Blazing the trail towards a low-emission economy

‘Financial institutions must address the risks climate change poses to their safety and soundness’

While there may be uncertainties around the impacts of climate change, one thing remains clear: all sectors will need to manage the transition to a low-emission economy.

Physical risks of climate change – such as more frequent and severe floods, fires, drought and hurricanes – are already affecting the global economy. The financial system is no exception.

Financial institutions must address the risks that climate change poses to their safety and soundness. A critical step involves the creation of transition plans outlining how they will manage the shift to a low-emission economy and navigate physical risks.

Regulators must make sure that they are playing their part in providing guidance on and reviewing these plans. This is to ensure individual institutions remain resilient and that the impact on the broader financial system is managed. The Network for Greening the Financial System is working to guarantee it has the tools to do so.

Having published the ‘Stocktake on Financial Institutions’ Transition Plans and their Relevance to Micro-prudential Authorities’, the report by the NGFS is a starting point, looking at emerging practices relating to transition plans and how they relate to micro-prudential regulators.

The report found that financial institutions do not operate in isolation, nor are they just takers. The extent to which a financial institution can credibly develop and implement a plan depends on the plans of its counterparties. They can manage their own risk by supporting and driving their counterparties to do the same.

Micro-prudential regulators need transition plans to understand risks. Transition plans can be crucial, forward-looking documents that help micro-prudential regulators better assess risk management, appetite, tolerance and monitor progress. Lastly, shared frameworks and concepts are key priorities. Common reference points (such as governance, strategy, risk management and metrics) and interoperability with both the financial sector and real economy are critical to maximising impact and reducing burdens.

While these findings may not be surprising, the understanding of them gained through this initial report will provide a sound foundation on which to move forward.

To that end, the NGFS will soon engage international authorities and standard-setters. Understanding the work of standard-setters and tying in the NGFS and its activities will be critical in ensuring that conclusions gleaned from this report are reflected in action. Coherence and integration among all international actors in this area will be key to making sure consistent signals are sent to industry, helping reduce regulatory burden and improve risk management quickly and efficiently.

Tolga Yalkin is the Chair of the NGFS Workstream on Supervision and the Assistant Superintendent, Regulatory Response Sector at the Office of the Superintendent of Financial Institutions.

Read the summer 2023 edition of the Sustainable Policy Institute Journal here.

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