institutional investors to align capital towards the Paris Agreement.

  1. Coalition for the energy efficiency of buildings

Retrofitting buildings will play a significant role in reducing emissions. Green mortgages and property linked finance are major solutions that can make a meaningful impact on tackling climate change.

  1. Poseidon principles

50% of ship financing is currently made by parties that have signed up to the Poseidon Principles. The principles are: 1. Assessment; 2. Accountability; 3. Enforceability; and 4. Transparency. The Poseidon Principles would make the accurate measuring of ship’s emissions and disclosing this information a covenant of financing documents.

  1. Securing commercial data sharing

The purpose of data sharing is to demonstrate that investments will deliver net zero and hold to account those implementing net zero solutions.

Climate data and metrics – guide

The CFRF noted that financial institutions use a wide range of climate-related metrics. The CFRF intends to identify a common set of core metrics. These metrics are organised into 5 primary use cases:

  • Transition risk
  • Physical risk
  • Portfolio decarbonisation
  • Mobilising transition finance
  • Engagement

This guide presents an illustrative climate disclosure dashboard to provide practical guidance towards the development of a set of common and consistent climate metrics. The dashboard proposed that the use case metrics could be further placed in one of three categories:

  • Basic: widely used; methodologies that are available today
  • Stretch: some use; methodologies at an early stage of development/acceptance in market
  • Advanced: forward thinking and holistic but not yet widely developed or accepted

The guide also analyses specific considerations for metrics that may be relevant for asset managers, banks and insurers, and provides real world examples (where available).

The authors

Marina Troullinou
Marina Troullinou
Jinu Choi
Jinu Choi

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