By Elisabeth A. Wilson
Risk managers everywhere are straightening their blazers, getting that crick out of their necks and taking a deep breath preparatory to walking (or Zooming) into the board room to explain to their bosses why climate change is not going to go away any time soon.2020 ushered in a perfect storm of events that have propelled climate change to prominence. The ongoing COVID-19 pandemic has laid physical and societal vulnerabilities bare. There are so many facets of climate change—increased storm severity, more extreme weather patterns, unexpected events such as wildfires, droughts and floods, to a name a top few—evolving rapidly in tandem with unprecedented uncertainty around social, political and environmental norms. This makes it difficult to determine how best to position a financial institution to react.
Additionally, the sheer wealth of climate change-focused literature and scientific data is juxtaposed against the fact that most of the information, though daunting, is vague in its predictions. Even more, there are currently no formal regulatory guidelines to drive climate change analysis and reporting standardization. There is no proven map when it comes to climate change, and financial institutions are faced with the prospect of charting new territory.
This is why bank board members and executive leadership might be less than prepared to wrap their arms around the less-than-glamorous but weighty topic of climate change. For risk managers, climate change can be a cumbersome subject, difficult to succinctly articulate and even harder to internalize in the fifteen minutes they may be lucky to get to present.
Additionally, business leaders may harbor concerns that, due to the meteoric ascent of its sister subject—environmental, social responsibility and governance factors, known as ESG—all this focus on climate change is the most recent risk fad, and it might ultimately prove to be cost-prohibitive to throw too many resources and dollars at it at this stage. Yet, risk managers need to present a compelling argument regarding the long-term view of climate change, not just for the good of the company, but because leadership’s top-down support is key to driving the transparency and risk inclusivity required to successfully layer climate change into any enterprise-wide risk program. To achieve this support and cohesion, risk managers should be prepared to address what likely will be the three most burning questions for bank leadership:
1. Will climate change still be a such a big priority in four years if the current presidential administration changes?
This is a question currently being pondered across the financial industry. Risk managers have witnessed a number of regulatory agencies institute climate change-focused committees or officer positions since the inauguration of the current administration in 2021, culminating in President Biden’s executive order on Climate-Related Financial Risk issued in May. Though no formal regulatory guidelines have come to fruition, the OCC in December issued the draft “Principles for Climate-Related Financial Risk Management for Large Banks,” and the SEC has signaled its proposed rules around climate change-related disclosures to follow in the near future.
Given the polarization in the United States at this time, it is not unlikely that a change in presidential administration in 2024 would shift or downplay focus on climate change-related risks to the financial industry. Financial institutions would naturally need to adapt to new regulatory priorities, and long-term, multi-phased climate change strategies might be curbed or abandoned.
While presidential administrations change and regulatory priorities shift, the more compelling argument around the long-term view of climate change is simple: Follow the money. Climate change has the potential to reshape not only our environment, but our financial and economic landscapes. Failure to weigh potential climate change implications seriously may result in physical risks inherent in credit portfolios remaining uncurbed, sudden market shocks catching institutions—and their capital and liquidity positions—on the back foot, and the unparalleled failure of insurance as an effective (or even viable) form of risk transfer. And these are just a few potential climate-induced scenarios that could spell significant financial risk, or even ruin, to financial institutions.
Change to the political climate and to Earth’s climate may differ or diverge, but the latter shows no sign of letting up. Regardless of whatever regulatory guidelines may or may not be instituted in the future, it is incumbent on our institutions to remain focused on what climate change-related risks could materialize, the financial repercussions they could introduce and what strategies are needed to minimize the resultant monetary effects to safeguard the bottom line.
2. We might be dead before climate change poses any catastrophic effects—Why should we care?
There is so much uncertainty around climate change. This stems from a lack of historical context, data scarcity, the difficulty in predicting unprecedented severe weather-related events and how the transition to green technologies will redirect investing and lending strategies. Identifying when these events may manifest is also challenging, though in alignment with carbon neutrality goals targeting 2050, the financial industry is starting to pinpoint 30 years as an appropriate target marker for executing climate change-related scenario analysis and modeling.
Thirty years is a long time away when you cannot even decide what you might want for lunch tomorrow. Apart from the difficulty in anticipating climate impacts, it is a significant challenge to also predict the potential economic, political, societal and technological implications that are more than a quarter of a century away, but which should also be incorporated into these analyses. Business leaders may be less than enthusiastic in the first place due to the amount of work this will entail, but pushback may stem from a more basic reason: They simply do not have skin in the game.
The average age of corporate directors is early 60s. Here again, there is a strong correlation between age and focus regarding climate change. While millennials and Generation X are more inclined to view climate change as the predominant existential threat of this era, concern seems to wane significantly for age groups over 55. So, board members and executive leaders in positions of power to drive fundamental climate change-driven strategies may inherently be less responsive. Planning for thirty years from now poses additional uncertainty for those in their mid-sixties. It is understandable if a business leader’s long-term view of climate change is quashed by a personal, albeit limited, line of sight.
Painting a compelling, persuasive argument around why climate change poses implications to an institution’s safety, soundness and bottom-line has nothing to do with the science of climate change. It is driven by the same principles as any other strategy, any other risk. It is all about shoring up a stable, profitable company to ensure it can evolve with the times, maintain capital and secure a healthy revenue stream for its shareholders in the years to come. This can no longer be done without serious contemplation of climate change. Board members and executive leaders in general want to build companies that are made to last, and comprehensive assessment of climate-change related risks inherent in the institution’s investing and lending practices are how these directors will safeguard their organization and ensure it does not (literally) go underwater after they pass the baton to a future generation of leaders.
3. Should banks wait until formal regulatory guidelines are issued before focusing on climate change?
Climate change is not waiting for anyone. It is happening now. Conversely, thanks to younger generations championing climate change as a grassroots movement, it is also the future strategic opportunity waiting to be seized by financial institutions. Rather than wait for prescriptive regulatory guidelines to come down the pike, driving time-crunched, check-the-box climate change risk analysis, financial institutions have the advantage now to commence wrapping their arms around climate change gaps to shore up control infrastructures and to identify new areas of innovative growth.
Our boards, our directors and our bosses fundamentally understand doing good business and incorporating the insatiable needs and wants of evolving consumer appetites into long-term strategy to maintain that delicate balance between risk and reward. Punting on climate change until it becomes mandatory from a regulatory perspective, thereby wasting precious time needed to build momentum and awareness across the enterprise, is also a risk. Positioning the company to face climate change as soon as possible and unflinchingly to minimize negative outcomes while also pursuing growth inherently attractive to shareholders, investors and consumers—now, there is the reward.
Elisabeth A. Wilson is AVP and operational risk manager at Atlantic Union Bank, a $20 billion bank based in Ruther Glen, Virginia. She has contributed to The RMA Journal and Risk Management Magazine. All views expressed in this article are her own and do not represent the opinions of any entity that she may be associated with.
