Creating a climate of change

The imperative for action has arrived

It might have been in the background before, but now—and with increasing frequency—signs point to the necessity of climate risk preparedness:

• In September 2020, the Commodity Futures Trading Commission’s Climate-Related Market Risk Subcommittee released its report, “Managing Climate Risk in the US Financial System,” which highlighted that “A central finding of this report is that climate change could pose systemic risks to the US financial system.”¹

• An August 2020 report by the Senate Special Committee on Climate calls for action, stating that “Climate-related financial risks are systemic, and if left unchecked, could destabilize our financial markets and economy. Our financial regulators … need to start assessing and managing climate risks.”²

• In October 2019, the San Francisco Federal Reserve Bank published 19 separate papers warning of economic risks associated with climate-related crises.³

• The Climate Change Financial Risk Act, introduced in November 2019, calls for the Federal Reserve to establish an advisory group of climate scientists and economists to help develop climate risk scenarios for financial stress tests.⁴

• European Union regulators are currently aligning sustainable finance with the objectives of the “European Green Deal,” which was endorsed in December 2019 in an effort to transition the continent to carbon neutrality by 2050.⁵

• The Task Force on Climate-related Financial Disclosures estimates that the transition to a lower-carbon economy is expected to require around $1 trillion of investments per year for the foreseeable future.⁶

It’s become clear that banks can’t afford to get this wrong. A lack of preparedness can lend itself to dramatic, systemic risks. Action is what’s needed—and now.

To that end, this paper explores the increasingly aggressive regulatory landscape and evolving investor expectations and shares practical steps that banks can consider to establish a proactive, responsible, and financially resilient plan for climate risk management.

Why climate risk should matter to banks: A fundamental risk to managing portfolios

The COVID-19 pandemic has dramatically illustrated the pervasive power of exogenous forces in the financial markets. And climate events represent a similar example, which is creating momentum for industry and regulatory action. Yes, climate risk had been on the industry’s radar, but the pandemic brought into stark focus how externalities can disrupt the financial industry, and more investors are taking note and taking action.

In fact, environmental, social, and governance (ESG) funds outperformed the market in Q1 and Q2 of 2020, underscoring the importance of factors that are paramount to investors, such as business resilience and employee and community impact.⁸

Banks should also bear in mind how their business and brand reputation can be affected by other constituents. In a 2018 report, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) expected that specific events, such as negative publicity from nongovernmental organizations (NGOs) or consumer pressure on ESG issues, could all be catalysts for moving banks to embrace climate risk in their risk management framework.⁹

The time for change is now

The regulatory terrain isn’t simple to navigate. Neither legislators nor investors will be passive. But by leaning into what’s coming, leaders can move beyond a reactive paradigm and develop a comprehensive response that puts the organization on the right footing.

As our report explains, there are six action steps that an institution can put in motion now. These include assessing the level of readiness; tailoring an approach that’s right for the organization at this point in time; then moving forward with a comprehensive, methodical, and actionable strategic framework.

But managing climate risk is about far more than compliance or protecting the organization from being caught off-guard. Yes, addressing these challenges now can increase resilience and allow greater focus on core business. But moving forward on climate risk management also means that bank leaders are acting in the wider interests of the communities they serve—and ultimately driving long-term shareholder value.

Read the full report to learn more.