By accurately assessing exposure to climate change-induced impacts such as severe flooding, droughts and rising temperatures, financial institutions can transform their business strategies to protect their resilience and prosperity as well as that of global economies and the communities they serve. In January 2021, UNEP FI and the Global Commission on Adaptation (GCA) came together with ten financial institutions from across banking and investment to commit to disclosing their risks from the physical impacts of climate change. UNEP FI’s Paul Smith reviews the progress made by the group, explains the importance of this commitment, and the issues facing financial institutions trying to accurately disclose their physical risk.
Climate change is already wreaking a trail of destruction. The last seven years (2015-2021) have been the seven hottest years on record, according to the World Meteorological Organisation (WMO, 2022). Munich Re estimates that 2021 was the second costliest in terms of losses from natural disasters after 2015, including $65bn of losses from Hurricane Ida and $54bn from flash floods in Europe – Germany’s costliest natural disaster on record. According to Munich Re, “many of the weather catastrophes fit in with the expected consequences of climate change, making greater loss preparedness and climate protection a matter of urgency.” Arguably, the most important outcome from the UNFCCC’s 27th Conference of the Parties (COP27) in Egypt at the end of the year will be the conclusions of the Glasgow-Sharm el Sheikh work programme. These will establish parameters of a Global Goal on Adaptation – a goal originally included in the Paris Agreement in 2015 and essential to now driving action in this area.
Why financial institutions are committing to taking action on adaptation to climate change
In 2017, the publication of the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) generated considerable interest in the potential risks of climate change for corporate institutions. Nearly 3,000 corporates are now supporters of the TCFD, including almost 1,300 financial institutions. However, evidence from the TCFD 2021 Status Report shows that physical metrics, such as ‘weather-related losses for real assets’, are far less represented than emissions-related metrics and that the quantitative disclosure of potential impacts is “less common, and most often found for forward-looking transition risks than forward-looking physical risks”. Furthermore, “discussion of physical impacts was typically in the form of qualitative descriptions rather than quantitative information.” (TCFD 2021, p.63)
This is why UNEP FI and the Global Commission on Adaptation (GCA) came together with five financial institutions from across banking and investment to commit to disclosing their risks from the physical impacts of climate change, with the support of the TCFD secretariat. The commitment was launched in September 2019 at the UN Secretary General’s Climate Action Summit and UNEP FI and the GCA gave these institutions two years to fulfil that commitment to demonstrate leadership and test methodologies. Only a month later, in October 2019, Mark Carney, the UK’s special representative for climate finance, stated that corporates would have five years to road-test risk disclosure mechanisms before global regulators would start to introduce disclosure mandates.
Then, just over a year later, in January 2021, five more financial institutions from banking and insurance signed the UNEP FI-convened commitment and the group launched a Call to Action to other financial institutions, and to supervisors, regulators and policy makers.
How have the original five institutions scaled up their disclosures of physical risks and what are the lessons learned?
As they had committed in 2019, the initial five institutions disclosed their exposure to risks from the physical impacts in reports published in September 2021. UNEP FI conducted a review of the disclosures of all signatories, covering eight of the eleven recommendations of the TCFD – the first two recommendations on governance apply to climate risk in general rather than physical risk specifically and the second recommendation under ‘Metrics & Targets’ refers specifically to greenhouse gas emissions. Assessment of the disclosures’ coverage was made by assessing seventeen questions across the eight recommendations.
The review is based on publicly available information, though given that physical risk disclosures are still in their early stages, full assessments are not yet possible. Detailed results have been shared with the financial institutions to verify the assessment, establish if certain key information is missing, and identify areas for improvements and areas of best practice. The main high-level conclusions are:
- Disclosures depend on high quality data, and good practice is underscored in those disclosures where the use of robust, transparent data is underlined. In countries where data is limited or opaque, risk analysis is challenging.
- Third party providers of climate analytics can provide considerable support in synthesising and managing data and this is reflected in the disclosure reports of firms that have used external specialists. In-house analysis can provide long-term benefits, and may increasingly become important as sustainability risk disclosure becomes mandatory, though it can take longer to build adequate capacity and analytical know-how.
- The best disclosure reports reflect climate risk management by firms that have strong support from the Board and senior management, the financial resources to carry out their work, and climate risk management is embedded in a wider risk management framework and strategy.
- Good practice is demonstrated by those institutions that follow the reporting structure set out by the TCFD recommendations and demonstrate clearly how they implement or aim to implement quantitative risk management.
