Thibaut Ghirardi is Managing Director of 2DII France, an independent non-profit think tank working to align financial markets and regulations with the Paris Agreement goals. Recently, 2DII, alongside the French Ecological Transition Agency (ADEME) and the French Ministry for the Ecological Transition (CGDD), have launched the 4th Edition of the International Climate Reporting Awards (ICRA). This contest targets financial institutions worldwide and rewards the best climate reporting practices both in terms of exposure to climate risk and contribution to the climate goals. This year, ICRA’s steering committee is composed of Eurosif, the World Benchmarking Alliance (WBA), Luxembourg Sustainable Finance Initiative (LSFI) and Finance For Tomorrow.
What does climate-related risks mean and why is it relevant for financial institutions to disclose them?
I think it is important to distinguish transition risks and opportunities from the physical ones. Transition risks are linked to the economy moving towards carbon neutrality by 2050. This means that we will drastically decrease our CO2 emissions thanks to new regulations, markets developments, technology, NGO campaigns and, more generally, increased awareness of the civil society. Transition risks arise if a company does not anticipate these drastic changes, whereas transition opportunities arise if a company anticipates and takes advantage of these changes. Physical risks are directly related to the negative consequences of climate change, such as increased number of floods or extreme climate events that will put human lives or infrastructures at risks, for instance. These risks influence the economy directly and have a financial impact. Another important point to underline is that the better, the swifter the transition, the higher the risks and opportunities. If the world takes the right path to reach the Paris Agreement goals, companies will face stringent transition risks and opportunities. If we fail to reach these goals, companies will face huge physical risks. In the end, it will probably be a mix of both situations so companies must be aware of these two types of risks.
We will provide detailed feedback to all the applicants, so it is a means to understand your strengths and areas for improvement gaining inspiration from best practices.
The speed of the transition will be key too. If it is smooth and ambitious, we can expect the risk to be less significant than if it is late and sudden. If the transition impacts companies financially, this will have consequences on the financial institutions that are related to them. To put it simply, if we face risks and opportunities at the level of the physical assets, those assets might gain or lose value and this will influence the performance of the financial products linked to them. These risks can spread to the financial systems and have a potential systemic effect. That’s why it is so important for financial institutions to disclose their exposure to transition and physical risks, for supervisors and for the society to better assess their long-term financial soundness.
How can companies disclose these risks: are there any standards or regulatory requirements at national or international levels?
There are an increasing number of standards and regulations. Regarding Climate related disclosure, the most known framework is the guidelines developed by the Task Force on Climate related Financial Disclosure (TCFD). The rationale behind these recommendations is that companies should disclose their climate risks so that, in turn, financial institutions investing in these companies better understand their own exposure to these risks. In the end, it should also help better understand the overall exposure of the financial system. The TCFD is based on 4 pillars which are 1/governance, 2/strategy, 3/risk management processes and 4/metrics and targets. The TCFD is a voluntary framework but is used as a basis for “soft” regulations in some countries. For example, in the UK the Prudential Regulation Authority (PRA) is urging banks and insurers to engage with this standard. In the case of France, ESG and climate risk disclosure is mandatory since 2016 and the adoption of its energy transition law. Its article 173 (now article 29 of the climate and energy law) is about mandatory ESG disclosure with a pillar on climate risk disclosure which is now consistent with the TCFD’s recommendations, including how remunerations are related to climate risk management. Apart from the TCFD, there are also standards at EU level, for example, the Guidelines on Reporting Climate related information linked to the former Non-Financial Reporting Directive.
It is important to realize that disclosure is a very interesting tool but is not enough. We also need to know at operational level if companies understand these risks and anticipate them according to different scenarios. It is also very relevant to see how they plan to mitigate these risks.
To help both companies and financial institutions in analysing their risk exposure, at 2DII, we are working on different tools such as a scenario repository, a scenario configurator, and a portfolio evaluation tool.
To what extent disclosing climate-related risk can impact the reduction of greenhouse gas emissions and combat global warming?
