Conference of the Parties (COP)
2020 will be no different to previous years as another COP will be held. What makes COP 26 different is that it will be hosted in the UK for the first time. In addition there are lots of expectations for this summit as it will be 5 years since the Paris Agreement.
The Paris Agreement, the outcome of COP21 in 2015, was a significant milestone in the history of the United Nations Framework Convention on Climate Change (UNFCCC). The Agreement is a pledge by UNFCCC member states to limit global heating to between 1.5°C and 2°C above pre-industrial temperatures, to be achieved through nationally determined contributions (NDCs) in domestic and international policies.
COP26 will be the first quinquennial “global stocktakes”. These are opportunities for member states to re-evaluate their NDCs against more recent climate science and strengthen commitments to new and existing plans. Climate Action Tracker[1], an organisation that assesses climate policies, estimates that current pledges under the Agreement would limit global heating to around 3°C, far beyond the intended maximum of 2°C.
It was hoped that COP 25 in Madrid would complete work on the final element of the “rulebook” of the Paris Agreement by settling on rules for carbon markets and other forms of international cooperation under “Article 6”[2] of the deal. The challenge with Article 6 is agreeing to rules that will lead to real emissions cuts as weak rules could undermine the entire accord and even lead to an increase in emissions. Carbon markets could be used to meet emissions reduction targets on paper whilst avoiding any real action.
COP will be covered in more detail in the next edition of the Treasurer e-magazine (14/02/2020).
Central Banks
Following efforts by the G20 Green Finance Study Group and the FSB Task Force on Climate-Related Financial Disclosures to encourage financial institutions to conduct environmental risk analysis and to improve environment- and climate-related information disclosure the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) was established in 2017. The role of the Network is to strengthen the global response required to meet the goals of the Paris Agreement and “to enhance the role of the financial system to manage risks and to mobilize capital for green and low-carbon investments in the broader context of environmentally sustainable development”.
Initially comprising the Banco de Mexico, the Bank of England, the Banque de France and Autorité de Contrôle Prudentiel et de Résolution (ACPR), De Nederlandsche Bank, the Deutsche Bundesbank, Finansinspektionen (The Swedish FSA), the Monetary Authority of Singapore, and the People’s Bank of China, the group now comprises 54 institutions.
As part of this, the Bank of England announced in December 2019 that it will use its 2021 biennial exploratory scenario (BES) to explore the financial risks posed by climate change[3]. The exercise will test the resilience of the current business models of the largest banks, insurers and the financial system to climate related risks and therefore the scale of adjustment that will need to be undertaken in coming decades for the system to remain resilient.
What’s coming up next?
The EU’s Non-Financial Reporting Directive (NFRD) will come into force on 1 January 2021 following the Taxonomy Regulation in December 2019. The Regulation significantly expands the scope of sustainability disclosures as it will introduce new reporting requirements for large organisations.
Financial and non-financial companies that fall under the scope of the NFRD will have to disclose information on how and to what extent their activities are associated with environmentally sustainable economic activities. This refers to large public interest companies with more than 500 employees, covering approximately 6,000 companies and groups across the EU.
The European Commission’s Technical Expert Group on sustainable finance (TEG) has had its mandate extended to 30 September 2020 but will be presenting and discussing the final reports on an EU taxonomy as well as further user guidance in relation to its recommendations for an EU Green Bond Standard at a stakeholder dialogue on 12 March 2020[4].
Part of the report from the TEG addresses minimum requirements for two new climate benchmarks: the EU Climate Transition Benchmark (EU CTB) and the EU Paris-aligned Benchmark (EU PAB). The report also provides suggested recommendations on ESG disclosure requirements, applicable to all investment benchmarks (with the exception of currency and interest benchmarks).
A climate benchmark is an investment benchmark that incorporates specific objectives related to greenhouse gas (GHG) emission reductions and the transition to a low-carbon economy. These specific objectives are incorporated next to financial investment objectives and are based on the scientific evidence of the IPCC, through the selection and weighting of underlying benchmark constituents.
The main objectives of the new climate benchmarks are to:
The EU CTB and EU PAB benchmarks build on existing low-carbon benchmarks, while also having broader climate action ambitions. Not solely limited to being used to fulfill a risk reduction objective, they can also fulfill objectives relating to opportunities, helping to increase the share of investments in climate-related opportunities.
Investors can use climate benchmarks:
Investors may wish to use the final report to investigate the differences of these benchmarks and to understand the criteria that have to be met to qualify as an EU CTB or an EU PAB. The following table sets out which types of financial institutions would use the two types of benchmarks:
Environmental Social and Governance (ESG) disclosure requirements
Alongside establishing the two climate benchmarks, the EU has also introduced requirements for ESG disclosures for any category of index, excluding interest rate and currency benchmarks. Index administrators are now required to provide information on both the methodology and benchmark statement. Regarding the methodology, the index administrator is required to deliver an explanation of how the key elements of the methodology reflect ESG factors for each benchmark or family of benchmarks. Regarding the benchmark statement, it is now required that the published benchmark statement contains an explanation of how ESG factors are reflected in each benchmark or family of benchmarks.
The new disclosure requirements apply to a wide range of indices available on the market and the final report sets out recommendations on minimum disclosure by asset class. For some asset classes, market practices have already been established and are expected to be applied (e.g. corporate and sovereign bonds and listed equities). However, many disclosure requirements apply to a wide variety of asset classes, including consolidated ratings for each element of ESG, a rating for ESG as a whole, and disclosure on alignment with the Paris Agreement.
[1] https://climateactiontracker.org/
[2] https://iccwbo.org/media-wall/news-speeches/article-6-important/
[3] https://www.bankofengland.co.uk/paper/2019/biennial-exploratory-scenario...
[4] https://ec.europa.eu/info/publications/sustainable-finance-technical-exp...
