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Environmental risk analysis by financial institutions – a review of global practice

September 2016 – The G20’s new Green Finance Study Group asked the Cambridge Centre for Sustainable Finance to serve as Knowledge Partner and make recommendations on how to integrate environmental risk into mainstream financial decision-making.

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Environmental_risk_analysis.pngContext

Under its first Presidency of the G20, China established a Green Finance Study Group (GFSG), reporting to Finance Ministers and Central Bank Governors. The GFSG’s objective has been to identify institutional and market barriers to green finance and, based on country experiences and best practices, analyse options on how to enhance the ability of the financial system to mobilise private green investment, thereby facilitating the green transformation of the global economy. The University of Cambridge Institute for Sustainability Leadership’s (CISL) Cambridge Centre for Sustainable Finance was asked to serve as Knowledge Partner to the GFSG.

About the report

The GFSG has been addressing a set of interrelated challenges across five areas of research, three of which have a sectoral focus (‘greening the banking system’, ‘greening the bond market’, ‘greening institutional investment’) and two of which are cross-cutting (‘risk analysis’ and ‘measuring progress’). The GFSG asked the Cambridge Centre for Sustainable Finance for a global stocktake of the tools and techniques that financial institutions are developing to analyse environmental risks. This paper presents the findings of this stocktake, which drew on CISL’s ability to cross boundaries between multiple fields of expertise and engage deeply with its global network of institutions right across the financial system.

The stocktake

The stocktake draws three key conclusions:

1. Important innovation is already happening in the financial sector, but it is at the margins of mainstream practice.

For example, a Chinese commercial bank has conducted stress testing on the impact of air quality regulations on the credit risk of its heavy polluting clients, finding significant deteriorations. Elsewhere, UK-based insurers have quantified how extreme weather events can drive food price spikes and hit stock markets around the world.

2. There are real challenges to integrate such innovation into mainstream practice and therefore good reason for regulatory attention.

The need to make good quality, relevant data available is well understood. Knowing how to process that data by connecting scenario analysis to financial impacts, however, requires multi-disciplinary expertise that is not often found within a single institution.

3. G20 Governments should put in place formal structures to accelerate action on environmental and financial risks across banking, investment and bond markets.

Governments and regulators need to help build capacity in local markets, plug knowledge gaps, improve data and level the playing field. All of these sectors need to be ‘greened’ to achieve the mobilisation of tens of trillions of dollars of green finance

Mobilising capital

Unless the institutions controlling so much of the world’s capital are fully sensitised to environmental risks, they won’t seek innovative green finance solutions with the determination and focus that is so badly needed.

The long-term vision of this work is to enable a revolution in how governments, financial regulators, financial institutions and other experts work together to ensure that environmental risks are integrated into mainstream financial decision-making. The result would be a financial system where business strategies, cost of capital calculations and drives for innovative solutions take the environmental risks to which economies and societies are already exposed fully into account.

Citing this report

Please refer to this report as Cambridge Centre for Sustainable Finance (2016, September). Environmental risk analysis by financial institutions: a review of global practice. Cambridge, UK: Cambridge Institute for Sustainability Leadership.

Published: September 2016

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Lead authors

The lead authors of this study were Andrew Voysey (CISL) and Nina Andreeva (Cambridge Judge Business School). The work benefited from invaluable contributions from G20 Green Finance Study Group delegates, members of finance sector business platforms that CISL convenes in the global insurance (ClimateWise), banking (Banking Environment Initiative) and investment (Investment Leaders Group) industries and a wide range of other industry and academic experts. They are too many to name, but the authors are indebted to them all. We are grateful to UNEP for financial support for this work.

Disclaimer

The opinions expressed here are those of the authors and do not represent an official position of the Cambridge Centre for Sustainable Finance, CISL, the University of Cambridge, or any of its individual business partners or clients. This report is not, and should not be construed as, financial advice. This input paper has been prepared by the authors as a contribution to the G20 Green Finance Study Group (GFSG) but has not been endorsed by it nor does it represent the official views or position of the GFSG or any of its members.