China: Climate risk disclosure strategies for financial institutions

Global warming is continuing and causing significant risks to the global economy. The impact of climate change is more widespread and severe than anticipated, and this reminds us of the urgency of addressing and disclosing climate risks.

On 20 November 2022, COP27 ended in Sharm El-Sheikh, Egypt. After two weeks of intense negotiation, the parties concluded an historic decision to establish a fund to assist nations that are particularly vulnerable to the adverse effects of climate change. The associated damages are already causing devastating economic and societal losses and impairing the realisation of the Sustainable Development Goals.

Chinese financial institutions play a vital role in decarbonising the global economy and achieving China’s 2060 carbon-neutral target. The Chinese regulators have developed certain policies and rules to guide the Chinese financial institutions in this regard, and are increasingly engaging with international counterparts on green finance-related issues to attain international harmonisation.

Most financial institutions around the world have now reached a consensus with regulators that climate risk is one of the important sources of financial risks. Since the climate risk is global, systematic, non-linear and highly uncertain, and given its large-scale and long-term nature, it will naturally affect traditional risks such as credit risk, market risk, operational risk, liquidity risk and reputational risk. This in turn will affect the safety and soundness of financial institutions and even have a broader impact on the entire financial system.

For financial institutions, climate risk disclosures can bring several important benefits. First, it can help financial institutions identify and manage climate-related risks and facilitate stakeholders’ assessment of a financial institution’s environmental impact. Second, one of the essential functions of financial markets is to price risks, and climate risk disclosures can facilitate more effective pricing mechanisms for climate-related risks. Third, it can create new opportunities for financial institutions, such as developing green financial products or structuring credit products and investment portfolios that are compatible with the transition to a net-zero economy.

Climate risk disclosure strategies should refer to the overall strategies of a financial institution when making climate risk disclosures, e.g. key aspects to be disclosed and what type of specific information to be disclosed. To improve the efficiency of disclosures, financial institutions should adopt appropriate strategies. First, since financial institutions are regulated entities, there may be some mandatory domestic regulations and rules to be followed, which shall constitute the core part of the disclosure strategies. Second, financial institutions may also take international practices for reference when making voluntary disclosures, such as the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), as adapting to international policies will help the financial institutions gain recognition from other market participants.

There have been a considerable number of environmental and climate-related policies adopted in the last decade. Below are some of the most far-reaching policies in the international market.

Since the adoption of the Paris Agreement, there has been an international consensus to actively address climate change and the risks it poses, leading to a considerable number of newly-developed environmental and climate policies. Some focus on the financial sector, which is quite important in contemporary times, as many environmental issues, especially those related to climate change, can only be resolved through international cooperation.

One of the most influential international frameworks for the disclosure of climate-related risks and opportunities affecting companies and financial institutions is the TCFD, which was launched by the Financial Stability Board in December 2015 following a request from the G20. The TCFD had an aim to take financial disclosures as a way to inform investors and other stakeholders about the climate-related risks organisations face, how those risks are being managed and the potential opportunities presented by climate change.

The TCFD provides a set of recommendations on climate-related financial disclosures that are particularly applicable to organisations in the financial sector, including banks, insurance companies, asset managers and asset owners. Better information disclosed will support investors, lenders, insurers, and other financial stakeholders in appropriately identifying, assessing and pricing a specific set of climate-related risks and opportunities when making decisions, allowing for the more efficient allocation of capital.

The TCFD structured its recommendations around four thematic areas that represent core elements of how organisations operate: governance, strategy, risk management, and metrics and targets. Take ‘strategy’ as an example, according to the recommendations, strategy refers to an organisation’s desired future state. An organisation’s strategy establishes a foundation against which it can monitor and measure its progress in reaching that desired state. Strategy formulation generally involves establishing the purpose and scope of the organisation’s activities and the nature of its businesses, considering the risks and opportunities it faces and the environment in which it operates. Therefore, the climate disclosure strategy regards the disclosure of actual and potential impacts of climate-related risks and opportunities on the organisation’s businesses, strategy, and financial planning where such information is material. For the financial sector, there is also supplemental guidance for the financial sector to identify special considerations.

Several Chinese financial institutions have also become supporters of the TCFD, including but not limited to:

• Industrial and Commercial Bank of China;

• Agricultural Bank of China;

• Bank of China;

• China Construction Bank;

• Bank of Communications;

• China Life Insurance Co., Ltd.;

• Ping An Insurance Group Company of China, Ltd.; and

• E Fund Management.

This demonstrates the commitment of these financial institutions to continuously improving the quality and consistency of climate-related financial disclosures.

The Sustainable Finance Disclosure Regulation (SFDR) is part of a package of legislative measures related to the European Commission’s Action Plan on Sustainable Finance. As one of the most stringent EU regulatory policies for the financial sector, the SFDR imposes comprehensive sustainability disclosure requirements covering a broad range of ESG metrics on almost all types of financial market participants (FMPs) and financial advisors. Although the SFDR is an EU-wide regulation, due to its broad coverage, compliance and disclosure are required not only for EU-domiciled financial institutions, but also for Non-EU FMPs or financial advisors who provide services or establish subsidiaries within the EU. Besides, a significant point of the SFDR is that the application is extended from the entity level to the financial product level, requiring public assessment and disclosure of ESG information from both levels.

In September 2020, China announced the goal to peak carbon dioxide (CO2) emissions before the year 2030 and achieve carbon neutrality by 2060. Given China’s scale, and the need to balance economic development and emission reductions, the transition to net zero faces significant challenges. Although being a late starter, China has adopted serious environmental and climate policies.

