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Embedding environmental scenario analysis into routine financial decision-making in Mexico and South Africa

November 2018 – Following on from its work as a knowledge partner to the G20’s Green Finance Study Group, CISL's Centre for Sustainable Finance has published reports on embedding environmental scenario analysis into financial decision-making in Mexico and South Africa.

Read the Mexico report  | Read the South Africa report

In 2018 the World Economic Forum designated extreme weather events, natural disasters and failure of climate change mitigation and adaptation among the top five global risks in terms of likelihood and impact (WEF, 2018). Accordingly, the last five years have seen major global steps at the G20 level to ensure the financial system is taking due account of environmental risks and, as a consequence, capital is being allocated appropriately in support of sustainable economic development.

Accordingly, financial firms need to keep pace with these developments and expose their strategy, risk and regulatory affairs teams to new areas of knowledge (from drought risk to the energy transition) in such a way that confidence can be built and new decisions made. To facilitate this process in Mexico and South Africa, the Deutsche Gesellschaft für Internationale Zusammenarbeit’s (GIZ’s) Emerging Markets Dialogue on Finance (EMDF) and the University of Cambridge Institute for Sustainability Leadership’s (CISL’s) Centre for Sustainable Finance joined forces with the Instituto Tecnológico Autónomo de México (ITAM), Banco de México and the South African National Treasury on a project to promote the integration of environmental scenario analysis into practice in financial decision-making.

Specifically, the aim was to empower financial institutions across the banking, insurance and asset management sectors, and their respective regulators in both countries with insights that enable them to take demonstrable new actions to embed environmental scenario analysis into routine decision-making. The outcomes of the project include two tailor-made roadmaps for the South African and Mexican regulators and financial firms on how to develop environmental scenario analysis relevant to their own national contexts.

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About the reports

Based on the analysis of the national context, coupled with the knowledge CISL has gathered about the approaches of various G20 members to understanding and incorporating environmental scenario analysis in their mainstream financial decision-making, the report provides information about data sources, scenarios and tools required to put environmental scenario analysis in practice. Further, the report elucidates the main challenges faced by the Mexican and South African financial system along with recommendations for addressing these challenges. Although South Africa and México have very different institutional and regulatory backgrounds, environmental challenges faced by these countries are similar. In terms of physical sources of risk, water risks feature prominently. Within transition sources of risk, both countries currently are highly dependent on fossil fuels. Further, social issues underline the need for a ‘just’ transition. The two roadmaps and recommendations therein reflect those similarities. The recommendations fall into three groups: recommendations for financial firms, recommendations for regulatory authorities and recommendations for the collaboration between the two.


The recommendations for MexicoMexico report

1.    Financial firms to develop methodologies and tools that enable incorporation of environmental scenario analysis into financial decision-making.

2.    Financial firms to ensure that senior management is committed to implementing environmental risk analysis via scenario analysis.

3.    Environmental authorities and the National Statistics Institute (INEGI) to proactively disclose environmental sources of risk data relevant and material for the financial system.

4.    Financial regulators to develop, through the work of a high-level advisory group on sustainable finance, a deeper understanding of environmental sources of risk for the financial sector. Based on this understanding, regulators to introduce a clear position and agenda on environmental sources of risk.

5.    Financial regulators to signal that environmental scenario analysis is a mainstream issue by adding priority environmental sources of risk to the country into the risk register for prudential supervisory activities.

6.    Financial regulators to supplement this with regular in-person Board-level roundtables to discuss recent developments.

7.    Convene a multi-stakeholder group (including industry practitioners, financial and environmental regulators and academic experts) to foster dialogue about environmental scenario analysis, construct a roadmap to implementation and explore creating a repository of risk data, scenarios and tools for environmental risk analysis.


The recommendations for South AfricaEnvironmental Scenario Analysis in South Africa

1.    Financial firms to develop methodologies and tools that enable incorporation of environmental scenario analysis into financial decision-making.

2.    Financial firms to ensure that senior management is committed to implementing environmental risk analysis via scenario analysis.

