What can banks learn from the 2022 Climate Disclosures?

Since 2021, listed UK banks have been required to align their climate disclosures with the Task Force on Climate related Financial Disclosures (TCFD) recommendations to ensure consistency and comparability across firms. Whilst 2022 Climate Disclosures are the most mature disclosures seen to date relative to the TCFD recommendations, climate disclosure frameworks are rapidly evolving, with the UK government endorsing the International Sustainability Standards Board (ISSB) and Transition Plan Taskforce (TPT) recommendations. These disclosure frameworks should not be underestimated, and 2023/24 will therefore require the most significant uplift to climate disclosures to date. UK banks need to have early engagement on the recommendations to ensure they are compliant.

We have identified seven key observations from the 2022 Climate Disclosures that UK banks should take note of and share some focus areas for 2023/24.

Observation 1: A significant uplift in capability is needed as a result of TPT

• Best practices: Certain UK banks have had early stage engagement on TPT recommendations. TPT is a build on TCFD & ISSB frameworks and seeks to establish a ‘gold standard’ for firms’ transition plans in the UK through a robust criteria and expectations for science based transition plans. 2022 disclosures focused on disclosing the objectives and vision of the transition plan strategy, how they will engage clients, government and industry on the net zero transition, and finally how the transition plan will be internally governed by boards and management teams
• Focus areas for 2023/24: UK banks that have acknowledged TPT in their disclosures have caveated the alignment as preliminary due to the significant number of gaps that are still required to be addressed relative to the recommendations. Notably, embedding the transition plan into business and financial planning is the largest gap across all of the banks relative to the TPT recommendations, and is critical to the implementation strategy. This will require a significant uplift in capability to analyse a full roadmap of short, medium, and long-term transition actions and how those actions may impact financial positioning

Observation 2: Addressing data gaps will improve the effectiveness of scenario analysis as a risk management tool

• Best practices: UK banks are undertaking counterparty level climate scenario analysis, typically across multiple scenarios and have started leveraging it as a risk management tool. Some firms are using well known climate scenario providers such as the IEA, NGFS and IPCC, whilst others are building internal climate scenarios, providing an in house view on a range of potential outcomes. The use cases for climate scenario analysis are now well established, with firms beginning to leverage results in Risk Appetite Statements and counterparty climate risk assessments, business planning and forecasting
• Focus areas for 2023/24: It is recognised within the industry that climate scenario analysis is in its early stages, and it is important to recognise its limitations and how capabilities will develop over time. The PRA noted in their Dear CEO letter in October 2022 that there are notable gaps that need addressing in order for climate scenario analysis to support effective decision making, particularly with regards to climate data. Whilst it will take several years to close these data gaps, firms should disclose how they plan to address data gaps over the coming years

Observation 3: Coverage needs to expand for counterparty climate assessment frameworks

• Best practices: The most advanced capabilities for counterparty climate assessment frameworks saw them performed from a climate risk and transition plan lens, including both quantitative (e.g. historical emissions, modelled scenario analysis results) and qualitative (e.g. questionnaires to assess credibility of transition plan and corporate governance) information. Less advanced assessments are of a qualitative nature only. Furthermore, these assessments are now feeding into the credit decisioning process for corporate clients, and as a helpful tool for collecting counterparty climate-related data e.g. collection of historical and projected emission (supporting observation #2)
• Focus areas for 2023/24: Banks that are only including qualitative factors need to uplift their assessments to include quantitative information. Coverage of the assessments also needs to widen. Assessments are widely performed for large corporates, however the SME portfolio has not been sufficiently addressed and can account for a significant amount of financed emissions (e.g. agriculture sector). Supporting these types of businesses on their transition journey is critical for banks for achieving their own transition to net zero

Observation 4: Active Net Zero steering mechanisms need to be implemented to achieve interim targets

• Best practices: Many new financed emission sector targets have been released by the UK banks in this round of disclosures. For previously disclosed targets, progress vs targets can now also be observed through net zero dashboards. Broadly, progress has been made and reductions in financed emissions are occurring, notably in high emitted sectors such as Oil & Gas and Power. These sectors have active steering mechanisms across the industry, by supporting clients with publishing credible transition plans that align with the overall sector target
• Focus areas for 2023/24: Whilst the majority of sectors are tracking towards their interim targets, some others are off track. It is widely recognised that financed emissions will not necessarily progress in a smooth downwards curve towards 2030 interim targets, and there could be some volatility in financed emissions values that are outside the banks control. However, there is a need for active steering mechanisms for banks to deploy beyond customer engagement. There is a wide range of active net zero steering mechanisms options including government and industry engagement, green products, carbon budgets, risk appetite and internal carbon pricing. Banks will need to make use of these tools more widely in order to actively steer the portfolio towards 2030 targets and ensure there is regular internal monitoring of progress towards targets (e.g. monthly / quarterly)

Observation 5: Recognition of climate risk increasing Expected Credit Losses (ECL) is beginning

• Best practices: No UK banks in our benchmarking is holding climate risk impairment charges, some firms did calculate illustrative climate risk ECLs impacts that were deemed immaterial. Some UK banks have noted that ECLs for climate risk will be considered into their corporate plans in 2023, and there was acknowledgement that climate risk is likely to increase the mean potential loss of portfolios over time, and therefore climate risk ECL charges on financial statements will also increase
• Focus areas for 2023/24: There are plain limitations with way climate risk ECL charges are being currently being calculated with immaterial impacts. ECLs being calculated either through qualitative approaches or through the use of climate scenarios such as the NGFS. Whilst these approaches may be effective for scenario analysis, there is limited usefulness in climate risk ECL calculations. In order to calculate climate risk ECLs, a view is required on what is likely to happen in the short-term given the political and technological drivers of transition, and how these could impact macroeconomic projections. A climate base case scenario that represents the most probable transition pathway is required to be embedded into ECL reporting, which can then be implemented in other use cases for planning (observation 1) and forecasting of financed emissions (observation 4)

Observation 6: Climate training needs to keep pace with a fast-evolving discipline

• Best practices: Climate disclosures noted that board members continue to be trained on how they can best influence climate and net zero strategy, as well as highlighting specific training initiatives being created for front line staff and risk teams. These training initiatives include classroom based training for climate risk and some initial climate specialist sector deep-dives
• Focus areas for 2023/24: Enhancing employees’ skillsets will continue to play a core part of the climate embedding journey. Boards will require training on TPT in order for them to effectively challenge transition strategies. Client facing teams will need detailed sector based deep dive training, including how they can best support their client’s transition, particularly as TPT and TCFD recommendations will become mandatory for corporate clients. Finally, risk teams will need upskilling on how to best identify, assess and manage climate risk (and other emerging risks such as greenwashing and biodiversity risks) in their respective areas. See Baringa’s detailed blog on building climate capabilities for additional information

Observation 7: Climate is now being considered into executive remuneration, but coverage varies

• Best practices: New for 2022 climate disclosures, some UK banks have embedded climate factors into remuneration for executive directors, typically as a 10% weighting in scorecards. Whilst most UK banks have embedded sustainable finance and operational emission targets into the 10% coverage, more mature disclosures have also embedded financed emission targets into scorecards. This a crucial step in ensuring direct accountability of the net zero roadmap and transition plan on executive directors
• Focus areas for 2023/24: Banks that have not embedded climate into senior executive scorecards or have not linked to strategic objectives of their transition plan need to consider implementing this as it is a key requirement under TPT recommendations to hold executives accountable

To learn more about how Baringa can support your climate disclosures, please get in touch with us