How can global financial supervisors integrate environmental risks into their regulatory activity?

Environmental, social and governance factors (ESG) are moving up the priority list for regulators and financial institutions alike. Climate change has been brought firmly into focus as a new generation of ethical investors emerge – making decisions rooted in conscious finance rather than profit alone.

It is with that background in mind that the Central Banks and Supervisors Network for Greening the Financial System (NGFS) was born. The NGFS, established in December 2017, is a body with a membership of more than 66 central banks and supervisors across the globe. Its purpose is to bolster the response required to meet the goals of the Paris agreement, as well as to explore how financial systems can manage risk and mobilize capital for green and low-carbon investments.

On 27 May 2020, the NGFS published a guide for supervisors on integrating climate-related and environmental risks into prudential supervision. The 64-page report explores how climate-change risks and financial risks are intertwined – from physical risks to property, affecting insurance and mortgages – to the transitional risks presented by the switch to a low-carbon economy, including stranded assets and reduced financial valuations.

Five recommendations

The report formulates five recommendations for NGFS members and the broader community of banking and insurance supervisors. The recommendations are not prescriptive and instead aim to offer guidance and inspiration to supervisors on how they can better integrate climate related and environmental risks into their work. The NGFS recommends that supervisors:

1. Determine risks: Determine how climate-related and environmental risks transmit to the economies and financial sectors in their jurisdictions and identify how these risks are likely to be material for supervised entities.
2. Develop strategies: Develop a clear strategy, establish and internal organization and allocate adequate resources to address climate-related and environmental risks.
3. Identify weak spots and potential losses: Identify the exposures of supervised entities that are vulnerable to climate-related and environmental risks and assess the potential losses should these risks materialize.
4. Set expectations: Set supervisory expectations to create transparency for financial institutions in relation to the supervisors’ understanding of a prudent approach to climate-related and environmental risks.
5. Manage and mitigate: Ensure adequate management of climate-related and environmental risks by financial institutions and take mitigating action where appropriate.

Climate change and COVID-19

The NGFS point out that much of this report was written prior to COVID-19 outbreak. While the effects of the pandemic have undoubtedly been devastating, the NGFS urges the industry not to lose sight of “the importance of doing all we can to fight climate change”. As such, it suggests that the financial industry’s response to the pandemic should be to leverage the momentum “to build a new economy that is more sustainable and greener”.

The NGFS is not the first body to call for a greener movement; global regulators have been embracing green finance and taking steps towards conscious, climate-related decisions. The coming year will undoubtedly present a wealth of change for financial services – effective change management systems will be essential.