3.    Environmental authorities and the National Statistics Institute (INEGI) to proactively disclose environmental sources of risk data relevant and material for the financial system.

4.    Financial regulators to develop, through the work of a high-level advisory group on sustainable finance, a deeper understanding of environmental sources of risk for the financial sector. Based on this understanding, regulators to introduce a clear position and agenda on environmental sources of risk.

5.    Financial regulators to signal that environmental scenario analysis is a mainstream issue by adding priority environmental sources of risk to the country into the risk register for prudential supervisory activities.

6.    Financial regulators to supplement this with regular in-person Board-level roundtables to discuss recent developments.

7.    Convene a multi-stakeholder group (including industry practitioners, financial and environmental regulators and academic experts) to foster dialogue about environmental scenario analysis, construct a roadmap to implementation and explore creating a repository of risk data, scenarios and tools for environmental risk analysis.


Conclusions

Worldwide, the cost of 6°C global warming could lead to a present value loss of USD 13.8 trillion. In Mexico, the average annual cost of natural disasters has been rising steeply (National Risk Atlas, 2018). The slowdown of South Africa’s 2015 GDP growth was driven by a severe drought (DEA, 2018). Against this backdrop, it is vital that Mexican and South African financial firms and regulatory authorities take due account of material environmental sources of risk. However, there is a growing recognition that traditional approaches to incorporating environmental factors into risk management systems are insufficient in the face of the changing scale, likelihood and interconnectedness of environmental sources of risk (CISL, 2016). This calls for the use of environmental scenario analysis as a key tool to allow financial firms to analyse, measure and manage material sources of environmental risk. Putting environmental scenario analysis in practice would ensure that capital is appropriately allocated in support of financial stability and sustainable economic development that is consistent with the conservation and rational use of its natural capital and renewable energy resources. Both Mexico and South Africa have already embarked on this journey, however it should take further steps to enable its financial firms and regulatory authorities to incorporate new areas of knowledge (from drought risk to the energy transition) and methodologies (such as environmental scenario analysis) in their daily financial decision-making in such a way that confidence can be built and better decisions made.

Citing these reports

Please refer to these reports as:

University of Cambridge Institute for Sustainability Leadership (CISL). (2018, October). Embedding environmental scenario analysis into routine financial decision-making in Mexico. Cambridge, UK: Cambridge Institute for Sustainability Leadership.

University of Cambridge Institute for Sustainability Leadership (CISL). (2018 October)Embedding environmental scenario analysis into routine financial decision-making in South Africa. Cambridge, UK: Cambridge Institute for Sustainability Leadership.

 

Published: October/November 2018

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Authors and acknowledgements

Mexico

This report was authored by Dr Nina Seega. The work benefited from invaluable contributions from Jesica Andrews (JBS), Andrew Voysey (CISL), Patricia Moles (ITAM), Juan Carlos Belausteguigoitia Rius (ITAM), Rafael Del Villar (Banco de México), Makaio Witte (GIZ) and Yannick Motz (GIZ). We are grateful to ITAM for acting as a source of local knowledge, facilitating the workshops as well as providing valuable input into and commentary on the report. We are indebted to Banco de México, whose support has been key to the success of the project. Finally, we are very grateful to the Federal Ministry for Economic Cooperation and Development (BMZ), the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH as well as the Emerging Markets Dialogue on Finance (EMDF) for financial support of this work. 

South Africa

The lead author of this report is Dr Nina Seega. Jesica Andrews is a contributing author. The work benefited from invaluable contributions of Andrew Voysey (CISL), Reshma Sheoraj (World Bank), Dino Lazaridis (South African National Treasury), Makaio Witte (GIZ) and Yannick Motz (GIZ). We are grateful to the South African National Treasury, whose support has been key to the success of the project. Finally, we are very grateful to the Federal Ministry for Economic Cooperation and Development (BMZ), the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH as well as the Emerging Markets Dialogue on Finance (EMDF) for financial support of this work.

Disclaimer

The opinions expressed here are those of the authors and do not represent an official position of their companies, CISL, the wider University of Cambridge or clients.