Ripples in the Global Pond - Broader Disclosure About Climate Risk in the Financial Services Sector Portfolios and the Impact on Society

A small pebble dropped into a pond will send out ripples that carry across the stretch of water, bouncing off the opposite shore and sending waves back.  “Ripple effect” is something we hear often as a business metaphor.  We are focused today on the powerful ripple effect of carbon emissions through the economy, through a company’s global supply chain, and on through the regulatory universe as more governments take up pricing schemes on emissions, and so on.

Applying this line of thinking to a question – what is the ripple effect of the global finance sector’s actions in directing (or not directing) capital toward industrial sources of today’s carbon emissions?  The CDP organization apparently was wondering about that and provided some answers for us: in a first-time analysis of “financed emissions” by institutions (including asset owners and asset management firms, banks and insurers), the portfolio emissions (those powerful ripple effects) are determined to be on average more than 700 times the direct emissions for each of the sector organizations that today do report on financed emissions.

Considering this again: while some financial services sector institutions are reporting on some of their direct carbon emissions, the broader impact of their portfolio activities (such as lending, investing, insuring etc.) could be as much as 700 times on average of the institution’s direct emissions (per organization reporting financed emissions). Pebbles in a global pond, indeed!

These perspectives come to us through the CDP report, The Time to Green Finance, released last week showing that almost all climate-related impacts and risks of global finance institutions comes from their financing of the wider economy.

And consider this: only 25 percent of the 332 financial sector institutions disclosing to CDP in 2020 in response to CDP’s first climate change questionnaire reported on their institution’s portfolio emissions.

How much bigger is the challenge to address climate change issues if the 75% (the non-responders) were to begin reporting on their respective portfolio emissions?  Many far-reaching ripples for sure!

Top line findings from the report:

• AXA Group, BNP Paribas, BNY Mellon, and other of the 84 organizations that did disclose portfolio impact hold US$27 trillion of assets; more than half of these asset managers responding to CDP did not include half or more of portfolio holdings in their respective financed emissions reporting and disclosures.
• Less than half of banks, asset owners and asset managers report taking action to align investments with a below 2-degree Celsius goal (consider the Paris Agreement for context); just 28% of insurers do so in their underwriting portfolios.
• Examples of what can done in 2021: institutions could be setting science-based emissions targets for emissions reduction; they could engage with portfolio company managements to reduce emissions; and better direct their investments in renewable energy.

The “vast majority” of financial sector institutions, says CDP, are not yet reporting on credit risks (65% do not); or borrow default on loan payments and market risks such as stranded assets and asset devaluation (74%).  The focus usually is on direct operational climate-related risks (physical damage, etc.).  The big risk, we can say here, certainly appears to be that ripple effect as governments around the world take steps to comply with the Paris Agreement goals over the next decade.  Where is that aspect of risk measured, managed and reported by financial institutions? 

One answer comes from the survey – some institutions appear to be focused on low-carbon transition opportunities such as in sustainability-linked loans, green and transition bonds, sustainable investment funds and insurance solutions (this valued at $2.9 trillion by CDP).

Conclusion from CDP:  Financial institutions must engage with companies in portfolio and insist to boards and management they must be prepared for the net zero transition that is underway; that begins with measuring and disclosing environment impact…today less than half of asset owners and asset managers are reporting such engagements.  CDP offers its Non-Disclosure Campaign and Science-Based Targets Campaign as possible steps forward for investors to begin the process of “active ownership”.

We are keeping in mind the focus of the Task Force on Climate-related Financial Disclosure (TCFD) recommendations (created to improve and increase reporting on climate-related financial information). Four industries within the Financial Services Sector were at the start in focus (banking, asset ownership, asset management, insurance). The Financial Stability Board (FSB) created the TCFD “to develop recommendations for more effective climate-related disclosures that could promote more informed investment, credit and insurance underwriting decisions’…to enable better understanding of the concentrations of carbon-related assets in the financial sector and system exposure to climate-related risks…”

As more financial services sector organizations encourage publicly-traded companies to look at TCFD recommendations for expanding ESG disclosure – we could ask those institutions about their own broad portfolio climate-related risks and the disclosures related to same…as outlined in this important CDP research effort. 

We like this perspective shared on the web by the coversation.com:  ripples… “the water rushes back too enthusiastically, causing a splash…and the bigger the rock, the bigger the splash.  And the splash recreates even more ripples that tend to move away from where the rock went into the water.”  

Think about the impact on the global society, on the transitions to a net zero economy that would come with more financial sector players measuring, managing and disclosing the climate risks in their own portfolios…ripples through the financial services sector and the corporate sector and well beyond would be very powerful indeed.  There are important perspectives on the topic here in this issue of the newsletter.

This is just the introduction of G&A's Sustainability Highlights newsletter this week. Click here to view the full issue.