Regulatory and Policy Initiatives to Address Sustainability-related Risks and Opportunities
IMF News, November 27, 2023
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- Published: November 27, 2023
Context and central finding
- Achieving net-zero carbon emissions by 2050 requires a deep economic transformation, substantially impacting financial systems.
- Financial sector regulators and supervisors have important roles in enhancing the resilience of the financial sector to climate-related shocks and in building a foundation of transparent and fair markets for investment in transition finance.
- Date: November 27, 2023.
Prudential framework and supervisory action
- Financial supervisors should incorporate climate-related financial risks into the prudential framework to ensure financial institutions can weather climate-related shocks and continue to provide financing for the transition to a low-carbon and sustainable economy.
- Experience shows that even simple supervisory actions can trigger a meaningful response from financial institutions and better climate-risk management.
- All climate-related initiatives of supervisory authorities should be consistent with their core mandate, primarily ensuring financial stability, and must be consistent with legal mandates.
- Prudential supervisors should focus on promoting a safe and sound financial system; securities regulators on creating fair and transparent markets with adequate investor protection safeguards.
- Financial regulation and supervision should not be used as substitutes for effective government policy on climate change.
Basel Committee guidance
- The Basel Committee on Banking Supervision Principles for the Effective Management and Supervision of Climate-related Risks:
- Provides specific guidance for supervisors and banks.
- Sets out 18 principles covering corporate governance, internal controls, risk assessment, risk management, and reporting.
- Extends and further specifies the Basel Core Principles for Effective Banking Supervision, while building on previous analytical reports and the work of the Network for Greening the Financial System.
- Offers a common set of high-level principles and guidance while retaining flexibility given heterogeneous and evolving practices.
- Member supervisory authorities should implement these principles through adapted supervisory guidance and monitoring, considering jurisdiction-specific risk profiles and the principle of proportionality.
- Additional supervisory guidance on transition planning is being considered, including forward-looking risk identification, client engagement, and climate scenario analysis.
Insurance sector guidance (IAIS and SIF)
- The International Association of Insurance Supervisors (IAIS) and the Sustainable Insurance Forum (SIF) published the Application Paper on the Supervision of Climate-related Risks in the Insurance Sector in 2021.
- Builds on a limited number of Insurance Core Principles covering supervisory review and reporting, corporate governance, risk management, investments and disclosure.
- Provides background and guidance on how the Insurance Core Principles can be used to manage challenges and opportunities from climate-related risks.
- Ongoing IAIS work includes three packages of additional material for supervisors:
- Consultation earlier this year on amendments to the Insurance Core Principles to incorporate climate-risk considerations directly in the Principles covering corporate governance and risk management.
- Recent consultations on climate scenario analysis and market conduct issues related to climate risk, notably covering the risk of greenwashing.
- SIF is working on guidance for transition plans and surveying the extent that Pillar 2 requirements are incorporating climate-related risks in practice.
Data, disclosures, and market transparency
- The quality and availability of climate-related data and information remains a challenge; evaluating physical and transition risks requires information that is currently largely missing.
- Financial Sector Assessment Program and technical assistance experience show that lack of relevant climate data is common across jurisdictions.
- International Sustainability Standards Board issued international standards on climate-related disclosures this year, building a global framework for reliable and comparable data around sustainability-related risks and opportunities.
- Supervisory reporting should be tailored to each jurisdiction depending on the risk profile and supervisory needs; data must be granular enough and adequately forward-looking.
- Interactive and focused dialogue between supervisors and industry should be enhanced to plug data gaps.
Scenario analysis and forward-looking supervision
- Scenario analysis is a critical aspect of the supervision process because historical trends and parameters are unlikely to hold under most climate-risk scenarios.
- Financial institutions should address climate-related risks in a forward-looking manner and supervisors should challenge the assumptions firms use in managing risks and setting strategies and business models.
- The NGFS has designed scenarios for assessing the impact of climate change on the financial sector and has updated them several times; these scenarios can be a useful reference for supervisory authorities to set up a forward-looking assessment toolkit consistent with a risk-based supervisory approach.
- The IAIS application paper under consultation builds on NGFS work in an insurance context.
Transition planning
- Transition planning includes:
- (i) the internal strategic planning and risk management processes undertaken by a firm to prepare for both risks and potential changes in business models associated with the transition to a lower carbon economy, and
- (ii) the “transition plan” as the firm’s tangible output of the transition planning process.
- Transition planning is becoming increasingly important in risk management and can be a useful source of information to supervisors.
Securities markets and transition finance
- Securities market regulators can create a foundation of transparent and fair markets for transition finance.
- Disclosure standards should be strengthened to ensure availability of relevant, accurate, and comparable information on climate risks and opportunities for investors.
- The regulatory framework for intermediaries and markets relating to climate products should be strengthened, along with improved supervision and enforcement with respect to greenwashing.
- Fair, efficient, and transparent transition finance markets with adequate investor protection safeguards will help boost funding for the climate transition.
Capacity building and IMF support
- Regulators and supervisors need to allocate adequate resources and set dedicated action plans to build effective supervisory capacity in the medium term, incorporating evolving international standards, methodologies, and practices.
- Supervisory authorities need to connect interdisciplinary knowledge and ensure action plans are inclusive across organizational functions, starting from the top.
- The IMF provides guidance through capacity development work, delivered in part by regional centers, on how to conduct climate-risk analysis and adjust frameworks in line with the Basel Committee’s Principles for the Effective Management and Supervision of Climate-related Financial Risks.
- Over time, IMF technical assistance will incorporate other international standards as they evolve.
Source: Regulatory and Policy Initiatives to Address Sustainability-related Risks and Opportunities (IMF), November 27, 2023.