The ECB and regulators are shifting priorities towards climate & environmental (C&E) risks and broader, sustainable finance. That’s important, as banks are already struggling to meet other regulatory obligations and to report on ECB supervisory expectations on the management of C&E risk.
What’s happening in C&E risk?
As new regulatory requirements and reports come to the forefront, banks are pushed into making concrete, organization-wide changes.
For example, we’ve recently hit the deadline for the thematic review on C&E risk integration, in which all participating banks had to update and share their current progress and road ahead. Other initiatives are the 2022 ECB climate risk stress test and the ECB’s supervisory assessment of institutions’ climate-related and environmental risk disclosures. Moving into 2023 the ECB intends to further push that agenda, with ongoing integration of climate risk management expectations into supervisory processes – with the goal of ultimately influencing banks’ capital requirements.
We’re looking forward to seeing how those changes roll out across banks, and how banks approach that ongoing move towards a more immersive approach to climate risk management. The ECB will publish their report on the thematic review in October, giving insight into how existing strategies have been working so far.
Challenges to embedding C&E risk into the risk management framework
While many financial institutions are aware steps have to be taken, most face challenges that make getting started in a meaningful fashion difficult. Integrating C&E risk is not just a tick-the-box exercise, it must be an integral part of the risk framework – from the risk charter to self-assessments and internal risk reporting.
At the same time, much of the useable data banks apply is discovered through practical application. Banks can’t work in siloes and expect to succeed. C&E risk is global, and banks must be aligned and communicating about practices, processes, and standards on a global level.
Lack of data and tools – Numerous organizations, like the IPCC and NGFS, exist to create knowledge, to steer regulation, and to deliver data. They provide a sea of knowledge which banks must navigate through. Unfortunately, doing so is often extremely complex, simply because the practical applications for that data don’t exist yet, available data is often not as accurate as financial predictions are accustomed to, and even a climate risk model with minimum wriggle room is still received with much skepticism. Therefore, to a large extent, programs must start blind, with only guidelines and milestones by which to steer.
Weighting C&E risk factors – Once you do get the data “good enough”, you get stress test and scenario analysis implications. On top of that you will get bottom-up information from your self-assessments. What now? Initiating controls and mitigating measures and then following up on them is complex and often involves weighting C&E risk factors against other risk factors. For larger organizations, this can be incredibly complex and the more varied the portfolio, the more complex the exercise becomes.
Structuring of resources – Combining ESG with risk management is a new field. For many financial institutions, this means steering blind, without experienced people to guide programs. Resourcing and hiring new people may seem impossible, which means financial institutions must set up a strategy to fill those gaps, either with internal/external training or consultants. The first may mean bringing ESG people into risk management, or vice versa, and setting up training programs. The second option often leads to deployment of external ESG experts in existing financial practices (e.g., Risk Management, or Finance). In both cases, we foresee centralized yet widespread teams taking advantage of their varying perspectives and the centralization of ESG knowledge. These widespread teams will prove an intermediate step towards true integration of ESG in the business model.
That’s especially pressing with the new focus on integrating C&E risk into the business as a whole – which can make building siloed teams challenging. Yet, wide-spread teams may be the only real way to build the knowledge density required for the organization to develop the skills and knowledge it needs to achieve its ESG targets. Therefore, dedicated ESG teams covering existing financial practices including risk management may be a good intermediary step – especially as many financial institutions don’t have alternatives.
Eventually, executive board members have to decide if the business will proactively adapt to ESG or other sustainability requirements or if it will wait and see. Do you lead the sustainability charge with the promise of compliance, new customers, and a safer environment – or do you follow trailblazers and allow them to take on the risks?
At ACE we’re experienced in these discussions – if you’d like to know more, contact us to schedule a cup of coffee or a chat, we’re happy to help.
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