OakNorth’s response to the SEC’s proposed rules to enhance and standardize climate-related disclosures for investorsOakNorth
March 24, 2022
Earlier this week, the Securities and Exchange Commission (SEC) announced proposed rule changes on climate-related disclosures to address investor concerns around the lack of consistency, comparability, and reliability of climate-related disclosures. Assuming the rules are adopted, it will have a significant impact on the reporting carried out by SEC registrants – with some companies being impacted as early as two years’ time.
A large number of commercial banks will need to consider these proposed rules if they are filing with the SEC – in conjunction with climate-related rules coming from their banking regulators (notably the Federal Reserve, OCC and FDIC). While there are some exceptions, the reality is that most commercial banks will be facing some form of regulation around climate change in the next few years, and the advice from regulators is to use this time wisely.
Summary of the proposals – SEC registrants would need to disclose:
- How any climate-related risks they’ve identified have had or are likely to have a material impact on their business and consolidated financial statements, which may manifest over the short-, medium-, or long-term
- For banks, this covers both the bank’s operations and physical locations (e.g. branches, data centers, etc.) but also the climate risks for the bank’s borrowers – as this will ultimately impact their ability to service and repay their loans
- How any identified climate-related risks have affected or are likely to affect their strategy, business model, and outlook
- Their processes for identifying, assessing, and managing climate-related risks and whether any such processes are integrated into their overall risk management system or processes
- Risk management is central to how banks are run, regulated, and report today; climate risk will need to be incorporated into this framework
- The impact of physical risks and transition activities on the line items of their consolidated financial statements and related expenditures, and disclosure of financial estimates and assumptions impacted by such climate-related events and transition activities
- Data on Scope 1 and Scope 2 emissions would need to be verified by an independent third party.
- These are the “controlled” emissions of a bank
- Data on Scope 3 emissions if they are deemed material or part of their climate targets. These disclosures would not be subject to third-party verification and would be protected from legal liabilities.
- It is likely that Scope 3 financed emissions will be “material” for most banks – namely what is your bank’s total contribution to the emissions of your borrowers (measured for each borrower as [your bank’s loans / total debt + equity of the borrower] x borrower emissions)
- If they have set a net-zero target or announced plans to transition away from carbon emissions, they would need to provide information around how they plan to reach those targets and by when.
- For banks that set net-zero targets incorporating Scope 3 financed emissions, this will need to incorporate both planned changes in loan portfolio mix, as well as anticipated changes in emission intensity for borrowers
- If the rules are adopted by the end of this year, large accelerated filers and accelerated filers would need to disclose Scope 1 and 2 emissions in 2024 and Scope 3 emissions in 2025 at the earliest.
What SEC-registered banks can be doing to get ahead of the proposals:Data
- In order to effectively examine the effects of climate change and develop a loan-level understanding of the climate risk within their portfolio, banks will need to obtain climate scenario/climate pathway data that informs their view of climate risk and impact at the borrower/sector/portfolio level.
- In conjunction, banks will need to consider what additional borrower-level data they can and should gather (in a structured form) that enables more detailed climate analysis in the future.
- Banks should therefore be investing sufficient effort now when originating new loans as part of the risk assessment underwriting, or when doing an annual review to collect the correct climate data, especially if they only collect financials on an annual basis. They should also be developing a plan for investment to evolve their data and analytics capabilities further.
- Banks will need to consider a broad range of climate scenarios/climate pathways with sufficient granularity to enable them to adequately assess the risks of meeting their risk management objectives and wider climate change targets.
- Banks that are more proactive in developing data taxonomies and mining the data they already have will have a good feedback loop into the policy process.
- The SEC will expect governance structures and banks’ culture to support risk management and be effective in cascading the climate change strategy and risk appetite throughout the bank.
- Banks should have a clear escalation and decision-making framework for climate risks, including(typically) a Board-level committee and a named C-suite executive who has responsibility for this.
- To provide investors, the regulators, and other stakeholders with the reassurance that disclosures are being reported accurately, banks will need to provide sufficient reliable information about their material exposures to climate change.
- To avoid greenwashing, banks must ensure that for the products they offer or deal in, they have implemented a robust controls framework – across valuation, modeling, accounting, due diligence, product governance, suitability, and disclosure.
- If banks wish to be trusted advisors to the businesses they lend to, they need to work with them so borrowers understand the potential opportunities climate change and decarbonization presents for their business, as well as their climate sensitivity and vulnerability and how that may impact their creditworthiness.
- Banks should therefore be coaching their front line to have transition-related conversations with clients, providing them with the right questions to ask for different industries and sub-sectors, and using the data from these discussions as one of several inputs to help inform decision-making.
- While the SEC has acknowledged many of the above challenges, it will expect banks (and all other registrants) to factor this uncertainty into formulating their risk management and business strategies going forward.
- A key task for banks’ boards will therefore be ensuring the bank is aware of uncertainties in climate risk data and is confident that it has a well-documented plan for managing those areas of uncertainty.
Don’t let perfect be the enemy of good – banks can get started on climate change plans today and OakNorth can help.
This was a sentiment echoed at the second ON Climate Consortium on February 25th this year. The Consortium is a group of innovative, climate-forward institutions driving commercial lending’s approach to climate risk and opportunity. Participants included 77 industry leaders from 29 commercial banks with assets ranging from $22B to over $3.3T. The results of a live poll OakNorth conducted at the Consortium revealed that almost half (46%) of the commercial banks in attendance plan to have a climate solution in place for their commercial loan book by the end of this year. Even those that are unlikely to be impacted by regulation for a few more years are taking actions today to prepare for potential changes in the future.
For commercial banks that are looking for a solution, OakNorth’s Climate Impact Framework helps banks quantify, report, and act on climate change-related risks and opportunities in their commercial loan portfolio.
For commercial banks that are not yet at the point where they are looking to implement a solution, OakNorth can support in putting a climate-ready plan together, in terms of gathering the right data, understanding the right questions to ask, building climate confident teams, and assessing how this all fits into existing credit and risk policies and procedures.