Links to the reports are given in the below table, along with good practice in disclosing around specific TCFD recommendations.
|Name||Stand-alone TCFD report||General climate report||General ESG / sustainability report||Good practice in reporting|
|EBRD||Yes||Strategy (a) & (c);
Risk Management (a), (b), (c)
Risk Management (a)
|Rockefeller CM||Yes||Strategy (a)|
|Standard Chartered||Yes||Strategy (b), (c);
Risk Management (a), (b), (c)
Metrics & Targets (a)
Of the five financial institutions, two have published stand-alone TCFD reports (EBRD and Standard Chartered Bank), while one other has released a climate report including TCFD case studies on physical risks (Rabobank). None has reported quantitative climate-related risks in their annual reports, which reflects the uncertainty of forward-looking climate scenario analysis and the level of work that still needs to be done to develop realistic, quantitative disclosures. Lessons learned from the assessment will feed into UNEP FI’s work on climate-related physical risk analysis, management and reporting.
How are 2021’s signatories progressing?
Five further institutions signed up to the Physical Risks and Resilience Commitment in January 2021, ABN Amaro, AXA XL, Danske Bank, ING and LinkREIT. Danske Bank and ING have published climate reports with information on progress towards TCFD-aligned disclosures, including case studies on physical risk assessments. Two institutions have included information on their progress towards TCFD-aligned disclosures (LinkREIT), one of which includes details of a physical risk case study (ABN Amro), while one institution has provided an overview of the work they are carrying out in anticipation of publishing a TCFD-aligned report in 2022 (AXA XL).
For completeness you can also find information on the sectors and climate hazards covered by the financial institutions’ reports, as well as some details on the data sources and analytics they use in this table.
Calling on peers and policy makers to take action
The problem is not that physical impacts are perceived as impacting less on financial institutions than transition risks. While this may have been the case when UNEP FI first looked at climate risk in 2018 in Navigating a New Climate, a recent paper from the European Central Bank noted that physical risks are now taken as seriously as transition risks. According to the ECB, “while over 50% of institutions deem both physical and transition risk drivers to have a material impact, institutions’ risk management practices for physical risk are less advanced than for transition risk.” The lower rate of disclosures is therefore likely to be associated with technical barriers. The TCFD underlined the difficulty in sourcing granular, asset-level data, which financial institutions have noted as making the analysis of physical risks and opportunities less common than that of transition risks and opportunities. Physical risks are often more complex with considerable variation at geographical and sectoral level, requiring capacity in processing geographical and specialist sectoral information. On launching the commitment in January 2021, the ten financial institutions not only called on peer financial institutions to scale up the assessment and disclosure of physical risks, but also put out a call to policy makers, regulators and central banks to:
- Specify the use of standards for climate-related reporting on physical risks, and more broadly on transition risks, not only in the finance sector but across the wider economy;
- Develop and specify standard scenarios sets to establish a foundation for scenario analysis;
- Build internal technical capacities, collaborate with data providers and access open-source data as appropriate, to ensure the availability of robust datasets for financial institutions;
- Develop a strategy and roadmap to mandatory climate risk disclosure in support of the UN Secretary-General’s call to make climate-related financial risk disclosures mandatory.
Over the past year, there has been progress in all four areas:
- On standards: At COP26, the International Sustainability Standards Board was launched by the IFRS Foundation, integrating the CDSB and the Value Reporting Foundation (GRI and SASB), which should lead to the development of a standardised global framework for reporting on sustainability.
- On scenarios: The NGFS launched its second set of standard scenarios in June 2021, while the release of the IPCC’s 6th Assessment Report in August provides a new set of SSP scenarios.
- On central bank capabilities and data: Over the course of 2021, the European Central Bank has enhanced its climate change capacities, including the recruitment of a dedicated climate scientist, top-down stress testing of physical risks, with a bottom-up test foreseen for 2022. More generally, membership of the NGFS has expanded to 105 members as of 15 December 2021, incorporating institutions from both OECD and non-OECD countries.
- On disclosure mandates: According to the 2021 TCFD Status Report, 8 jurisdictions have mandated climate-related financial disclosures aligned with the recommendations of the TCFD, including Brazil, the European Union, Japan, Hong Kong, New Zealand, Singapore, Switzerland and the United Kingdom.
However, there is still considerable work to be done. The ten signatories to this commitment continue to call on policy makers, regulators and central banks to ensure greater open-source access to physical risk data, as well as developing standards on firm-level exposure and vulnerability data. They also call for greater guidance on definitions of physical hazards, and physical risk metrics, to support the identification, assessment and disclosure of physical risks in the finance sector.