Why financial regulation can sit at the heart of embedding climate risk into the financial community.

The future of the planet looks bleak but could financial regulators be the unlikely heroes who save the day. That was the suggestion of the Environmental Audit Committee’s Green Finance Enquiry. One of the main messages of its report, Greening Finance: Embedding Sustainability into financial decision making was that regulators needed to promote a step change in climate risk reporting.
The financial sector is often lumbered as the villain of the piece. Almost all the world’s problems from poverty to hunger and climate change are laid at its door – not entirely without justification. If it’s part of the problem, then, it stands to reason that it could be part of the solution.

The fact is that the financial sector has an enormous amount of power to improve the sustainability of our planet. It decides where capital goes, and what business practices are rewarded. It can shape a view of the world which is short-term and profit focused or long term and sustainable. The hope of the MPs producing this report is that it can become the latter.

According to the report the financial sector is all too often incentivised to prioritise short-term revenue over longer term and more sustainable considerations. As Mary Craegh, Chair of the ECA said, that not only presented a threat to the environment but it also created a long term financial risk.

She is quoted as saying: “We need to fix the incentives in our financial system that encourage short term thinking. Long-term sustainability must be factored into financial decision making. Climate change poses financial risks to a range of investments – from food and farming, to infrastructure, construction and insurance liability.”

Their recommendations include giving pensions savers greater involvement with where their money is invested, and to make climate risk reporting mandatory. This, they say, could be done under the current regulatory framework. It says the companies act 2006 requires companies to disclose climate risks which are deemed to have financial liabilities.

There is growing momentum behind this. Earlier in the year the Taskforce for Climate Related Financial Disclosures (TCRFD) created a voluntary framework to embed climate risk reporting as part of the overall filing process.
So far, a number of companies have already made the move to adopt the framework, but in terms of official progress, things are looking slow. The Government has made some encouraging noises, but that’s about as far as it goes. The Bank of England has made some progress, but the FCA and FRC have both faced criticism for failing to enforce existing rules.

While that’s the case, little will change. Perspectives will continue to be short-term and businesses will remain unsustainable.

It is regulators who can inject lasting change. By forcing companies to report on climate risk they can encourage a longer-term perspective and promote a greening of the financial world. For this to happen campaigners are calling for two things. Firstly, that regulators adopt guidelines for their specific areas based on the recommendations of the TCRFD. Secondly, they want to see public examples of enforcement so the sector can see that regulators are following through on their commitments.

One follows the other and, while the EAC’s report only focuses on climate risks which present a threat to the profitability of the company, the very fact that firms start to report on climate risks will do much to inject sustainability into the system. As such, financial regulators may well represent the last great hope of planet Earth. All they need now is a cape.