The global economy must urgently transition away from business as usual to avert catastrophic climate change, writes Christine Reddell, Centre for Environmental Rights.

The Paris Agreement on climate change delivered consensus that the global economy must urgently transition away from business as usual to avert catastrophic climate change. It is particularly in the energy sector that this transition must occur, given the substantial contribution of this sector to global carbon dioxide emissions.

Financial institutions need to navigate the climate-related risks and opportunities that they are exposed to through their lending and other financial intermediary activities.

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures, categorise climate-related risks into two major types; risks related to the transition to a lower-carbon economy and risks related to the physical impacts of climate.

Banks have a significant role to play in ensuring finance flows that are consistent with low-carbon and climate resilient development.

This article sets out the various climate change related obligations, which have an impact on banks in South Africa, and the key risk assessment measures that incorporate these obligations.

Paris Agreement

In advance of the COP21 negotiations, which led to the adoption of the Paris Agreement in December 2015, all countries were required to submit national plans and targets for limiting greenhouse gas (GHG) emissions and adapting to the effects of climate change.

These plans are known as Intended Nationally Determined Contributions (INDCs). The Paris Agreement commits signatory governments to the goal of keeping the increase in global average temperature to well below 2°C above pre-industrial levels, while increasing the ability to adapt to the adverse impacts of climate change.

The INDCs do not yet go far enough to keep global warming below 2°C, but the Paris Agreement traces the way to achieving this target.

South Africa’s INDC commits to addressing climate change by setting significant reduction targets against business as usual scenarios. South Africa’s INDC records that our GHG emissions will peak from 2020-2025, and thereafter plateau and then decline from 2035.

To ensure that this decline occurs, there cannot be investment in new projects, which will significantly contribute to the country’s GHG emissions beyond 2025. Banks that do not play their role in facilitating this transition, expose their shareholders to financial risk in investing in carbon intensive projects, because of the very real possibility that these projects will become ‘stranded assets’ in the near future.

Limiting climate change to less than 2°C requires that a large portion of existing fossil fuel reserves remain in the ground. These assets could accordingly become ‘stranded’ because of new government regulations that limit the burning of fossil fuels; shifts towards renewable energy (as a result of increased demand from consumers, and lower energy costs); and legal action taken by civil society to ensure that governments meet their climate change obligations.

The TCFD’s recommendations

In 2015, the Financial Stability Board (FSB) established an industry-led Task Force on Climate-related Financial Disclosures (TCFD) to develop voluntary, consistent climate-related financial risk disclosures.

Amongst the aims of the disclosure recommendations is the promotion of “more informed investment, credit, and insurance underwriting decisions”, which in turn, “would enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.”

In June 2017, the 32 industry members of the TCFD, finalised the recommendations after extensive public engagement and consultation. The TCFD also published an annex in the same month entitled ‘Implementing the Recommendations of the TCFD’, which includes information on applying the recommendations, guidance for all sectors, and supplemental guidance for select financial sectors and non-financial groups.

The TCFD specifically highlights the exposure of banks to climate related risks. In terms of legal obligations, the TCFD warns that “asset-specific credit or equity exposure to large fossil fuel producers or users could present risks that merit disclosure or discussion in a bank’s financial filings”.

The TCFD also cautions that banks could “become subject to litigation related to their financing activities or via parties seeking damages or other legal recourse”, and that “investors, lenders, insurance underwriters, and other stakeholders need to be able to distinguish among banks’ exposures and risk profiles so that they can make informed financial decisions.”

In addition to the applicability of the general guidance on disclosures recommended for all sectors, the TCFD provides specific recommendations for banks.

These specific disclosure recommendations include: describing significant concentrations of credit exposure to carbon-related assets; characterising climate-related risks in the context of traditional banking industry risk categories such as credit risk, market risk, liquidity risk, and operational risk; and disclosing the metrics used to assess the impact of transition and physical climate-related risks on the bank’s lending and other financial intermediary business activities in the short, medium, and long term.

The Equator Principles

The Equator Principles are a “risk management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in projects”.

The Equator Principles have been adopted by 91 financial institutions in 37 countries, covering over 70% of international project finance debt in emerging markets.

In South Africa, the Equator Principles have been widely adopted by the country’s biggest banks, including Barclays Africa, FirstRand Bank, Nedbank, and Standard Bank.

The Equator Principles are intended to assist banks in identifying, assessing and managing environmental and social risks and impacts in a structured way, and on an on-going basis.

Banks that sign up to the Equator Principles commit to providing project finance and project-related corporate loans only to projects that meet the requirements of the Equator Principles (which encompass 10 separate principles).

Principle 1 requires the review and categorisation of proposed projects based on the magnitude of potential environmental and social risks and impacts. Projects classified as having potential significant adverse environmental and social risks and/or impacts that are diverse, irreversible or unprecedented (Category A) must be rigorously assessed before project financing or loans can be provided.

There are also additional assessment criteria applicable to proposed projects where the emissions are expected to be more than 100,000 tonnes of CO2 annually, including: an alternatives analysis to evaluate less GHG intensive alternatives and public reporting of GHG emission levels.

It is clear that there are climate change obligations, which significantly affect banking in South Africa, and that steps have already been taken to incorporate those obligations into risk assessment and decision-making frameworks.

Given the increased awareness around the urgent action required to address climate change, these obligations, and the measures put in place to meet these obligations, will be more carefully scrutinised by all stakeholders.

In this context, banks that purport to address climate-related risks but actually continue with business as usual, are likely to face increasing challenges from a wide variety of stakeholders.

By Christine Reddell. Source: ESI Africa