Faced with the clear observation of the systemic and urgent dimension of climate risks, FSB is proposing a global framework for supervising them. This involves a series of recommendations for supervisory authorities, such as strengthening the governance related to climate risk, the framework for internal and supervisory stress tests, the collection and processing of ESG data and prudential reporting on climate risk.
1. The FSB’s finding on ESG risk: a systemic dimension and an aggravation factor for other risks
Climate-related risks, including physical, transition and liability risks, have a systemic dimension as they can be transmitted by domino effect to the entire global financial system through various transmission channels.
Taking climate risks into account is therefore becoming essential in a context where the world is facing two very important challenges:
- The increase in the frequency and intensity of extreme weather and climate-related events.
- The intense debate on energy policies in many countries.
Supervisors are therefore faced with the challenge of taking forward this urgent work, despite the difficulties associated with the availability of data and methodologies to assess this risk.
2. The need for a harmonised global ESG risk supervision framework
There is a need for a more coherent, harmonised global approach to :
- Framing climate-related risks.
- Mitigate financial vulnerabilities.
- Reduce the risk of damaging market fragmentation.
- Assist supervisors and regulators in developing their approaches to climate risk supervision.
- Propose macroprudential tools or approaches to complement microprudential instruments.
3 A SERIES OF FSB RECOMMENDATIONS TO ADDRESS THE URGENCY OF CLIMATE-RELATED FINANCIAL RISKS
After a consultation phase, the FSB published a report in October 2022 consisting of a series of recommendations that could serve as guidelines for supervisory authorities in the management of climate risks.
The FSB has identified a list of actions to be taken in 2024:
- Conduct a peer review of supervisory and regulatory practices in comparison with the recommendations made in this report.
- Conduct a more in-depth review of the state of development of macroprudential tools.
The FSB has identified a list of actions to be taken in 2025:
- Conduct a review to determine whether the report’s recommendations should be updated.
3. A data collection and reporting framework for climate risks affecting financial institutions
The problem of poor quality climate data, a real challenge for banks the quality of climate data is a real challenge for financial institutions. Data is either missing or insufficiently consistent, comparable, reliable and granular.
The data to be collected includes:
- Data on economic sectors or activities that are sensitive, vulnerable or exposed to physical, transitional and liability risks.
- The exposure of financial institutions to these sectors or economic activities.
- The geographical location of the exposures of the financial institutions most exposed to physical risks.
- Publication of carbon-related metrics by financial institutions and their counterparties, including: Scope 1, 2 and 3 greenhouse gas (GHG) emissions.
As authorities continue to assess their information needs and move towards standardised regulatory reporting requirements, the main policy considerations are
- The return on investment in collecting more granular and specific climate-related data.
- Capacity building, including improving staff skills and developing analytical tools.
- Information systems capacity.
- Consideration of proportionality, taking into account the nature, size and risk profile of a financial institution.
3.1. FSB recommendations on climate data quality and reporting
3.1.1. Accelerating climate data collection
Supervisory and regulatory authorities must :
- Accelerate the identification of information needs to address climate risk issues.
- Work on the identification, definition and collection of climate-related data.
- Establish metrics to inform climate risk assessment and monitoring.
3.1.2. Strengthening governance around ESG data
Supervisory and regulatory authorities must :
- Analyse the governance, processes and controls of financial institutions related to climate-related data reporting.
- Analyse the reviews carried out by the internal audit of financial institutions on the reliability of data.
- Clearly define prudential expectations for climate data.
- Take into account the need for third party verification to combat greenwashing and strengthen the reliability of climate-related data, for example on emerging key indicators that are widely relied upon by authorities and financial market actors.
3.1.3. Harmonising definitions of climate risk terms
Supervisors and regulators should use common definitions for :
- Physical risks, including acute and chronic risks.
- Transition risk, including technological advances, social behaviour or changes, policy changes.
- Liability risk, whether separate or as a subset of transition risk.
3.1.4. Requiring prudential reporting on climate risk
Supervisory and regulatory authorities must :
- Require financial institutions to report to supervisors on qualitative information supplemented by increasingly available quantitative information (including, where full information is not available, the use of estimates).
- Request regular, standardised regulatory reporting as the availability and quality of data and measurement methods improve, in a manner commensurate with the nature, size and risk profile of the financial institution.
3.1.5. Establishing a global cooperation on building the common regulatory information framework
Supervisory and regulatory authorities should work to develop
- Joint regulatory reports.
- Common data sets for future work.
4. FSB proposition on climate risk monitoring tools
5.1. THE NEED TO BUILD AS MUCH AS POSSIBLE ON THE EXISTING PRUDENTIAL FRAMEWORK An analysis of climate risks is based on elements of existing prudential frameworks:
- The supervisory review and assessment processes.
- The use of risk analysis tools such as scenario analysis and crisis simulations.
- Prudential measures to address failures in climate risk management.
- Macroprudential tools and policies to address systemic risks.
4.1. FSB recommendations for a supervisory framework for climate risk
4.1.1. Conducting macro-prudential and micro-prudential supervision
Supervisory and regulatory authorities must :
- Implement micro-prudential supervision measures at the enterprise level for climate risks.
- Take into account the potential widespread impact of climate-related risks across the financial system.
4.1.2. Establishing a framework for internal and supervisory climate stress tests
Supervisory and regulatory authorities must :
- Increase the use of climate scenario analysis and stress tests as a tool for macroprudential purposes.
- Include the following features in the design of the scenarios to get an overview of the system:
- The physical and transition risks of key financial sectors (banks, insurers, asset managers and pension funds).
- Interdependencies between physical risks, transition risks, geographical and sectoral risks.
- A better understanding of the impacts on financial risks.
- Systemic aspects of climate-related risks, such as indirect risks.
- Exposures, risk transfers, spillovers and feedback loops.
- Adopt the features that can best illuminate a system overview through a top down and bottom up approach. The latter allows to
- Capture the cross-sectoral, system-wide aspects of climate-related risks.
- Consider the assumption of a dynamic balance sheet that could help capture potential second-round effects and feedback loops, while recognising the challenges inherent in making assumptions about the future actions of financial institutions over a longer time horizon.
- Include in the scenarios the range of financial risks beyond credit and market risks, to the extent that they present significant risks, such as liquidity and insurance (underwriting) and take into account the interconnections of risks.
- Develop climate scenarios based on the updated work of the NGFS, to harmonise the data and methodologies used in these analyses.
4.1.3. Establishing global cooperation on building the common framework for climate risk supervision
Supervisory and regulatory authorities must :
- Work towards a common framework for a systemic view of climate-related risks.
- Include a joint analysis of climate stress test scenarios at the global financial system level.
- Engage in an active dialogue on home-host coordination in the context of cross-border coordination and cooperation, through means such as institution-specific colleges of supervisors, taking into account the global nature of climate-related risks.
- Build on standard-setting and international bodies providing an important platform for cooperation and coordination on cross-jurisdictional risks arising from climate-related financial risks.
5. Conclusion
The FSB’s recommendations are highly consistent with the texts already published by the EBA and the ECB. Their strength lies in the international dimension of their scope in a context of lack of harmonization of ESG risk supervision approaches at the global level. The FSB pinpoints one of the greatest challenges of ESG risk management, namely the extreme complexity of managing the associated data, and proposes a roadmap accordingly. This nevertheless remains a problem for which the answers provided are still very partial.
6. References
Supervisory and Regulatory Approaches to Climate-related Risks FSB
