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Cambridge Institute for Sustainability Leadership (CISL)

Environmental risk analysis

5 September 2016 – World leaders meeting at the G20 Summit in Hangzhou, China, today issued a Communiqué recognising the importance of scaling up green finance and welcoming the voluntary options put forward by the G20 Green Finance Study Group (GFSG).

 

This is the first time that G20 Leaders have referenced the importance of greening the financial system in the summit’s annual Communiqué. G20 members also published a Green Finance Synthesis Report that examines the necessity and challenges of developing green finance. It provides seven voluntary options to overcome these challenges including: promoting international collaboration to facilitate cross-border investment in green bonds and facilitating knowledge sharing on environmental and financial risks.

CISL, through its Centre for Sustainable Finance, was invited to serve as Knowledge Partner to the group. Specifically, the Centre for Sustainable Finance was asked to review the practice of financial institutions globally in integrating environmental risks into financial decision-making. In conjunction with experts in financial stress testing from the Cambridge Judge Business School, this analysis drew on CISL’s ability cross boundaries between multiple fields of expertise and engage deeply with its global network of institutions right across the financial system.


Welcoming the Communiqué

Zhou Xiaochuan, Governor of the People’s Bank of China (co-chair of the GFSG), said:

“The global financial system has a major role to play in mobilizing private capital for investments in green sectors, and appropriate incentives should be given to green investment.”

Mark Carney, Governor of the Bank of England (co-chair of the GFSG), said:

“The adverse effects of climate change threaten economic resilience, growth and financial stability. Given the scale of the investment capital needed, financial markets are best placed to finance the transition to a low carbon economy. So the work of the Green Finance Study Group is critical in identifying options to address institutional and market barriers to bringing green finance into the mainstream.”

Andrew Voysey, Director of Finance Sector Platforms within the Cambridge Centre for Sustainable Finance, said:

"Languishing and increasingly unequal growth rightly led G20 Leaders in Hangzhou to focus on the inclusiveness of the global economy. Simultaneously, they made a watershed decision to consider how to ‘green’ the financial system, which we welcome. Our analysis highlights important innovations by financial institutions worldwide, but this is currently happening at the margins. If we are to truly green the financial system, such innovation needs to be accelerated urgently into mainstream practice."


The Centre for Sustainable Finance’s analysis concluded that:

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


Comments on the Centre for Sustainable Finance’s input

José Marcos Ramírez Miguel, Chief Executive Officer at Grupo Financiero Banorte, said:

"According to World Bank data, 6.3 per cent of México’s GDP depends on natural resources. Yet the reality is that over half of the country is defined as arid or semi-arid and is therefore highly vulnerable to droughts. Understanding our environmental risks will help Banorte make smarter capital allocation decisions. Our work done with leading financial institutions to incorporate water risk into corporate bond valuations will help us increase this understanding. We are convinced all debt issuers and underwriters should be taking similar actions where water is a critical element in the supply chain, which is why it is timely that the Cambridge Centre for Sustainable Finance has highlighted these practices to G20 Leaders.”

Frank Elderson, Executive Director at the Dutch Central Bank, said:

“Environmental risks can have a profound impact on financial institutions. Not only through physical risks affecting the performance of insurers, but also through transition risks related to environmental policy, which can have a significant effect on the investments and loans held by institutional investors and banks. We greatly appreciate the important work of the G20 and the Cambridge Centre for Sustainable Finance in the field of environmental risk analysis and are proud to share our analysis of carbon bubble risks in the Dutch financial sector as a contribution to this paper, which represents a milestone in bringing together best practices from around the world.”

Jeremy Wilson, Vice Chairman of Corporate Banking at Barclays and Chair of the Banking Environment Initiative Working Group, said:

“Barclays sees a significant commercial opportunity in helping our clients (be they institutional investors or companies of any size) to mobilise the tens of trillions of dollars of green finance required over the coming decades of the 21st century. Properly sensitising the financial system to environmental risk is central to achieving this; without doing so, those capital flows that have supported economic progress in the 20th century will continue to dominate. This will require collaboration across many boundaries, which is why the role of governments as facilitators, not least in the G20, is so important.”

John Melville, Executive Head of Risk Services at Santam, said:

“The combination of increasing levels of climate risk and community vulnerability is a key issue for sustainable development and therefore general insurance. Santam has started to tackle this, partnering with municipalities to manage fire and flood risks and to build our understanding of the systemic risks inherent in places we do business. But we believe that a broader sectoral response will have a more significant impact on the levels of climate risk to which our communities are exposed, hence we welcome this latest evidence that Governments are using the G20 to look at such issues.” 

Maurice Tulloch, Chairman of Global General Insurance at Aviva and Chairman of ClimateWise, said:

“An open and resilient financial system is needed to address the systemic risk posed by climate change and degradation of the environment. For Aviva, tackling climate change is a business imperative. We welcome G20 Leaders’ recognition of the important role of private sector finance in identifying and developing solutions, and this latest analysis by the Cambridge Centre for Sustainable Finance. The paper demonstrates that institutional investors and insurers are collaborating to consider scenarios and assess exposure to anticipated risk and are integrating resilience at an economy, society and a business level. Going forward, the work of ClimateWise will focus on the protection gap: the divide between rising exposure to climate risks versus a need for increased access to insurance cover.”

Liselotte Arni, Managing Director and Head of Environmental and Social Risk at UBS, said:

“Collaboration with multiple players in the financial sector is now required to refine methodologies for quantifying climate change risks and we believe the G20 GFSG is a promising forum to bring all the relevant actors together. We value the support of the Cambridge Centre for Sustainable Finance to guide and consolidate different methodologies from several jurisdictions.”


Read the Centre for Sustainable Finance’s G20 GFSG Input Paper, Environmental risk analysis by financial institutions – a review of global practice.

To read the full text of the G20 Summit Communiqué, visit the G20 website.

To download the Synthesis Report and a full range of GFSG input papers, visit the UN Environment’s Inquiry website.

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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.