Sustainable Finance has been catapulted to the top of the list of priorities for regulators. Following ESMA’s technical advice to the European Commission on Sustainable Finance, more regulatory authorities turn their intention to the question how to use finance to promote environmental, social and governance objectives. Examplary are the activities of the German financial watchdog. What does this mean for senior management and regulatory change management? That you ought to start preparing for things to come than this ambition highlights than the authorities are serious about the matter and you better be ready.
Everybody Talks Sustainable Finance
Isn’t it funny? Sometimes a topic receives very little coverage for ages and then, seemingly all of a sudden, everyone talks about it: The Banque de France recently hosted a conference for the Network for Greening the Financial System(NGFS), during which the BdF’s Governor Francois Villeroy de Galhau issued a call for action to tackle climate risk. The conference also produced a comprehensive reporton the matter that included six recommendations:
- Recommendation n°1 – Integrating climate-related risks into financial stability monitoring and micro-supervision
- Recommendation n°2 – Integrating sustainability factors into own-portfolio management
- Recommendation n°3 – Bridging the data gaps
- Recommendation n°4 – Building awareness and intellectual capacity and encouraging technical assistance and knowledge sharing
- Recommendation n°5 – Achieving robust and internationally consistent climate and environment-related disclosure
- Recommendation n°6 – Supporting the development of a taxonomy of economic activities
-The Six Recommendation issued by the NGFS
The Banca d’Italia issued a report on “Natural catastrophes and bank lending”, which concluded that lending to nonfinancial firms is negatively correlated with their flood risk exposure, stressing the importance of climate related factors in every-day life for financial services.The head of the FCA, Andrew Bailey, emphasised in a recent speech the desirability of sustainable economic growth in the UK, while the Governor of the Bank of England, while the PRA published a report on the impact of climate change on the UK banking sector, and Mark Carney pointed out at the European Commission Conference on sustainable financethat “Banks have begun considering the most immediate physical risks to their business models – from the exposure of mortgage books to flood risk, to the impact of extreme weather events on sovereign risk”.
“Banks have begun considering the most immediate physical risks to their business models – from the exposure of mortgage books to flood risk, to the impact of extreme weather events on sovereign risk”
Mark Carney, Governor of the Bank of England
It is a report by the German regulator BaFin though that shows both the commitment of the authorities most impressively as well as the way forward for the regulatory framework and the indications on how to prepare for it. The key topic in its monthly newsletter is also the subject of a special report(in German) that discusses on 86 pages sustainable finance on a global, European and national level, its importance for the supervisory practice, as well as why it is both a challenge and an opportunity for the financial industry and the insurance sector.
The first chapter describes the intentions of the European Parliament with insights from a German MEP. It analyses the initiatives on a global level and explains in detail the views of the German regulator itself. The global initiatives range from the Paris Agreement to the Coalition of Finance Ministers for Climate Action to the G20 Action Plan we already discussed and where we also reviewed the European ambitions. Transparency with regard to climate, social and governance objectives will be the key element in the regulatory actions, the BaFin explains, and should thus also be at the centre of considerations of financial institutions preparing for the future framework. Establishing common standards for EU wide green bonds on the other hand are only a first, practical step. Interestingly, BaFin points out its opposition of the idea though to reduce capital reserve limits because of green supporting factors because sustainable investments should not be rewarded with a reduction of financial stability – a relief in terms of strict rules with regard to capital resources is therefore not in sight.
But what does this mean for national regulatory authorities like the BaFin? The Germans stress in the report that physical and transitory risks will affect the market more than we can imagine today and will eventually give rise to risks to financial stability. Regulators thus need to tackle challenges on all levels of market risk, credit risk and operational risk. The BaFin refers to the three pillars model of the Basel regulations focusing on capital requirements, its basic principles for qualitative banking supervision and risk management in banking as well as the obligations in terms of transparency as model to manage this change from a regulatory perspective.
Important points that were also at the centre of the presentations and discussions of BaFin’s conference on sustainable finance that took place on 9 May (details and conference videos in German) and the underline that the German regulator means business.
It is about time, you might say, that authorities wake up and embrace the importance finance plays in the fight for a sustainable economy. And it remains to be seen what the actual outcome will be for the future regulatory framework in the EU and elsewhere. In fact, as the recent the discussions about the details of the Commission’s Action Plan for Sustainable Finance show, the risk that some member states could push back on the new rules and wash it down, cannot be ignored. How quickly the tide can turn because of changes at the top can most visibly be seen in the course the USA has taken on climate change.
Nonetheless, financial leaders would be ill-advised to postpone preparations for the envisaged changes. If anything, they will need to consider the following: assets under management in Europe alone have reached €25.2 trillion in 2017, which represents 147% of GDP. Blackrock, the world’s largest fund manager, has forecast that the total share of sustainable investments in Exchange Traded Funds globally will increase from today’s 3% of total assets, to 21% of all assets by 2028.
Hence, sustainable investment is growing fast and even if governments might not be able to change the course of history, the pockets of investors could.