Climate has started affecting the fiduciary duties of board directors. Globally, investors and regulatory efforts are beginning to move climate discussions to boardrooms. Estimates are that trillions of dollars of assets will be written off due to extreme climate events, climate driven migration, curtailment of fossil fuels, and weather events disrupting communities, businesses and supply chains.
Banks need to be prepared, as a ‘nature first’ culture is required. Board directors must quiz management to drive change and develop a ‘net-zero future’ mindset in the organisation.
The US banking regulator recently asked boardrooms of regulated entities to discuss some pertinent questions, for example: what is the bank’s overall exposure to climate change? Which region, counterparties and industry sectors are exposed to climate risk concentrations? Does the bank face exposure to stranded assets or borrower write-downs? Which projects should not be financed by the bank? What opportunities are available to scale up low-carbon financing? What are the plans to offer green deposits driven by massive public demand?
Left unplanned, things could easily go wrong. Nature-based financial risks cannot be pushed into shadows.
A plan of action
Bank boards must welcome candid responses and engage management. Understandably, the answer to such questions may be that of responsibility shifting — ‘I don’t know’ or ‘the regulator has not mandated yet’. Is that enough? Final responsibility rests with the board. Employees must be sensitised on climate issues affecting both the organisation and its clients — staff must be environmentally alert.
Risk staff must understand underlying climate consequences, particularly how climate change could affect a client’s finances. Alternative plans must be in place to ensure back-up data safety and business continuity from climate events. Regulator-mandated green stress tests are now being contemplated.
Is the bank’s or client’s business exposed to potential carbon taxes? Some would ask why they should assess this risk when governments have not yet levied it. Yet, a proposal has been mooted at multilateral forums to levy a carbon tax that will help direct capital towards net-zero economic activity. At the very least, an analysis is required to check what happens to the bank’s capital adequacy and portfolio should a carbon tax be imposed.
What accounting treatment will be given to climate related write-downs? Banks must have ability to identify and raise flags on climate risks residing in a portfolio. Embedding climate risk is seen as rating positive move.
Ratings impact
It’s all about big picture. Credit rating agency S&P recently shared proposed general principles of how environmental, social and governance factors can influence ratings. Climate risk forecast is outside of financial forecast horizon, but a part of industry or geographical assessment. Even public policy change could impact client ratings and the bank’s portfolio.
The University of Cambridge’s recent case study in Brazil suggests incorporating soil health in lending decisions. It highlights agribusiness value chain vulnerability and the land’s reduced value due to degraded soil, unsustainable land use and sowing of non-native crops (see figure). Those with healthy soil saw a valuation uplift.
The energy sector in Asia may witness substantial stranded assets. The Asian Development Bank and some financial firms (banks, financial institutions, pension, equity funds and insurance firms) have recently launched a plan to speed-close coal power plants in the Philippines, Vietnam and Indonesia. Guidelines are required for fossil fuel-intensive clients to hold more capital. Lack of sustainability data disclosure is also an issue, particularly over how sustainability claims of unlisted, unregulated, private entities would be disclosed. Therefore, bank staff must exercise judgement.
Regulatory imperative
Supervisors have started requiring banks to appoint board members experienced in understanding nature-related financial risks. Mandates of individual board committees now need tweaking to bring climate risk aspects within their purview to complement a robust board governance structure. Organisations are hiring climate risk officers, which direct reporting lines to the board.
Bank boards need to tilt their remuneration frameworks and variable bonuses in favour of climate resilient operations. Board and staff must have a common understanding of the meaning of ‘green’. Some banks have started following science-based targets with no room for ‘greenwashing’. Efforts must be made to cross-check whether clients’ sustainability claims that pose reputational risks are patchy and inconsistent.
In addition, Asian regulators must take an active position on climate. Public sentiment towards climate change is moving quicker than the regulators’. Boards could foster a climate for identifying weak spots, become a leading voice, develop roadmaps and high-impact policies for nature-resilient operations.
Climate governance is not simply the domain of policy-makers. It’s now an economic imperative for financial firms. Boards of financial firms must regularly engage in climate discussions — every drop in the ocean counts.
Ajay Sagar is a former senior staff member of the Asian Development Bank Philippines. Views are personal.