That’s for me the core of the discussion. The current paradigm is based on the premise that managing risk at systemic level will generate financial reallocation and the transition of the economy. The problem is that this might not be the case and there is no scientific evidence that it will be in the coming years. That’s why when covering this topic the notion of double materiality is key: this refers to the distinction between managing the climate risks impacting a company versus managing the impacts of a company on the environment, i.e. its contribution to the climate goals. These risks can be the two faces of the same coin. For example, a financial institution wants to engage with a cement company that is in its portfolio to push for CO2 reduction policies. If it manages to do this and the CO2 emissions of this cement company decrease, it will reduce its exposure to transition risks while reducing the impact of the cement company on climate. Another option would be that the financial institution decides to divest from the cement company. In this case, this means that the financial institution will reduce its exposure to transition risks. However, as probably someone else will buy the shares of the cement company, there will be no CO2 reduction in the real economy. In this case the divesting strategy of the financial institution did not have a positive impact on climate, at least not directly.
That’s why it is very relevant to distinguish these two angles taking into account this double materiality concept. At 2DII, we’ve developed a methodology called “PACTA” (Paris Agreement Capital Transition Agreement) which is used for portfolio alignment analysis. This methodology can be the first step in the development of climate strategies. It supports financial institutions in understanding the exposure of their portfolios to carbon intensive sectors, to then help them choose which climate action they can put in place to reduce their risk exposure and/or optimise their impact.
For the 4th consecutive year, 2° Investing Initiative, along with the French Ecological Transition Agency (ADEME) and the French Ministry for the Ecological Transition (CGDD), are launching the International Climate Reporting Awards. What could you tell us about this award?
The award first took place in 2016, and now it is the 4th year that it is organized with the support of the French Ecological Transition Agency (ADEME) and the French Ministry for the Ecological Transition (CGDD). The goal is to reward the best climate reporting practices both in terms of risk and contribution to the climate goals. For 2021, we aim to review more than 60 financial institutions internationally and we will give prices based on several criteria such as governance, risk management, alignment and impact. To do so, we have developed a scoring grid to review the financial institutions’ reports. Based on this grid, we will provide the jury with a score for each institution. Finally, the jury will select the institution they would like to reward.
The jury is usually composed of representatives of various European and International institutions, such as the European Commission, the UN PRI, financial supervisory authorities (the Luxembourg’s CSSF will be part of the Jury this year), Universities, etc.
The application is now open for interested financial institutions and it closes on the 30th of July. The award ceremony will take place in October.
What is the aim of this award and how has it evolved over time in terms of participation and requirements?
We have seen the topic of non-financial disclosure growing both in terms of financial institutions covered and of information to be disclosed. The purpose of the award is generally to encourage disclosure as well as helping the work on standardising non-financial information so to make it comparable.
Looking at recent developments, I would like to highlight an initiative: the Climate Transparency Hub (CTH) that was launched in France this year. It is an online platform where French financial institutions can voluntarily deposit their climate reportings which are afterwards made publicly available, consolidated and analysed to identify best practices. The CTH then produces one report for each institution using the same grid to guarantee their comparability. The CTH was built based on the climate awards’ grid and will be used to collect climate reports of French institutions participating in the awards. International financial institutions won’t apply through the CTH (as it is a tool dedicated to France based companies) but will have to submit their reports directly to the climate awards’ organisation. All reports will therefore be assessed based on the same grid. The scoring of all the applicants will be shared with the jury which will then proceed to the final selection.
The grid is trying to combine best practices stemming from different standards and regulations, such as the TCFD, or the French article 29 that we mentioned earlier.
In this edition we are also focusing on impact and contribution to climate goals. We have a specific pillar in the grid dedicated to contribution to climate goals. We are convinced this is a topic that needs to be properly addressed if we want financial institutions to really contribute to the climate goals.
What would you say to nudge Luxembourg based financial institutions to participate in this contest?
First, I think it is a great way to compare their practices with other financial institutions and show leadership on the topic which is increasingly important for clients, supervisors, and regulators. Second, we will provide detailed feedback to all the applicants, so it is a means to understand your strengths and areas for improvement gaining inspiration from best practices. Third, to be a first mover and anticipate regulation, even if for now climate disclosure might be voluntary, we can expect regulations to make this mandatory in the coming years. Finally, to show that they have disclosure practices that are as mature as other countries, and that would be a good signal for Luxembourg, showing they are leading the way.