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Steps forward for regulatory frameworks on climate disclosure and systemic risk management

The wheels grind slow, but the need is urgent

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The FSB meet in Basel. Image via Flickr:financialstabilityboard
The FSB meet in Basel. Image via Flickr:financialstabilityboard

The stakes were high during the World Bank and International Monetary Fund’s Annual Meetings. Discussion of how to address the “polycrisis” took place alongside calls by stakeholders at all levels to reform the international financial institutions. Reformers powerfully advocated for shifts in policy priorities, changes to balance sheets and, in some cases, changes in institutional leadership.

Bureaucratic tradition was nonetheless honoured, and the annual meetings featured the usual document ‘air drops’ by financial standard-setters. Despite lack of progress around financial reform by the G20 in 2022, most of the new publications were responses to past G20 requests and some broke substantial new ground. In particular, new outputs from the Financial Stability Board (FSB) demonstrated the G20 economies’ ‘pivot to regulation’ for climate-related financial sector standards. This structural shift in international financial architecture is gaining momentum and institutional backing, and not a moment too soon.

Speed is always relative when dealing with financial regulation. Seven years ago the Taskforce for Climate-related Financial Disclosures was created to improve and increase the reporting of climate related financial information. The FSB’s 2022 reports show how industry-led recommendations have developed into substantial regulatory momentum to finance the real economy’s transition to net zero while ensuring financial stability.

Key messages from FSB’s reports include:

  • It’s not just the banks. The legacy of the 2008 financial crisis is long-lasting. Banks were identified then as ‘systemically important actors’ and have long been the centre of reform efforts. The FSB has now signalled that authorities should scrutinise all types of firms, including asset managers and pension funds. Recent economic events in the UK drive this point home.
  • More stress-testing please.  The FSB likes stress tests – assessment of climate impacts on balance sheets – and wants to see more of them, with increased use of scenario analysis. It also signposts new future approaches to capital requirements, potentially through a climate-related ‘capital buffer’, which can address both transition and physical risks. A preferred approach is unlikely to emerge any earlier than 2024, but even so this is an important piece of signalling.
  • Disclose, disclose, disclose – including your transition plan. Progress by of the International Sustainability Standards Board to create a baseline for an international disclosure standard is mapped, with most major economies already moving towards adopting ISSB. Transition plans are noted as a promising new tool, with the UK highlighted for having announced a regulatory requirement for firms to publish plans. The EU and other jurisdictions are rapidly developing their own approaches and ISSB will likely provide detailed guidance in future.
  • Go macro or go home.  The clearest message from the FSB’s guidance is that climate risk requires macroprudential (and sometimes macroeconomic) supervision. Microprudential tools cannot mitigate climate risks’ systemic dimensions. Authorities are encouraged to move towards “regulatory and supervisory policy actions in the near to medium term on the appropriate enhancements to their regulatory frameworks.” 
  • International convergence is key. The FSB outlines its position on two live issues. Firstly, by framing the ISSB as a baseline standard, it points to the option of adding impact reporting requirements, e.g. via the EU’s “double materiality” approach which captures a company’s impact on the environment and society. The onus is on the EU to make this work as it sets European standards. Secondly, the FSB makes it clear that Scope 3 emissions are likely to be material for firms with low Scope 1 and 2 emissions (e.g., financial firms). This plays into the politics of the US SEC’s proposed Climate Disclosure Rule, where some US companies are resisting calls to disclose these emissions and potentially influencing international forums such as GFANZ.

The financial system is at an inflection point for financial regulation around climate change. The journey here has been excruciatingly slow for many, just about right for others, and way too fast for some. However, climate change does not respect bureaucratic timelines and there is no time to waste in closing the deal on climate disclosure and prudential standards. Robust rules will facilitate the transition to net zero and limit systemic financial risks. They will also enable the pricing of externalities and reduce the potential for costs to fall on the state and taxpayers. We have no time to lose.

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