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Climate risk and the financial system

Julia Walker
Julia Walker
Head of Government & Industry Affairs, Refinitiv

A Refinitiv/OMFIF report, The role of data in sustainable investment, policy and regulation, analyzes how ESG and alternative data can be used to integrate climate risk into the financial system and help key decision-makers adopt new ways of thinking about sustainability.

  1. The move towards sustainability is accelerating even as the global economy grapples with the consequences of COVID-19. Socioeconomic resilience in the face of risks such as the pandemic and climate change is moving to the forefront of agendas across the financial sector.
  2. Key decision-makers need to be able to answer important questions regarding materiality, data transparency, risk and return, and technical capacity building. This will mean that old ways of thinking will need to change.
  3. For climate risk to be properly integrated into the financial system, ESG and alternative data must be coherent, comprehensive and comparable.

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The threat posed by climate risk is substantial. Considerations are increasingly influencing the decision-making of lenders, investors, firms and regulators.

Markets mirror the real economy, which is impacted by major events, and there is a need to internalize and quantify external risks and their impact on investments and assets. This is a major challenge.

Traditionally, central banks have focused on aggregate information, and that was enough for all the different policy purposes of central banking. However, now there is enormous demand for more granularity, and detailed information on instruments and institutions.

Reorientating financial markets towards sustainable development requires many levers.

Regulators, supervisors, standard setters, and investors will need to answer key questions around materiality, data transparency, risk and return and technical capacity building. Old ways of thinking will need to change.

The role of data in sustainable investment, policy and regulation. Climate risk and the financial system

Read the report: The role of data in sustainable investment, policy and regulation

Stress tests for climate risk

The Bank of England, Banque de France and De Nederlandsche Bank are either conducting — or are in the process of implementing — climate-aligned stress tests for banks and insurers.

The intent of such stress tests is primarily focused on reducing systemic vulnerabilities to the physical, transition and liability risks that will emerge due to climate change.

Leon Saunders Calvert quote. Climate risk and the financial system

Bring on the taxonomies

Taxonomies of economic activity aligned to a sustainable future are seen as a growing tool for supervisors. Many see the EU Taxonomy as best practice, serving as an important ‘first mover’ framework. Asia Pacific-based regulators are also starting to move at pace, establishing their own taxonomies and mandating climate risk disclosures.

The EU Taxonomy Framework sets out economic activity that can make a substantial contribution to climate change mitigation or adaptation, while avoiding significant harm to the four other environmental objectives: sustainable use and protection of water and marine resources; transition to a circular economy; pollution prevention control; and protection and restoration of biodiversity and ecosystems.

Disclosures and transparency

The historical lack of mandatory disclosure of corporates and financial institutions’ non-financial information inhibits the ability to integrate environmental and social risks and opportunities into lending decisions and capital allocation.

Robust regulation to improve consistency and coverage in disclosures is needed, but it will not provide a solution for all data gaps. Forward-looking data and scenario planning is required alongside retrospective disclosures because the magnitude of systemic risk remains uncertain. A repository of comparable financial and non-financial ESG information — raw, but standardized — is seen as an important step.

Technologies such as cloud computing, drone and satellite imagery, and machine learning are increasing capabilities in data collection and analytics. Combining geospatial data with other existing datasets could enable more intuitive and easily accessible use of these data by financial professionals.

Going beyond climate change

The integration of other environmental metrics such as biodiversity, chemical pollution, ocean sustainability, and water will require more varied, frequent and extensive data collection and technical expertise.

Data and metrics on biodiversity loss and natural capital is set to become the new focus of regulators and investors, and will be critical to support the ambitions of the Task Force on Nature-related Financial Disclosures (TNFD).Sherry Madera, Chief Industry and Government Affairs Officer, Refinitiv quote: "It is evident that there is a need to arrive at a place where ESG and alternative data is coherent, comprehensive and comparable."


Sustainability data in a post-pandemic world

As the line between fiscal and monetary policy becomes increasingly blurred, there will be greater demand for regulatory action on sustainability issues, and clear ways to deliver public investment that is socially beneficial over the long-term to build back better.

As regulators plan for economic recovery via stimulus initiatives, high-quality data on non-financial risks and impact will be needed more than ever to develop, monitor and evaluate any ‘green strings’ that will be attached to the substantial post-COVID-19 surge in government spending.

Watch — Refinitiv Perspectives LIVE: From ESG to the SDGs: How can we achieve sustainable development?

Read the report: The role of data in sustainable investment, policy and regulation

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