In February 2012, the China Banking Regulatory Commission (now, the China Banking and Insurance Regulatory Commission (CBIRC)) issued the Guidelines on Green Credit, which provides specific requirements on the environmental and social risk management of financial institutions’ green credit operations. In August 2016, the People’s Bank of China (PBOC), Ministry of Finance, National Development and Reform Commission (NDRC), Ministry of Environmental Protection (now, Ministry of Ecology and Environment), CBIRC and China Securities Regulatory Commission (CSRC) jointly issued the Guidance Opinions on Building a Green Financial System, taking the lead in building the green financial system.

In July 2021, the PBOC, based on the experience of the pilot institutions, and drawing on the international mainstream methodology for climate and environmental information disclosure and in light of the characteristics of Chinese financial institutions, issued the Guidelines on Environmental Information Disclosure of Financial Institutions, which requires financial institutions to disclose their own environmental information, both quantitative and qualitative. According to the Guidelines on Environmental Information Disclosure of Financial Institutions, qualitative information includes environmental strategy, governance structure, environmental risk management strategy, and identification of major issues; and quantitative environmental information includes environmental benefits and environmental stress tests of their own operations and investment and financing activities.

As an important participant in global green finance, green bonds, green credit, green insurance and other financial products have developed rapidly since China proposed to build a green financial system. More than half of the projects supported by green bonds are in the transportation and energy sectors, effectively promoting low-carbon development in those areas, and China has become the world’s largest investor in clean energy.

Although China’s green bond market is currently the largest in the world, it faces barriers regarding investor access and is lacking in international harmony. To remove the barriers, the PBOC, NDRC and CSRC jointly issued the Catalog of Projects Supported by Green Bonds (2021 Edition) (Green Bonds Catalog 2021). It is the first update of the Catalog of Projects Supported by Green Bonds (2015 Version) and is further aligned with international standards on the identification of green projects and the selection of projects, while being more compatible with other existing domestic standards for defining green economic activities.

The key updates in the Green Bonds Catalog 2021 include:

• For the first time, the definition of green projects by the relevant regulatory departments are unified, and the projects covered are aligned with the Green Industry Guidance Catalog (2019 version) jointly issued by seven ministries, the green loan-related policies issued by the POBC and the green financing statistics issued by the CBIRC. This will effectively reduce the costs of issuance, management and transaction in the green bond market, promote the synergy among various regulatory departments and enhance market efficiency; and

• The fossil fuel projects which are controversial in the global market are excluded, bringing China closer to international practice and contributing to the facilitation of cross-border green bond transactions.

With the introduction of ‘2030 Carbon Peak, 2060 Carbon Neutral’, China’s green financial policy system has been evolving and improving. In particular, the Guidelines for Green Finance in the Banking and Insurance Sectors (Green Finance Guidelines) from June 2022 provide comprehensive and clear guidance on ESG-related obligations of financial institutions for the first time, and explicitly includes insurance institutions in the scope of the Green Finance Guidelines.

The Green Finance Guidelines are developed based on the Guidelines on Green Credit issued in 2012. To promote the development of green finance in the banking and insurance sectors, the Green Finance Guidelines expand the green credit to green finance and refines relevant requirements. The key changes brought by the Green Finance Guidelines are as follows:

Although some previous regulations provided guidance on the fulfilment of environmental and social responsibilities by insurance institutions, before the issuance of the Green Finance Guidelines, there was no comprehensive and clear guideline for insurance companies. The Green Finance Guidelines, for the first time, included the insurance institutions in the green finance regulatory framework and provided special requirements for them.

The Green Finance Guidelines expand the applicable business scope to include all types of green finance businesses of banks and insurance institutions, and adds environmental, social and governance risk management for the financing of small enterprises, online financing and other businesses.

The Green Finance Guidelines puts forward clear and specific requirements for the organisational structure of banks and insurance institutions. In the future, banks and insurance institutions should further adjust and optimise their own organisational structure to make them better conform to the requirements of the Green Finance Guidelines.

Compared to the Green Credit Guidelines which mainly focuses on environmental and social risks, the Green Finance Guidelines requires that banks and insurance institutions shall pay attention to environmental, social and governance risks. Further, they should focus on the hazards and risks arising from the construction, production and operation activities of customers (financing parties), their main contractors and suppliers due to corporate governance deficiencies and inadequate management.

The Green Finance Guidelines expand disclosure obligations to green finance-related contents based on the Green Credit Guidelines, and require banks and insurance institutions to improve information disclosure by drawing on international practices, guidelines or other good practices. Furthermore, the Guidelines also require that banks and insurance institutions establish an effective assessment system and incentive and punishment mechanism for green finance, implement relevant measures, and improve due diligence and liability exemption mechanisms to ensure the continuous effective implementation of green finance.

Since China is a late starter to climate risk disclosures, domestic policies in this area are not yet well developed. However, as mentioned, some domestic financial institutions (e.g. Industrial and Commercial Bank of China) have been issuing disclosure reports based on TCFD’ recommendations for years. With the continuous development of green finance, the domestic regulatory requirements will gradually converge with international principles and China’s policymakers will improve the disclosure system, introducing more specific and enforceable disclosure standards for financial institutions in line with the national conditions.

A growing challenge for the financial sector is greenwashing. Greenwashing by companies to gain favour from the financial markets is widespread worldwide, imposing significant risks to financial institutions. In China, greenwashing is generally identified as misleading claims about environmental practices, performances or products, and the regulators may punish greenwashing in accordance with provisions in the existing laws and regulations. Currently there are no special regulations for the identification of green financial products and punishment of greenwashing. It is expected that clear, strict and enforceable regulations for the identification of green finance products will be implemented in the near future, to effectively curb greenwashing and regulate green finance business.

Han Kun would like to thank Ye Li, an associate, for her contribution to the article.