Climate risk: What are the next steps to consider?
Although the finance sector made significant progress in understanding climate risk, organisations need to keep their focus on this issue in order to successfully navigate it. We spoke to David Carlin, Head of Climate Risk and TCFD, United Nations Environment Programme Finance Initiative (UNEP FI), to understand the positive strides the industry has made and the next hurdles to overcome.
How have climate related risks evolved in the past 5 years?
How has climate risk evolved over the last several years is a great question because we've seen so much of a change both in perception, but also in reality. The perception really is now that climate risk is a mainstream risk. We see central banks taking it seriously. We see business executives and organisations taking it seriously, but we also see the manifestation of both climate and transition impacts roiling the economy, whether it's record temperatures this year or whether it's unprecedented damages or shifts in energy markets. We see that the volatility that climate and the transition brings is here with us, and here now.
Have we made any positive strides?
Have we made any positive strides in managing climate risk? It really gets down to the analytics that we're using – and I think those are so much better than they have been, in terms of using new data techniques, using AI and machine learning, and really bringing a greater level of transparency to the overall disclosure regime. I think that is highly positive.
On the other hand, this information needs to be used by stakeholders and it needs to be integrated into one's practices and operations for it to really make a difference in managing that risk.
Can you give us an overview of the upcoming regulations in this space?
With climate risk coming into the financial sector, there's a number of upcoming regulations that play a central role. Probably the most notable that was released in June of 2023 is the work of the International Sustainability Standards Board, or ISSB, with a broad sustainability disclosure regulation and a specific climate one.
This will form the basis of disclosure regimes in a number of different countries, and will be connected to be interoperable with others that are being developed, such as that of the Securities Exchange Commission in the U. S., as well as in Europe, the Corporate Sustainability Reporting Directive that is expected to come into effect shortly. So with a number of these, there's really a move from a voluntary regime to a mandatory around the disclosure side.
What progress has the industry made to overcome data challenges?
Data challenges are a major issue when trying to measure and manage climate related risks. On the transition side, emissions data has been often particularly challenging for small and medium sized enterprises. But fortunately, there's a large number of companies working both to collect that data, audit it, and provide a more accurate evaluation of it for input into baselining and assessment.
On the physical side, we're seeing newer models and newer tools that are beginning to take more nuanced perspectives on how these physical risks interact with the built environment and with societies. That work is still ongoing, but we can see even in the level of resolution a far greater resolution than we have previously on physical risk assessment.
What talent is missing and how can we approach them?
There's no question that the financial sector needs to develop further skills and develop greater positions around climate and the climate risk management process overall. What that means is bringing in individuals that not only take a financial perspective, but can bring in some of the environmental realities.
What we really need are systems thinkers, those that can cut across stress testing, risk modeling, but also environmental subjects such as climate and how those may fit together. We need individuals who are also at the business line working directly with institutions and clients in order to affect these changes, not just in models, but in the actual implementation with those clients.
What’s the next hurdle to overcome?
What the next hurdle to overcome for the financial sector really boils down to implementation. Not to the generation of reports, not to the conducting of stress tests. These things have been done and will continue to be done and continue to improve, but it really boils down to the operating model.
So going beyond that skin deep commitment into something that gets into the DNA of the organisation. How do we act in a sustainable way in terms of the products we offer, in terms of the way we work with clients? And that is really where I expect to see the most focus and the most need in the coming years, which is changing our operating models.
What’s the one thing risk managers should do in order to make a positive impact?
Risk management and risk managers can play a really important role in having a positive impact on climate by being able to communicate the findings that they have and ensure that those findings are implemented in risk models within the firm, in the approaches to limits and targets around different areas of the portfolio. And in continuing to be the eyes and ears for the senior level parts of the team, [risk managers can] show where risks may be emerging and how in this rapidly moving space these changes are manifesting.
