How financial services can heed regulators’ call for sustainable financeBy Aloysius Fua
Increased regulatory interest in sustainability will require financial institutions to address its ESG strategy, risk management, regulatory compliance, and data challenges.
In September 2021, the Monetary Authority of Singapore (MAS) announced the formation of a new Sustainability Group. The Group will coordinate the authority’s green finance and sustainability agenda, aimed at strengthening the financial sector's resilience against environmental risks and developing a vibrant green finance ecosystem to support Asia's transition to a low-carbon future. It will also identify strategic green finance collaborations with regional and international counterparts and reduce MAS' own carbon and environmental footprint.
This news is certainly welcomed. Regulatory interest in sustainability or environment, social and governance (ESG) factors is not new – the US Securities and Exchange Commission and Hong Kong’s Securities and Futures Commission have also set up similar task force or groups to look into ESG-related initiatives.
Managing impact of ESG risks on financial stability
Central banks and financial regulators now widely acknowledge that climate change and ESG factors can threaten financial stability via physical and transition risks — with financial institutions already reporting significant losses as a result of such risks. Pricing of climate-related risk is still a nascent field and, with its unique and longer-term characteristics, remains a challenge across the board for corporates, financial institutions and financial markets.
Financial authorities recognize that, in general, assets continue to be mispriced and that there is a need for new data, methodologies and disclosures to better understand, size up and manage these risks.
Prudential authorities, for their part, are increasingly focused on the necessity for financial institutions to expedite changes in governance, risk management and disclosure to ensure climate-related risks are properly accounted for and built into decision-making processes, including capital assessment and allocation.
With MAS’ latest announcement of the Sustainability Group, coupled with the MAS Green Finance Action Plan announced in October 2020, the direction that Singapore’s regulators are taking is clear. The pace of supervisory and regulatory development is expected to hasten with the 26th United Nations Climate Change Conference or better known as COP 26.
Similar moves can be expected from regulators in other jurisdictions as well. Countries and regions will move toward greater accountability and transparency, and more will be making commitments to achieve net zero by 2050. As well, there will be increased legislations mandating sustainable finance for banking, capital markets and non-bank financial institutions.
Three key actions for financial institutions
Financial institutions are sitting up to climate risks too. Many of their stakeholders expect them to support their transition to a zero-carbon economy. The latest EY and Institute of International Finance (IIF) bank risk management survey revealed that climate change has topped the list of long- and short-term risks for Asia-Pacific banks for the first time since 2010.
In navigating the evolving sustainability risk landscape and regulatory requirements, financial institutions should look into three areas with urgency.
First, adhering to regulatory guidelines is key. Globally, it is only a matter of time before sustainability risk management becomes a regulatory imperative, if not already. Financial institutions should not wait for further formal and detailed supervisory guidance, let alone changes in prudential requirements.
There are wide variations in how advanced financial institutions are in this regard. The institutions leading the way will set the baseline for peer comparison from supervisory and market perspectives. A defining feature of these financial institutions is the board-level commitment to understand and drive climate-related risk and sustainability considerations through strategy and into the fabric of how the institution governs the business.
Second, financial institutions need to address the challenge in sustainability-related data, which will be critical to comply with regulatory expectations and requirements. Having a coherent and robust data strategy is particularly important, given the unique nature of the data required. There will likely be significant gaps in fulfilling regulatory reporting and disclosure requirements. Organizations may have to rely on estimates, best guesses and third-party data providers, and these could pose various reliability issues from an internal risk management and regulatory perspective.
Third, financial institutions must consider broader sustainability factors beyond climate risk. While much attention has been placed on environmental concerns (climate in particular), there is a growing emphasis on social factors amid renewed considerations around governance, which in part, is due to reflections driven by the COVID-19 pandemic. In fact, new or planned regulatory requirements are placing a greater focus on these aspects. These include global initiatives such as the World Economic Forum working with major accounting bodies to develop frameworks, standards and metrics with respect to sustainability that considers ESG aspects and long-term value creation, in order to foster transparency and comparability in disclosures.
With sustainability rising on the agenda of regulators and stakeholders, the ability to demonstrate compliance is clearly vital. Yet, reporting to stakeholders must be only one of the end objectives. The starting point is arguably more important. How do you align your organization strategy with an ESG-centered purpose and execute on the commitments, while capitalizing on the opportunity to offer sustainable finance and help other organizations make the transition to net zero?