The global financial system relies on a stable climate and environment, and therefore should account for risks that create instability and erode economic value, like climate change and environmental degradation.
Climate-related risks include the physical impacts of climate change, like wildfires and drought, and transition risks, those associated with responding slowly to the transition toward a low-carbon economy, driven by the rapid adoption of climate policies or technologies that affect economic activity. Nature-related risks are associated with economic activities that jeopardize the integrity of natural systems on which those activities rely, such as biodiversity loss and ecosystem degradation.
Climate- and nature-related risks are interconnected, and a financial system that accounts for them requires that they be factored into decision-making. Measurements of climate- and nature-related risks help corporations target investments and interventions that advance sustainable business transformation by reducing greenhouse gas (GHG) emissions and enhancing climate resilience. Accurate, timely, complete and comparable disclosures from non-financial corporations (those that operate in the real economy) are needed for other market stakeholders — like financial institutions and regulators — to deploy capital efficiently and monitor and manage risks at a portfolio or systemic level.
The International Sustainability Standards Board (ISSB) and the Taskforce on Nature-related Financial Disclosures (TNFD) have developed standards and frameworks to help corporations and other organizations measure and disclose the financial impact of these risks in a consistent, actionable manner. These frameworks are useful for any corporation seeking to manage climate- and nature-related risks in their operations.
The growing awareness of climate- and nature-related risks in the private sector is already driving businesses to respond. Businesses are adopting net-zero transition plans and introducing internal carbon prices to implement the changes that will help them manage a transforming technological, political and consumer landscape driven by climate change. Businesses can also aim to mitigate biodiversity harm and ecosystem degradation in order to reduce their exposure and contribution to such risks. So far, most climate- and nature-related risk disclosure has occurred on a voluntary basis, but regulators in most of the world’s largest capital markets are considering mandating such disclosures and incorporating them into the supervision of the financial sector.
Mandatory disclosure requirements will be necessary to standardize and measure risks across the entire economy. Thirty-five countries have set some form of mandatory climate disclosure requirements, with the EU’s initiative expected to be the most comprehensive and rigorous. Likewise, financial risks must be integrated into the supervision of financial institutions and the financial system as a whole. Regulators also need to ensure that climate risk integration does not lead to inequitable outcomes, such as reducing access to financing for communities that are most vulnerable to climate impacts.
Integration of climate- and nature-related risk measurement and disclosure will help individual firms and markets respond to and manage these risks. It will also allow investors to value companies accurately.
Risk integration by itself will not set the global economy on a path to net-zero GHG emissions. Companies and financial institutions must not only manage risk, but also ensure that their investments are aligned with Paris Agreement goals. However, risk management will accelerate the movement of capital (and change the cost of capital) in response to other systems shifts, such as climate policy and technological changes. It will complement other necessary shifts in the financial system and other sectors.
