Banks in the GCC region are tackling climate transition risk, but it remains a ‘work-in-progress’

Standard & Poor’s Ratings has this week addressed frequently asked questions about climate transition risk facing banks in the Gulf Cooperation Council (GCC) countries, describing banks’ efforts in measuring the risk to date as a ‘work-in-progress’. S&P evaluated the risks facing the banks it rates primarily thorough the three channels of credit, liquidity, and legal risk.

S&P identified 12% of banks’ financing going to transition-exposed sectors in the region. It also highlighted the relatively low direct exposures to hydrocarbons, saying it “may be surprisingly low, given the importance of hydrocarbons in GCC economies, but it is worth noting that large national oil companies typically self-finance via joint ventures or access international capital markets.”

This was one of the points noted in the RFI Foundation’s financed emissions reports on markets in the GCC. The method we used to estimate banks’ Scope 3 emissions takes this into account by matching domestic emissions with domestic financial institutions. This measurement incorporates only those emissions from activities domestically, which excludes Scope 3 emissions from use of exported commodities and leads to estimates that are more relevant when considering domestic financial assets.

On the topic of financed emissions, like those covered by RFI Foundation’s financed emissions database, S&P highlighted that “banks’ difficulties with measuring scope 3 emissions come up regularly in our discussions”. This is understandable because emissions measurement is an almost universal challenge for banks globally. Data collection often improves based on efforts to require it for large, listed companies through stock exchanges, and by bank regulators through their regular supervisory channels including stress testing.

The data collection and validation process is one that develops over time, and like most emerging and developing countries, the GCC countries have only more recently embarked on these types of processes, with all regional exchanges signing up to the Sustainable Stock Exchanges initiative during the past decade. Climate disclosure and stress testing for banks has been a more recent phenomenon in developed countries where the underlying data are more accessible, and has only become elevated as a priority in GCC countries in recent years as the understanding of the financial impacts of climate-related risks has grown.

This context was the motivating factor for the way RFI undertook its financed emissions work, which is catalogued in an open-access database with five years of data covering banks and financial markets in the six GCC countries and five other markets. There are several dimensions of ‘financed emissions’ that matter for different stakeholders.

The regulatory view is guided by the importance of maintaining financial stability and resilience to climate-related shocks. It is focused on how individual banks are managing their climate-related financial risk exposures within their overall risk management strategies. Regulators are also concerned about the consequence of market-wide climate-related risk exposure and the aggregate impact of a climate-related shock and banks’ response to it on financial stability overall.

This view is not necessarily shared by investors, who are primarily focused on comparing the near-term, climate-related risks they are exposed to in the shares, bonds and sukuk of one bank compared to another peer bank or one in another market. One of the main differences is the time scale over which data quality improvements are expected to occur and how data gaps should be filled.

A hypothetical investor may want to prioritize access to high-quality, comparable data for all banks as soon as possible, which has been embedded into sustainability reporting frameworks such as the IFRS Foundation’s S2 climate disclosure standard, with some form of assurance to ensure quality and especially comparability.

A regulator may share the investor’s appreciation for banks providing the highest quality of data to investors and other stakeholders, but the availability of data alone may not be enough of a priority if it detracts from the ability of the bank to understand the climate-related risks its financing portfolio contains and to manage or mitigate as the risks materialize over time. In addition, governments are often concerned both about the financial impact of climate-related risk and the potential consequences for financial stability, but also about the impact of the energy transition on the wider economy.

Research conducted for the International Labour Organization (ILO) and Islamic Development Bank (IsDB) that was released at COP identified significantly divergent outcomes for employment across the MENA region depending on how policies were selected to achieve or exceed countries’ climate NDCs. The macroeconomic estimates they presented found that substantial economic growth and millions of jobs could be created through strong industrial and climate policies.

The financial sector plays a key role in financing the types of scenarios envisaged by the ILO and IsDB, and will need substantial new capabilities beyond what they have now. Among those capabilities will be many that focus on understanding, measuring and disclosing climate risks to investors in a form that is consistent with international reporting standards, but improving carbon accounting skills is just one part of what banks will be asked to do.

They will have to balance the commitments they need to make in improving their data collection and reporting of climate data with the need to build climate strategy into their overall business and risk management strategies. While this is happening, they will need to orient their activities in the near-term before the climate data that investors seek are available.

‘Order of magnitude’ estimates such as those developed by the RFI Foundation will play a key role in evaluating climate risks and interlinkages within the financial sector. Because they are developed from the top-down, they don’t need as much data to provide useful insights for banks, regulators and policymakers. Over time, they may be overtaken by bottom-up data and regulatory-led or mandated scenario analysis. When speed is the name of the game, as it is with climate change, it is better to act today with the data we have than waiting to act tomorrow with improved data.

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