Financial Stability Board progresses climate risk disclosure work

The Financial Stability Board (FSB) has proposed the creation of an industry task-force to look at climate risk disclosure, as it seeks to progress the work initiated by a coalition of organisations that seek to get entities to disclose and take responsibility for climate and disaster risks.

The FSB is an international body established to monitor and make recommendations about the global financial system. It has taken up the initiative for which the groundwork was laid by a number of others, to try to get climate risk and disaster risk encoded into the financial system.

The FSB is proposing the creation of an industry-led disclosure task force, focused on climate-related risks. That includes weather risks and also natural disaster impacts, as disclosure should be for exposures that threaten impacts to the financial system, plus also to communities, workers and employees of those that should be disclosing exposures.

This follows on from the 1-in-100 initiative, that was led by a coalition involving insurance and reinsurance broker Willis Group alongside the United Nations and other entities. This work proposed the disclosure of 1-in-100 year exposures on the balance-sheet of public companies, also seeking to extend the disclosure to cities and sovereigns as well.

The FSB explains that its task-force would seek to “develop voluntary, consistent climate-related disclosures of the sort that would be useful to lenders, insurers, investors and other stakeholders in understanding material risks.”

By encouraging entities to disclose their climate (or weather or disaster exposure) it would inform stakeholders, shareholders, investors and partners how exposed they were and once you get an exposure on the balance-sheet you can quickly see the need for those adopting disclosure to put a contingent source of capital on the balance-sheet as well, to offset the exposure.

That’s where insurance, reinsurance and risk transfer come in. As a way to climate-harden the world and encourage resilience measures, responsibility to be taken for exposures to employees and residents, as well as encouraging risks to be transferred if not mitigated, the idea of a standard for disclosure is a good one.

The proposal explains that the risks from climate could fall into three categories:

• Physical risks: the impacts on insurance liabilities and the value of financial assets that may arise from climate- and weather-related events, such as floods and storms that damage property or disrupt trade. In the financial sector, these losses have consequences most immediately for the insurance sector, but also extend more widely;
• Liability risks: the impacts that could arise if parties who have suffered loss or damage from the effects of climate change seek compensation from those they hold responsible. Such claims could come decades in the future, creating liabilities for carbon extractors and emitters and their insurers;
• Transition risks: the financial risks which could result from the process of adjustment towards a lower-carbon economy. Changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent. The abruptness with which such re-pricing occurs could influence financial stability.

The FSB is clearly looking to the insurance and reinsurance sector for a lead on how this disclosure and reporting should work, which considering insurers and reinsurers have always reported their peak exposures, no matter what lines of business, shows that the industry can teach the broader financial sector and other industries a lot.

The FSB continues:

These potential risks to the financial sector from climate change are complex, and the understanding of them is still at an early stage. Risk management is currently most active and sophisticated in the general insurance and reinsurance sectors where catastrophe risk modelling and capital standards take climate risks into account.

Establishing the task-force is a first-step in gaining broader acceptance of a standardised way for climate risk disclosure to be achieved, however it is likely to have similarities to the way insurers and reinsurers report their peak return period exposures.

Clearly access to risk modelling will be key, to enable the likes of major public companies to better understand and describe their exposure levels to their stakeholders and investors.

Where this will get interesting is if banks adopt it, or large multi-nationals with bases all over the developed and emerging world, or cities which face specific resilience issues from climate related factors like rising sea levels.

Very quickly you can begin to see that by reporting exposures these entities may be compelled to either increase their resilience to the climate or weather risks, or to ensure they have the contingent financial protection to protect their company, customers, employees and shareholders up to certain return period levels.

That could result in new insurance, reinsurance and risk transfer demand. When you begin to think of supply chain type exposures it could also result in greater use of structures featuring parametric triggers and the like.

When you start to think about this level of disclosure on a global scale, you very quickly realise that the traditional insurance and reinsurance market alone is not going to be deep or liquid enough to manage these risks, without the help of the capital markets and insurance-linked securities (ILS) techniques.

The FSB’s proposal can only serve to further drive home the need for climate risk understanding, mitigation, resilience and risk transfer. The engagement of the re/insurance and capital markets in these initiatives is key.

More details on the FSB’s proposal here.

Also read:

– Companies called on to disclose natural disaster risks.

– Climate change a trillion-dollar threat. Re/insurance & ILS can help.