The U.S. and China are the two largest economies in the world, each with great influence, including on investment and the financial system. As the latest IPCC report suggests, the world is on track to reach and surpass 1.5 degrees of warming within the next two decades, if urgent actions are not taken. The U.S. and Chinese governments must require the financial sector to take more action beyond committing to net-zero. Institutions in the financial sector must establish science-based targets, robust disclosures, and clear plans to ensure their actions will have an impact on the economy, and their respective governments must put these initiatives into real action through coordinated financial regulation. As the G20 Summit rapidly approaches (October 30-31, 2021), one of the key topics will be about sustainable finance and risks to the financial system from climate change. This puts a spotlight on the recently re-established Sustainable Finance Working Group (SFWG), jointly chaired by the USA and China[i]. The working group will be “central for coordinating international efforts to mobilize sustainable finance, which is crucial to achieve a global green and sustainable recovery.”
During the Green Swan conference[ii]—co-sponsored by the Bank for International Settlements (BIS), Bank of France, International Monetary Fund and Network for Greening the Financial System—both Federal Reserve chair Jerome Powell and People’s Bank of China (PBOC) governor Yi Gang explicitly stated that sustainable finance is a main area where the two countries will collaborate.
During the G20 SFWG Private Sector Roundtable, Luigi Federico Signorini, Senior Deputy Governor of the Bank of Italy, stated that the initial focus will be centered on standardized taxonomy, good data, and climate disclosures.
He said, "Greenwashing' is a danger; good data, an agreed taxonomy, and adequate company disclosure are necessary. Global consistency is important, as fragmentation of standards across jurisdictions is confusing for investors and costly for companies. Standards are currently being drafted in many countries and regions. It is therefore important to strive for an early global understanding, before national choices become entrenched."
Based on these focal points, we offer an update on where the US and China stand on these areas, as well as suggestions of where they could collaborate and support the SFWG (and beyond).
The EU taxonomy is a system used to clearly delineate the types of financial activities that can be classified as sustainable. The system is meant to lay the foundation for new sustainable finance products, help financial institutions transition to a more sustainable business model, as well as allowing investors with sustainable mandates to easily find investments that align with their strategy.
Over the past few years, China has been updating its green bond taxonomies and currently states that it is approximately 80% similar to the EU green bond taxonomy. In addition,
People’s Bank of China (PBOC) has published new standards such as the Financial Institution's Green Finance Assessment Plan, which expands the scope of assessment from green loans to more financial instruments, particularly bonds, and the Environmental Equity Financing Instrument Standards, which clarifies the overall requirements, value assessment, risk control, and other details for environmental equity financing instruments.
In the U.S,. the current White House administration has declared climate risk as a systematic risk to the financial system through its recent report coming out of Executive Order 14030. U.S. regulators are cognizant of the risks posed by climate change and are looking to address them. Recently, Michael Hsu, the acting comptroller of the Office of the Comptroller of the Currency (OCC), laid out a two-prong approach to identifying, measuring and managing climate risk. He states that, “First, we must engage with and learn from others. The OCC recently joined the Network for Greening the Financial System (NGFS), a group of central banks and supervisors from across the globe who share best practices. Second, we must support the development and adoption of effective climate change risk management practices at banks.”
Climate risk disclosures and good data
Financial institutions face many different types of risk due to climate change. Regulators and financial institutions alike must understand the impact that climate can have on their traditional categories of risks: credit risk, market risk, liquidity risk and operational risk. Without a thorough understanding of the effects of climate on an institution’s financial statements, regulators and investors lack a proper grasp of the stability of individual firms and the entire financial system, nor a proper plan to respond to potential shocks to the system.
The PBOC must use the tools at their disposal to ensure that financial institutions and investors are well prepared for risks that arise from climate. As an important early step, China has taken a firm stance on climate and emissions disclosures becoming mandatory in the very near future.
Diving further into understanding the risks from climate change, the PBOC has been conducting stress tests to assess climate risks for systematically important banks and look to roll out broader testing on all 4000+ banks this year to understand how the financial system would react to potential shocks. In addition, the PBOC has published the Guidebook for Environmental Disclosures for Financial Institutions. This guidebook is a firm attempt from the central bank to standardize environmental disclosures for financial institutions and help guide capital towards green/low carbon projects with more precision through the quantification of environmental risks in financial terms.
Furthermore, the China Securities and Regulatory Commission issued an updated guidance on the content and format of annual and semi-annual reports for listed companies, including adding a dedicated chapter for ESG, disclosing all enforcement records for environmental violations, and encouraging the disclosure of carbon emission reduction efforts and its impact.US regulators have not yet begun stress tests, though several leaders have discussed them as a likely future step, with no specific timeframe given yet. They are much further along in requiring mandatory disclosures, with the Securities and Exchange Commission (SEC) moving forward developing a rule at this time.
While existing rules and guidance do push companies to disclose climate risk, it is taken as voluntary. A new proposed rule is expected by December or January. To start the process, the SEC issued a Request for Information (RFI) earlier this year on climate reporting, which NRDC provided detailed comments to, encouraging this move as essential for understanding climate risk in investments and our economy. Since that RFI, SEC Chair Gensler has publicly committed to requiring climate disclosures for public companies. As Gensler and other regulators have pointed out, mandatory disclosure is a key first step to understanding the enormous risks climate change poses to our investments, economy, and financial system by providing consistent, reliable, and comparable data.
As both countries make progress on climate risk disclosure, ensuring frameworks and reporting align to the point that investors can compare across investments and geographies will make the systems stronger and less burdensome.
Different disclosure standards and ESG requirements can lead to inconsistent and sparse environmental data. The veracity and wealth of underlying data must exist to ensure proper execution of establishing the proper standard taxonomies and climate disclosures mandates.
As iterated by the US Treasury, “quality data and comparable frameworks of disclosure are crucial for addressing climate-related financial risks and mobilizing sustainable finance. We note the importance of working to address these risks. We look forward to discussing, at our meeting in October, the SFWG Synthesis Report and a multi-year G20 Roadmap on sustainable finance, initially focused on climate.”[iii]
At the G20 Summit, we expect the U.S. and China to discuss and work together on 1) creating a global standard for various frameworks and taxonomies for addressing climate risks, 2) creating a global methodology in which to measure these risks, and 3) enforcing these methodologies through coordinating mandatory climate disclosures for both public and private institutions in the financial sector.
[i] https://www.g20.org/g20-sustainable-finance-working-group.html “G20 Sustainable Finance Working Group”