14 February 2022

UNEP FI: One year on from commitments on adaptation: lack of risk data and standards delaying progress

By accurately assessing exposure to climate change-induced impacts such as severe flooding, droughts and rising temperatures, financial institutions can transform their business strategies to protect their resilience and prosperity as well as that of global economies and the communities they serve. In January 2021, UNEP FI and the Global Commission on Adaptation (GCA) came together with ten financial institutions from across banking and investment to commit to disclosing their risks from the physical impacts of climate change. UNEP FI’s Paul Smith reviews the progress made by the group, explains the importance of this commitment, and the issues facing financial institutions trying to accurately disclose their physical risk.

Climate change is already wreaking a trail of destruction. The last seven years (2015-2021) have been the seven hottest years on record, according to the World Meteorological Organisation (WMO, 2022). Munich Re estimates that 2021 was the second costliest in terms of losses from natural disasters after 2015, including $65bn of losses from Hurricane Ida and $54bn from flash floods in Europe – Germany’s costliest natural disaster on record. According to Munich Re, “many of the weather catastrophes fit in with the expected consequences of climate change, making greater loss preparedness and climate protection a matter of urgency.” Arguably, the most important outcome from the UNFCCC’s 27^th Conference of the Parties (COP27) in Egypt at the end of the year will be the conclusions of the Glasgow-Sharm el Sheikh work programme. These will establish parameters of a Global Goal on Adaptation – a goal originally included in the Paris Agreement in 2015 and essential to now driving action in this area.

Why financial institutions are committing to taking action on adaptation to climate change

In 2017, the publication of the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) generated considerable interest in the potential risks of climate change for corporate institutions. Nearly 3,000 corporates are now supporters of the TCFD, including almost 1,300 financial institutions. However, evidence from the TCFD 2021 Status Report shows that physical metrics, such as ‘weather-related losses for real assets’, are far less represented than emissions-related metrics and that the quantitative disclosure of potential impacts is “less common, and most often found for forward-looking transition risks than forward-looking physical risks”. Furthermore, “discussion of physical impacts was typically in the form of qualitative descriptions rather than quantitative information.” (TCFD 2021, p.63)

This is why UNEP FI and the Global Commission on Adaptation (GCA) came together with five financial institutions from across banking and investment to commit to disclosing their risks from the physical impacts of climate change, with the support of the TCFD secretariat. The commitment was launched in September 2019 at the UN Secretary General’s Climate Action Summit and UNEP FI and the GCA gave these institutions two years to fulfil that commitment to demonstrate leadership and test methodologies. Only a month later, in October 2019, Mark Carney, the UK’s special representative for climate finance, stated that corporates would have five years to road-test risk disclosure mechanisms before global regulators would start to introduce disclosure mandates.

Then, just over a year later, in January 2021, five more financial institutions from banking and insurance signed the UNEP FI-convened commitment and the group launched a Call to Action to other financial institutions, and to supervisors, regulators and policy makers.

How have the original five institutions scaled up their disclosures of physical risks and what are the lessons learned?

As they had committed in 2019, the initial five institutions disclosed their exposure to risks from the physical impacts in reports published in September 2021. UNEP FI conducted a review of the disclosures of all signatories, covering eight of the eleven recommendations of the TCFD – the first two recommendations on governance apply to climate risk in general rather than physical risk specifically and the second recommendation under ‘Metrics & Targets’ refers specifically to greenhouse gas emissions. Assessment of the disclosures’ coverage was made by assessing seventeen questions across the eight recommendations.

The review is based on publicly available information, though given that physical risk disclosures are still in their early stages, full assessments are not yet possible. Detailed results have been shared with the financial institutions to verify the assessment, establish if certain key information is missing, and identify areas for improvements and areas of best practice. The main high-level conclusions are:

• Disclosures depend on high quality data, and good practice is underscored in those disclosures where the use of robust, transparent data is underlined. In countries where data is limited or opaque, risk analysis is challenging.

• Third party providers of climate analytics can provide considerable support in synthesising and managing data and this is reflected in the disclosure reports of firms that have used external specialists. In-house analysis can provide long-term benefits, and may increasingly become important as sustainability risk disclosure becomes mandatory, though it can take longer to build adequate capacity and analytical know-how.

• The best disclosure reports reflect climate risk management by firms that have strong support from the Board and senior management, the financial resources to carry out their work, and climate risk management is embedded in a wider risk management framework and strategy.

• Good practice is demonstrated by those institutions that follow the reporting structure set out by the TCFD recommendations and demonstrate clearly how they implement or aim to implement quantitative risk management.

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