Banks chafe at pace of new climate regulation

There has been much speculation over what was behind HSBC asset management’s now-suspended head of responsible investment Stuart Kirk’s recent incendiary presentation on climate change. The administrative burden of having to quantify long-term climate risk on loan instruments with an average tenor of six to seven years certainly seems to have been part of it.

“The amount of work these people make me do,” he lamented, criticising central banks and regulators’ obsession with climate-related risk-assessment procedures.

Aside from pushing industry leaders to question their own company culture and commitment to net zero, Kirk’s comments certainly highlighted the ongoing frustrations within the banking sector over the pace of administrative processes that underpin the slow transition towards responsible methods of investing.

The message from regulatory bodies is clear: investment banks need to clean up their portfolios, provide adequate climate-risk assessments, and get their clients over the net-zero finish line as soon as possible.

But sustainable investment teams want policymakers and regulators to meet them halfway.

“In a lot of sectors, we see our clients having the ability to go faster than regulation,” says Tanguy Claquin, global head of sustainability at Crédit Agricole CIB.

For Claquin, who has been leading Crédit Agricole CIB’s sustainable banking business since 2009, societal pressure incentivises banks to demand more ambitious carbon-reduction targets.

Without shying away from their responsibilities to facilitate the transition to net zero, some sustainability teams question the actual influence the banking sector has if policymakers don’t provide legal clarity.

“If a government decides to maintain some exposure to coal, there’s not much that banks can do about it even if they chose to stop financing coal production” says a sustainability finance expert.

Many in the industry argue that while there is no denying that demands for the banking sector to go faster are legitimate, they should not come at the expense of other options that can incentivise society.

Amongst those options, common metrics for climate-risk assessment across sectors and jurisdictions should be a priority.

“Banks rely on data coming from their clients,” says Sophia Velissaratou, director of ESG research for banks at Sustainalytics. "Lack of standardization and data availability and accuracy become an issue since clients might be based in non-EU countries that are not subject to the same regulation and don’t have good quality of data or have no data at all."

Banks have been complaining about lack of standardization in environmental, social and governance data for a long time now, and international regulators have already begun converging on key policies related to climate-risk assessments to move beyond country-specific frameworks.

The International Sustainability Standards Board (ISSB) has said it wants to fully integrate the Taskforce on Climate-related Financial Disclosure (TCFD) framework in its draft standards.

The standards, which are due to be finalised by the end of the year, will provide “a comprehensive global baseline of sustainability disclosures designed to meet the information needs of investors in assessing enterprise value,” according to the IFRS website.

In the US, the Securities and Exchange Commission will impose new disclosure requirements

on the marketing of US funds – news that came two months after the SEC announced broad rules on companies’ climate-risk assessments.

Stricter regulations present an additional set of challenges for banks as their clients grapple with measuring the impact of material shocks down their supply chains and sustainability due-diligence processes are lengthened.

“The new disclosure challenge will be exacerbated by the complexities of gathering and analysing comparable ESG metrics for all potential issuers, to confidently screen them fully and fairly for inclusion in a portfolio” says Volker Lanier, vice-president of product management and regulatory affairs at financial data company GoldenSource.

There is also the risk that the disclosure challenge will be further compounded if suppliers need to respond to different data needs for each of their investors and stakeholders.

On the asset-management side, heterogeneous fund labelling rules burden sustainable investment teams with additional due diligence, to ensure that the strategies align with the label.

“Extensive labelisation has made things more complicated,” points out Sacha Bernasconi, senior portfolio manager at Syz Asset Management. "A lot of time is lost in debating or negotiating what falls under ESG and what doesn’t because there are no commonly-agreed definitions."

For Bernasconi, the only sustainable investment products with merit are the ones that are well defined, ring-fenced and under the supervision of one regulatory body.

“That’s why we’re keen on green bonds," Bernasconi continues. "There is a clear definition under Icma [the International Capital Market Association], and the product either aligns with the principles, or it doesn’t.”

Meeting regulatory requirements comes back to a resource issue.

Bigger, sophisticated banks might have the capacity to build in-house teams, recruit experts and develop tools to lower the cost of compliance for their clients. Smaller, regional banks might need to seek third-party support.

“EU regulation changes sustainability reporting from voluntary to mandatory,” says Velissaratou. "Larger banks need to abide by certain sustainability reporting standards in 2023, while smaller institutions will have more time to align.”

She adds that the steep learning curve will eventually bring the much-needed standardization.

Overall, the banking sector is concerned with the high administrative loads resulting from different reporting requirements. Banks with a larger global footprint and that need to abide by disclosure requirements sooner could do with simpler, homogeneous rules and regulations.

This paperwork burden might have been what motivated the Kirk’s comments, but if sustainability teams are to meet their net-zero targets, lengthy first steps are a normal part of the regulatory process.