Finance leaders attend Sustainable Finance 2021

‘Achismo’ simply won’t work on climate risk assessment says BdP director

Representatives of Portuguese banks, companies and academic institutions gave presentations at Sustainable Finance 2021 which took place at Fintech House in Lisbon on Thursday. Figures included Luís Laginha de Sousa, board member from the Bank of Portugal who opened the day’s sessions which covered topics such as Banking under New EU Regulations, Measuring Sustainability using the Power of Data, Sustainable Investments as a Vehicle for Value Creation, Funding Sustainable Value Chains, and Inspiring Future Leaders.
The event, mentored by Think Tank PSO also included several speakers from international organisations who appeared remotely and included Standard & Poor’s and Cambridge Institute Sustainability Leadership.
Referring to the data challenge, Luís Laginha de Sousa said it was vital to ensure that banks have comprehensive, reliable timely and cost effective data on sustainability.
“The main concern is that these become absorbed adequately by the economic agents that are affected by them and incorporate them into there policy actions,” he said.
The BoP director said authorities, regulators, companies and legislators had a “marathon” in front of them to take the world from the Paris commitment to carbon neutrality but the world is “very far from the finish line.”
He said there were many opportunities for the financial sector and that it plays an absolutely critical role in this process of transition to a sustainable economy.
“On the one hand the balance sheets of the financial institutions are affected by environmental risks, and thee risks need to be adequately managed to safeguard financial stability,” said Laginha de Sousa.
On the other hand the energy transition will only be possible if the financial system is able to finance a very significant amount of essential investments which will have to occur over the coming decade and if financial stability is at stake, the ability of the financial sector to provide the amounts that are required will also be at stake.
“We are faced with a duality situation which is a case for the financial system of a concept called double materiality that applies to the corporate world in more general terms.”
The Portuguese central bank has undertaken a lot of work on assessing the financial risks from climate change and adaptation of the regulatory and supervisory framework.
It was important to quantify the exposure of financial institutions to the risk which is challenging because of the uncertainty involved, the long time horizons involved, the non-linearity of the processes, the dependence on short-term actions, the sector activities involved and how/where these exposures are located.
“Traditional risk measurement techniques are based on statistical relationships that are extracted from vast information and are therefore not suitable to asses company low carbon transformations from climate risks since they are unpredictable and transitional risks with no historical precedent.”
Despite these difficulties, the central bank wants to contribute towards building a path based on technical and scientific knowledge, instead of guessing or ‘achismso’. (reckoning by extrapolation)
“When we don’t have technical or scientific knowledge this extrapolating tends to fill the gaps and it is a very dangerous game,” said Luís Laginha de Sousa.
The Bank of Portugal has recently published a study about the banking system’s exposure to firms which are most sensitive to a transition to a low carbon or carbon-free economy and the study suggests that around 60% of the banks’ exposure to non-financial corporations are in climate policy relevant sectors such as construction, real estate and transport and energy-intense industries.
The BoP has also been involved in the ongoing work at a European level to adapt the regulatory and supervisory framework.
“This work aims to encourage financial institutions to make this progress in identifying, measuring and mitigating climate and environmental risks that they are subject to on the medium to long-term horizons.
The ECB has also published a final guide on climate-related and environmental risks for banks with a view its next supervisory stress test in 2022 which will focus on such risks.
The guide explains how the ECB expects banks to prudently manage and transparently disclose such risks under current prudential rules.
The ECB will now follow up with banks in two concrete steps. In early 2021 it will ask banks to conduct a self-assessment in light of the supervisory expectations outlined in the guide and to draw up action plans on that basis.
The ECB will then benchmark the banks’ self-assessments and plans, and challenge them in the supervisory dialogue. In 2022 it will conduct a full supervisory review of banks’ practices and take concrete follow-up measures where needed.
The gap analysis that was conducted revealed that the vast majority of European banks are still very far from ensuring that their practices are aligned with supervisory expectations in the guide. So they will need to adapt and improve their risk management tools.
The BoP has also extended these expectations to all the financial institutions that fall under its direct supervision, coming into force in Q2 2022.
“The notion of risk typically comes with a negative perception, but in reality risk, if properly managed, can also be associated with very significant opportunities,” he said.
Of course this will force all non-financial entities — corporations, insurers, asset managers to adjust their business models in a very profound way.
The transition in terms of opportunities will involve a substantial investment spread over several decades achieved through public and private investment including VC and equity capital.
Climate risk and biodiversity loss and identifying the economic opportunities that the energy transition will bing also implies filling a data gap, defining the right reporting requirements is absolutely vital.
“Energy transition is underway and will speed up and everything suggests that there will be no postponement of deadlines or easing of new requirements which is why financial institutions cannot stay in a position of ‘wait and see’, he said.
In order to make the best use of opportunities that lie ahead, institutions must integrate environmental risk into their business strategies and models, into their internal governance structure and also in their risk management policies.
“The cost of acting only when the regulatory and reporting frameworks are complete will likely be much higher than the cost of doing it right now even wit limitations and data gaps,” concluded Luís Laginha de Sousa, board member at the Bank of Portugal.