Our new guest column features a contribution from a different professional body or associated institution every quarter.
Simon Thompson, our first contributor, introduces the new Climate Risk Certificate, developed by the Chartered Body Alliance (an alliance of professional bodies comprising the CISI; Chartered Banker Institute; and Chartered Insurance Institute), setting out the need for it and how it can help financial sector professionals pass the ‘Carney Test’.
We, at the Chartered Banker Institute, are delighted to have been working with colleagues in the Chartered Body Alliance on our first ever collaborative qualification, which has established our first joint syllabus panel and points the way to future collaboration too.
We chose climate risk because collectively, we recognise that understanding, identifying, measuring, managing and disclosing climate, environmental and sustainability risks (especially climate risks) have become a priority for policymakers, central banks, financial regulators and the financial services sector in recent years. These are seen as significant sources of risk to customers, businesses, financial institutions and the economy overall in the short, medium and long terms, with the potential to threaten institutional and global financial stability. These are not new or emerging risks, however. The direct costs of climate-related events, and the need to invest in climate-resilient infrastructure, have been apparent for some time.
We also believe that while the Climate Risk Certificate focuses on climate risks, the same approaches and techniques used to assess these can also be used by asset managers, investors, insurers, banks and others to identify opportunities from the transition to net zero.
Physical, transition, and liability risks
The Climate Risk Certificate considers physical, transition, and liability risks in some detail. The Task Force on Climate-related Financial Disclosures (TCFD) has established a framework for climate-related financial risk disclosures for use by companies providing information to investors, lenders, insurers, and other stakeholders, that is designed to encourage consistency in identifying, disclosing and managing them. By encouraging and promoting greater, more consistent disclosure, climate-related financial risks should become more central to board and investor decision-making, to shareholder engagement with management on climate change issues, and should assist central banks and regulators.
The implications of the transition to net zero are systemic for all sectors and all firms. Some, such as the automotive, steel and construction sectors, face an existential threat unless they transform their business models in response to transition risks. This creates substantial risks to financial institutions lending to or investing in these. Physical, transition and liability risks may result in stranded assets, which have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities. An abrupt, disorderly transition, where governments and others are forced into taking swift action in response to, or to avoid, catastrophic climate change also needs to be avoided, as this could very easily threaten financial stability.
The prudential and systemic risks involved explain why central banks and financial regulators are increasingly adopting a coordinated, harmonised approach to the supervision of climate risks. The voluntary TCFD approach is now being mandated in several jurisdictions; regulation and guidance is being rapidly developed and implemented. Some regulators and others are also now considering nature-related and other environmental and sustainability risks.
It is difficult for organisations and investors to understand, model and quantify climate risks, due to the complexity and interrelated nature of variables involved. It is also difficult to estimate the financial impacts, as they depend on different scenarios regarding the degree of global warming, speed of transition, changing regulation, cost of legal liabilities and many other variables. Scenario analysis is a useful technique to use in attempting to understand the impact of different assumptions regarding the speed and impacts of climate change on products, services, organisations, and investment portfolios. Carbon pricing and the use of big data have the potential to improve the accuracy of the pricing of climate-related risks.
The Carney Test
In his continued response to climate risk, Mark Carney, the former Bank of England Governor, COP 26 finance adviser and UN special envoy has made a key objective of his Building a private finance system for net zero “to ensure that every professional financial decision takes climate change into account”. We believe that to meet this objective, or the Carney Test, as we now refer to it, we must ensure every finance professional develops the expertise required to manage climate risks and identify the opportunities from the transition. By developing the Climate Risk Certificate as a first step, the Chartered Body Alliance, which includes three of the UK’s world-leading financial professional bodies, is demonstrating the key role it can play in establishing the standards, norms, values and practices to develop the capability and capacity of the finance sector globally.
Simon Thompson FCBI
This column was originally published in the June 2021 edition of The Review.
Chief Executive, Chartered Banker Institute
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