Increased transparency for a more climate-friendly financial sector

Disclosure standards increase transparency and reduce the costs incurred by investors as they search for sustainable investments, making easier the comparison of financial products. It was against this background that the Financial Stability Board launched, in 2017, a Task Force on Climate-Related Financial Disclosure (TCFD), with recommendations on how to improve investors’ ability to appropriately assess and price climate-related risk and opportunities.

While voluntary reporting frameworks have proliferated, there is a need to align global disclosure standards with TCFD recommendations, which can become the benchmark for mandatory climate-related financial risk disclosure, as pointed out by a recent G7 Communique.

Globally, disclosure has increased since 2017, but continuing progress is needed. Greenwashing—the process of conveying a false impression or providing misleading information about how a company's products are environmentally sound—remains a threat to transparency and comparability. The accounting profession could play a leading role in ensuring high-quality and consistent measurement of disclosure requirements.

Accordingly, the International Financial Reporting Standards (IFRS) foundation is strategizing the response to the growing and urgent audit demand of sustainability reports coming from stakeholders. The move has been welcomed by the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB).

Supervisory guidance could strengthen climate-related financial risk disclosure, and some emerging markets and developing economies (EMDEs) have already moved in the right direction. One example is the Philippines, with the Sustainable Financial Framework. Yet progress has mostly been achieved by advanced economies, such as the European Union and the United Kingdom, partially thanks to the agreement on a green taxonomy.

Banks should see disclosure not just as a burden generating compliance costs. Rather, they could seize opportunities to reshape their long-term strategy and integrate this framework in their risk management metrics, gaining further insight into their own risk profile.

How could supervisory guidance look like?

Principles. In line with the TCFD recommendations, EMDE supervisors could expect that banks disclose material information, whose omission or misstatement could lead to wrong decisions. Disclosure should be specific and complete, encompassing all banks’ exposures to potential climate-related impacts. It should also be clear, balanced, and understandable, serving the need of both sophisticated investors and less specialized customers.

Climate disclosure must be consistent over time and comparable among banks and jurisdictions, allowing to benchmark risk across portfolios. It should also be provided on a regular basis and in a verifiable way.

Governance. Banks could be expected to describe how the board provides oversight for climate-related risks and opportunities, including the arrangements adopted, the frequency and type of information received, the monitoring of the progresses against goals, and the extent to which remuneration policies take account of climate-related performance.

Strategy. Banks could be expected to describe the climate-related risks and opportunities identified over the short, medium, and long term. Disclosures could spell out how physical and transition risks affect a bank’s strategy for each time horizon, and how banks are adapting their business model and financial planning to the changing environment. Banks could also be expected to describe the resilience of their strategy to different climate-related scenarios, also referring to the NGFS climate scenarios.

Risk management. Banks could be expected to describe the processes for identifying and assessing climate-related risks. In order for all stakeholders to understand the process, banks could disclose the transmission channels as well as the climate-related impacts on traditional banking risks. Banks could also describe how the processes for identifying, assessing, monitoring, and reporting climate-related risks are integrated into their overall risk-management framework.

Metrics and targets. Banks could be expected to disclose the metrics used to assess and the target used to manage climate-related risks and opportunities in line with their strategy and risk-management processes, as well as the actual performance against those targets. Larger, complex, and most exposed banks could be expected to keep abreast of the evolving disclosure framework related to metrics, including forward-looking indicators.

Impact of banking business on climate change. In addition to the impacts that climate change might have on banks, credit institutions could be encouraged to disclose their most significant impacts on climate change based on the Principles for Responsible Banking. These could encourage banks to report on positive and negative impacts, and to prioritize their most significant impacts and explain how they are planning to manage these impacts. In addition, banks could also disclose their own greenhouse gas emissions, calculated in line with the ‘Greenhouse Gas Protocol’ methodology.

Pillar 3 of Basel Framework. To promote market discipline, EMDEs that have transitioned to Basel II/III banking regulation agreements could expect banks to include qualitative and quantitative information on physical and transition risks in their Pillar 3 reports, like the European Banking Authority has recently proposed. Banks could establish a formal board-approved disclosure policy for climate-related risk Pillar 3 information that sets out the internal controls and procedures for disclosure of such information.

A robust disclosure framework and sound banks’ practices could allow investors and stakeholders to compare the sustainability performance of banks. It could also help them identify vulnerabilities—including how physical and transition risks exacerbate traditional banking risks—as well as strengths—namely how banks are mitigating those risks and how they are supporting their customers in the adaptation process to climate change and in the transition toward a more sustainable economy.  

To conclude, supervisory guidance can contribute to increase availability and quality of climate-related financial disclosure in EMDEs. This could support both capital reallocation toward greener projects and effective climate risk management by banks. In line with the new Climate Change Action Plan for 2021-2025, the World Bank stands ready to assist the supervisory authorities in client countries. The recent World Bank Toolkits for Policymakers to Green the Financial System provides a practical overview of actions that can be taken to build a sustainable financial system.

Emma Dalhuijsen and Martijn Regelink contributed to this blog.

This concludes a three-part blog series on how financial supervisors can help green the financial system. Part 1 discussed corporate governance and Part 2 focused on risk management.