Michele Leung, Green Finance Advisor of Friends of the Earth (HK)

Similar to other corporates, banks are exposed to ESG risk across Environmental, Social and Governance pillars.

A strong corporate governance would support the long-term sustainability and resiliency of the banks. The recent failure of U.S. regional banks like Silicon Valley Bank and Signature Bank indicated there is a lack of risk management expertise on the board, which raised questions on their board oversight. Some research also showed banks in APAC lagged behind their global peers in maintaining the independence of risk committees.

Under social aspects, human capital development and privacy & data security are the two key issues to pay attention to. Especially under current economic slowdown, there is increasingly more employee turnover and scrutiny related to hiring practices and employee benefits.

Among all three pillars, environmental risk stood out as banks are heavily exposed to environmental risks through their lending and underwriting activities, which may lead to reputational and credit costs. Banks should review and mitigate their environmental risks by first understanding their loan book exposure across different environmental intensities, then integrate these into their overall risk framework and oversight, price ESG risks into financing activities or even explore green finance opportunities.

Specifically on climate, many countries ramped up their efforts on climate related banking regulation. Regulators are setting expectation on integrating environmental and climate risk across the bank’s business model, strategy, governance, risk management and disclosure. For example, on the international level, Bank of International Settlement published general principles for climate risk management. In the EU, the European Central Bank conducted a climate risk stress test in 2022 and the European Banking Authority published its final draft Implementing Technical Draft (ITS) on Pillar 3 disclosures on ESG Risks. In APAC, the Monetary Authority of Singapore (MAS) published guidelines on environmental risk management for banks. In Hong Kong: Hong Kong Monetary Authority (HKMA) published the Supervisory Policy Manual (GS1: Climate Risk Management) in Dec 2021, and recently announced the Round 2 of Climate Risk Stress Test (“CRST”).

Carbon footprinting is the fundamental step to measure and understand their exposures, as a next step, banks are asked to use climate scenario analysis in managing their climate risk, for example, HKMA request banks to adopt NGFS scenario and cover different paths including orderly, disorderly, run the assessment from now to 2050. In addition, banks would evaluate physical risk and access their loan portfolio’s regional exposure to chronic and acute risks.

Banks should start preparing now, they are expected to familiarize themselves with local and global regulations as the regulatory landscape is evolving. They should also get ready for Scope 3, an analysis showed financed emissions account for almost 80% of financial institutions’ total carbon footprint. Scope 1/2 and Scope 3 emissions must be disclosed on a best effort basis covering the most relevant sectors. Banks should begin to consider other ESG factors, while the current focus of disclosure requirements is on climate, this will eventually be extended to broaden the scope of quantitative disclosures to other ESG factors (i.e. other environmental issues and biodiversity topics).