Managing Environmental Threats in Financial Sectors

Managing Environmental Threats in Financial Sectors

Financial institutions are gearing up to tackle climate-related risks, including nature risks and environmental tipping points, as the global economy transitions towards a new era of opportunity in transition finance.

Udaibir Das from the National Council of Applied Economic Research has highlighted the persistent mismatch between finance and climate action in developing countries. Meanwhile, William Attwell at Sustainable Fitch has stated that most banks have a long way to go in providing comprehensive climate-related information.

Despite these challenges, there are several integrated approaches that financial institutions can adopt to address these risks and prepare for evolving sustainability regulations.

Firstly, environmental and nature risks should be incorporated into risk management frameworks and stress tests. Banks are increasingly including climate risks in capital assessments, and are encouraged to expand to nature-related risks following guidelines such as those from the European Central Bank (ECB) and the Prudential Regulation Authority (PRA) in the UK. It is crucial to go beyond climate-only risks by embedding biodiversity-related risks to close regulatory blind spots.

Secondly, reliable, standardized environmental and climate data should be collected and analyzed to identify exposures accurately and comply with growing reporting requirements such as the EU’s Corporate Sustainability Reporting Directive (CSRD) and IFRS S2 climate-related disclosures. This data foundation supports risk identification, scenario analysis, and aligns with regulatory expectations.

Thirdly, robust climate and nature risk scenario analyses and stress testing should be implemented to reflect complex, real-world conditions. The use of science-based, dynamic scenarios rather than static ones enhances decision-making and resilience building.

Fourthly, financial institutions should adopt science-based targets and frameworks such as the Science Based Targets initiative’s Financial Institutions Net-Zero Standard to align financial flows with global net-zero pathways and to drive emissions reductions across lending, investment, and underwriting portfolios.

Fifthly, adaptive transition and resilience plans should be developed that integrate physical climate risks and nature risks, with clear timetables and alignment to national policies (NDCs, NAPs). This creates clearer investment pipelines and strengthens engagement between firms and financial actors, supported by enabling policy and data environments.

Sixthly, frameworks like the Physical Climate Risk Appraisal Methodology (PCRAM 2.0) and Climate Resilience Investment Framework (CRIF) should be engaged with. These methodologies provide structured methodologies for assessing, targeting, and managing physical climate risks at asset and portfolio levels, driving more resilient investments and risk-aware capital allocation.

Seventhly, financial institutions should adapt to regulatory updates and legal requirements such as the EU’s revised Capital Requirements Directive (CRD VI), which mandates that banks address risks from transitioning to climate neutrality by 2050.

Lydia Marsden from University College London has emphasised the need for policy-makers to better understand nature risk and the implications of ecosystem tipping points. Isabela Ribeiro Damaso Maia of Banco Central do Brasil has highlighted options for central banks to support the transition, including adjusting regulatory frameworks and comprehensive data collection.

Marcus Pratsch from DZ BANK writes that nature-positive solutions should remain central to the net-zero transition. David Carlin, D. A. Carlin and Company states that this is an age of recalibration for sustainability regulations.

In summary, financial institutions should build integrated frameworks that combine enhanced data, risk assessment tools, science-based targets, and adaptive transition planning, all while aligning with evolving sustainability regulations and supervisory expectations to effectively address climate-related risks—especially nature-related ones—and environmental tipping points.

[1] OMFIF's Sustainable Policy Institute Journal, July 2021 [2] Sem Housen and Emily Dahl, United Nations Environment Programme Finance Initiative [3] Sharon Asaf and Sebastian Werner, Citi [4] Linda-Eling Lee, MSCI Sustainability Institute [5] Paul Hiebert, European Central Bank

1. Financial institutions are being urged to handle climate-related risks, such as nature risks and environmental tipping points, as the global economy transitions into a new era of transition finance.
2. Udaibir Das has pointed out the persistent gap between finance and climate action in developing countries, while William Attwell has stated that most banks need to provide more comprehensive climate-related information.
3. One approach for addressing these risks is to incorporate environmental and nature risks into risk management frameworks and stress tests, expanding beyond just climate risks to include biodiversity-related risks.
4. Reliable, standardized environmental and climate data is vital for identifying exposures and meeting increasing reporting requirements like the EU's CSRD and IFRS S2 disclosures.
5. Financial institutions should conduct robust climate and nature risk scenario analyses and stress testing, using science-based, dynamic scenarios to make informed decisions and build resilience.
6. Adopting science-based targets and frameworks like the Science Based Targets initiative’s Financial Institutions Net-Zero Standard can help align financial flows with global net-zero pathways and drive emissions reductions.
7. Financial institutions should develop transition and resilience plans that integrate physical climate risks and nature risks, aligning with national policies like NDCs and NAPs to create clearer investment pipelines.
8. To effectively address climate-related risks, especially nature-related ones, financial institutions need to build integrated frameworks that include enhanced data, risk assessment tools, science-based targets, and adaptive transition planning, while staying updated with evolving sustainability regulations and supervisory expectations.

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