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The temperature is rising : Prudential regulation of climate risk across Asia Pacific

2022 is the year of climate risk regulation for banks. Supervisors across the Asia Pacific region encouraged banks to identify, measure and manage the risks associated with climate change last year, and regulation will start to take effect from 2022.

This will look different across our region. Australia, Hong Kong, Malaysia, and Singapore have introduced formal guidelines for climate risk management, while South Korea and Thailand are emphasising the adoption of green finance frameworks.

But critically, the repeated recognition by prudential regulators of climate change as a systemic risk to the financial sector was reinforced in November 2021, when the Basel Committee on Banking Supervision (BCBS) issued its draft guidelines to improve management and supervision of climate-related financial risks, containing 18 principles. Eight of the 28 members of the Basel Committee are in the Asia Pacific, and it is expected that the final version of Basel guidelines will form the basis for global regulatory efforts.

To determine what this means for the financial sector, Deloitte assessed the level of harmonisation between the BCBS draft standards and regulatory documents in 12 Asia Pacific nations on behalf of the Asia Securities Industry & Financial Markets Association (ASIFMA). We found that the Basel principles were more comprehensive than any previously published material, with no jurisdiction issuing any material contrary to the anticipated global standard.
Harmonisation of BCBS principles for management of climate-related financial risks across 12 Asia Pacific nations, as of 20 January 2022 (Deloitte analysis)

Most prudential supervisors either have converged or are converging towards recognising material climate-related financial risks (Principles 13 and 14). As a minimum expectation, banks will be required to adopt a consistent definition of climate-related financial risks that encompasses physical and transition aspects – this is likely to form the foundational elements for climate stress testing and comparable disclosures of material climate-related financial risks. Banks will eventually need to demonstrate compliance at the obligation level, showing adherence to the standard or broader risk management standards.

Furthermore, climate stress testing has been a key focus in forums such as the ASEAN Central Banks and the Network for Greening the Financial System (NGFS). Most regions in the Asia Pacific will conduct climate stress tests in the next two years. Supervisory review of these stress test outcomes will help banks and supervisors determine the data, systems and resources required to support an orderly transition to net zero carbon emissions.

A consistent theme of climate risk regulation is the timeframe over which climate risks are expected to emerge. While much of the climate risk management regulation follows paths laid out for previous risk categories by following an ‘identify, measure, manage, mitigate and monitor’ cycle, the timeframe over which risks should be assessed is longer than for any previously regulated risk type. The most widespread example of this is the convergence of climate stress testing to a 30-year time horizon (from 2020 to 2050), requiring banks to consider risks beyond their typical strategic planning time horizon more often than previously.

Countries that have schedules for stress-testing requirements include Australia, Japan, China, Singapore, South Korea (by 2022) as well as New Zealand and Malaysia (by 2023).

The analysis found that resourcing and the capacity to effectively manage climate-related financial risks emerged as the key challenge for banks and supervisors.

Principle 17 notes a need to take regular stock of existing skills and projected requirements, consider relevant evolving market practices, and take timely measures to build adequate expertise in identified skill sets. At best, what we have observed is an acknowledgement of this function to be considered and integrated into future policies. Appropriate knowledge is also required to ensure that the results of any scenario analysis are credible and realistic.

The challenge for prudential regulators and banks is to develop relevant capabilities in monitoring compliance with climate risk management obligations. The establishment of the International Sustainability Standards Board (ISSB) at COP26 is a step in the right direction to help banks direct efforts towards better capacity-building and reconciling climate disclosures.

The Basel principles do not address the question of support for green financing. National regulators that are focussed on establishing green industries, which include China and South Korea, have given speeches that indicate supervisory expectations may stretch beyond risk management to include differential risk appetites and loan pricing.

Climate has become an overtly systemic risk in the banking sector. Banks need to ensure they are prepared to respond to these new prudential requirements, as climate risk regulation will inevitably alter the landscape. Regulators need to determine how this will be enforced.

While we know this is coming, the shape of change is yet to form. But one thing is for sure: if banks have not started on this journey, then the time to act is now.