G-20 Study Urges Finance Firms to Better Assess Environment Risk

  • Study was presented to Group of 20 meeting in Hangzhou
  • Increasing scale and likelihood of environmental risks

Financial institutions should improve the way they assess risks to their operations from environmental threats, according to a paper presented to the Group of 20 meeting which concluded on Monday.

"Inadequate understanding of growing environmental sources of risk could allow threats to financial institutions to accumulate and limit progress towards sustainable global growth," the U.K’s Cambridge Centre for Sustainable Finance said in the paper.

The study was commissioned in January by the G-20’s Green Finance Study Group as part of efforts to stimulate more sources of private finance for environment-friendly projects, such as via the development of green bond markets. At their meeting in Hangzhou, China, G-20 leaders discussed climate issues, as well as ways to jump start growth which slowed to 2.7 percent last year in the group’s economies.

Financial institutions face environmental threats of "increasing scale, likelihood and inter-connectedness," the study said. At the same time, the firms need "new tools and techniques to understand and manage them."

The study highlighted a number of challenges in the way of improving risk assessments by financial firms. Information on credit default risks stemming from green policy changes might require the collaboration of finance, environment and policy specialists, which "can be costly and time consuming," the study said.

Understanding Data

Lack of data is also a problem. To understand risk stemming from a drought, for example, financial institutions would need data on ownership rights in the affected region and the water intensity of companies operating there. Financial institutions also need to create the ability to understand and use the data, according to Andrew Voysey, one of the authors of the study.

Recent drought in Brazil forced the country to switch from hydroelectric to thermal power generation, triggering inflation as electricity prices surged. "This demonstrates the materiality of environmental risks to the financial system," Voysey said in an interview last week.

"It also highlights the need for financial institutions to access multi-disciplinary expertise if they are to truly integrate such risks into mainstream decision-making," he added.

The failure to price such risks properly exacerbates the danger of a "race to the bottom," according to the study, where -- in the case of a government decision to tighten its carbon budget, for instance -- individual financial institutions adopt a "wait and see" approach, rather than acting pre-emptively and risk losing business to competitors.

To address the issue, the G-20 could ensure work to improve data disclosure focuses on "all types of data required for effective risk analysis," the study said.

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