The politics of sustainability have become more difficult with the ongoing debate, especially in Europe, about how to reconcile environmental goals with renewed energy security concerns, along with the emergence of an “anti-ESG” faction, and the spilling over of disagreements over the binding nature of some climate targets within the Glasgow Financial Alliance for Net Zero (GFANZ).14,15
But 2022 also provided ample evidence of how disruptive sudden swings in food and energy prices can be, as well as the impacts of increasingly frequent and intense natural disasters. These risks will only become more pronounced as the climate transition unfolds, and they will increasingly shape the FS operating environment. Insurers face particular challenges given the twin tasks of managing the solvency implications of exposures to physical risks while continuing to protect policyholders, many of whom may face escalating costs for coverage, creating the risk that protection gaps emerge or widen.
Regulation and supervision will be key determinants of how firms must respond to these risks. In some areas, there appears to be a degree of supervisory convergence, most notably around prudential risk management and risk governance. Climate-related stress tests and/or scenario analysis exercises are becoming features of supervisory frameworks in many major jurisdictions, being well established in the EU and UK, Japan and Hong Kong, and emerging onto the agenda in the US. Elsewhere, however, despite shared ambitions to address issues such as greenwashing (with investment funds in particular in the crosshairs around fund names, labelling, disclosure practices, and the green credentials of their underlying assets), firms are finding themselves contending with differing national requirements, particularly in terms of sustainability taxonomies. Even where supra-national attempts have been made, such as with the Association of Southeast Asian Nations (ASEAN) taxonomy, national variants will persist.
There have been more ambitious attempts to develop international standards around disclosure, most notably the ongoing work of the International Sustainability Standards Board (ISSB), which is driving toward the development of a global baseline with the support of international regulators such as the FSB. Some countries are continuing to develop their own frameworks, and while such frameworks may converge over time, in the near term firms will need to be able to store and manipulate data flexibly so that it can be moulded to meet the needs of different jurisdictions. Indeed, sustainability data quality and coverage remain significant challenges for firms and with the use of proxy data still widespread, regulators are expected to push industry to address this in 2023.
There is divergence in the technical detail of regulatory frameworks to address sustainability, for instance in terms of how risks are captured in prudential rules, how funds are labelled, how insurance products are underwritten or offered, and what firms must disclose to the market. But the issue is fundamentally one of risk management, and to fulfil their risk management obligations, Boards need confidence that they understand their business footprint and risk exposures. This confidence will not be delivered through mere compliance with regulation, but through the development of better data, sophisticated modelling capabilities, plausible scenario analyses, and engagement with scientific expertise and judgement. The absence of harmonised rules should not be a barrier to action, and the onus will very much remain with firms to be able to meet multiple sets of expectations and reconcile them across their operations where necessary.
The need for risk management has its complement in the development of new opportunities for innovation and market development. The reallocations of capital required for the climate and nature transition are enormous, with trillions of dollars needing to be intermediated, invested, insured, and risk managed worldwide across virtually all areas of economic activity. And, put simply, the better grasp firms have of the risk environment, the better placed they will be to identify and exploit the corresponding opportunities in the years ahead.