Adapting to climate risk can be a daunting task for financial services firms, but it will be necessary to remain competitive and compliant in the coming years. Pressures to change are coming from all fronts, including regulators, investors, and peers. As with any challenge, however, there is also opportunity. Board members can seize this opportunity to proactively navigate their businesses through the changing landscape induced by climate risk, evolving to ensure resiliency. 

Aside from developing regulatory imperatives, climate risk is expected to become a major strategic consideration for businesses. To set the scene, between 2 and 10 percent of global financial assets are at risk from the increase of environmental instability.¹ Climate change is estimated to put $250 billion at risk within the largest U.S. banks², and the rate of climate disasters is expected to increase by 40 percent by 2030 (from 2015), causing disruption to natural resources on which half of the world’s GDP ($44 trillion) relies.³ Thus, for lending institutions, climate risk serves as a systemic risk to business operations.

There are emerging demands for businesses to adopt climate risk into their models. International standards groups such as the IFRS have released specific sustainability disclosure standards this year, and national groups such as the SEC (US) and EFRAG (Europe) are expected to release updated standards between 2023 and early 2024.⁴ 

Additionally, ESG assets are booming, anticipated to grow by 15 percent to $53 trillion by 2025 as more investors and shareholders prioritize ESG.⁵ In response, companies are preparing enterprise-wide adaptations. These will fundamentally alter operations, shifting priorities and changing the way data is collected and reported across all departments within a firm. Evolution on this scale necessitates board involvement, and not just as supporters—they must be the leaders of these initiatives.

The foundational task is to get the board - on board. Board members need to understand climate change, agree on objectives, and make it clear throughout the organization that climate risk is a priority. To achieve unity, a calibrated approach can be taken via three key steps:

1. Provide context: Initiatives should be translated to be specific to the business. Implementation is most successful if it is presented in terms of current operations. 
   a. Example: For a bank involved in lending, specify board materials to commercial & real estate loan risks from increased rates of flooding.
   b. Key questions: Does your organization perform climate stress testing? How are your competitors integrating climate risk into their operations? How vulnerable are your data centers and critical services to extreme weather?⁶ 
   
2. Define roles: Board members should take ownership of different functions for implementation, leveraging pre-existing governance structures. This should be supported with new climate goals and compensation incentives.
   a. Example: Board members who have ownership over technology should focus on prioritizing activities such as tool enhancements to meet new reporting requirements. Board members with  ownership over business and operations should prioritize tasks like the establishment of new policies and governance structures.
   b. Key questions: How does your board engage with the broader organization on climate transformation? How does leadership sign off on climate targets? Is there a defined RACI?
   
3. Share initiatives: Lean on climate experts to provide relevant context. Although implementation can take time, this is a challenge that all companies are facing, and there is an opportunity to learn from both industry experts and competitors. a. Key questions: How does your organization monitor progress? How does your organization benchmark compare to peers? Which counterparties, sectors, or locales warrant heightened attention and focus?⁷
   
   

After this stage, the board will have new climate goals and compensation incentives defined. To operationalize these in the broader organization, leadership should target three key objectives:

1. Set the tone from the top: Senior executives are responsible for driving climate risk transformation and achieving goals as set by the board, including creating impetus and accountability. Communications around these efforts should be enterprise-wide, and they should come directly from leadership to emphasize their significance. Periodic communications should be instituted to ensure alignment on the organization’s progress against climate goals.
2. Strengthen communication channels: A centralized repository should be established to give transparency around the organization’s climate goals and provide resources explaining context to foster an educative environment. Channels for escalations and questions should be built to offer specific guidance to employees. Lastly, climate risk and ESG should be included in the agendas of relevant all-hands, divisional, and departmental meetings.
3. Turn practices into habits: Adapting to climate risk will fundamentally change the way that an organization views itself. Companies should embed climate risk into their cultures, integrating it into policies, processes, and governance structures. This will be especially tangible for data governance and management, as ESG and climate reporting regulations may require major enhancements to current capabilities. To facilitate this, continuous education should be provided to senior leadership and the broader organization. This may not be a fast process, but it will ensure that your organization is prepared, both culturally and operationally, to remain competitive in the face of climate risk.

These steps and objectives will equip the board with the necessary toolbelt to mitigate the challenges of climate risk. While adapting to climate risk is no small task, preparing the board readies the organization for success, and enables an organization to set the tone from the top. 

To find out more about how Capco can help you overcome your ESG challenges and implement best board practices, contact our ESG expert team.

References: 

¹“Key Sustainability Trends That Will Drive Decision-Making in 2023.” S&P Global, www.spglobal.com/esg/insights/featured/special-editorial/key-sustainability-trends-that-will-drive-decision-making-in-2023. Accessed 13 July 2023. 
²Ceres cites $250 billion annual physical climate risk to Banks - CREFC. Accessed July 13, 2023. https://www.crefc.org/cre/content/News/Items/advocacy-items/CERES-Cites-250-Billion- Annual-Physical-Climate-Risk-to-Banks.aspx.  
³ “Biodiversity Speaks.” Spotify for Podcasters. Accessed July 13, 2023. https://podcasters.spotify.com/pod/show/ibios 
⁴“Key sustainability trends that will drive decision-making in 2023.” S&P Global, Key sustainability trends that will drive decision-making in 2023 | S&P Global (spglobal.com). 
⁵ “ESG assets may hit $53 trillion by 2025, a third of global AUM.” Bloomberg Professional Services, ESG assets may hit $53 trillion by 2025, a third of global AUM | Insights | Bloomberg Professional Services. 
⁶ Acting comptroller of the currency Michael J. Hsu November 8, 2021 ... Accessed August 9, 2023. https://www.occ.gov/news-issuances/speeches/2021/pub-speech-2021-116.pdf.                 
⁷ Acting comptroller of the currency Michael J. Hsu November 8, 2021 ... Accessed August 9, 2023. https://www.occ.gov/news-issuances/speeches/2021/pub-speech-2021-116.pdf.