The Financial Services Council (FSC) today published its “Climate Scenario Narratives for the Financial Services Sector” (Report). A link is available here.
Who needs to read it and why?
Directors and Senior Executives of the approximately 190 large financial institutions and NZX-listed companies which are climate reporting entities (CRE) under Part 7A of the Financial Markets Conduct Act 2013 (FMCA), as well as any person involved in preparing the climate-related disclosures (CRD), should read the Report. It will be particularly relevant to CREs who are licenced fund managers and life and health insurers as the FSC is the lead industry association for such entities. However, CREs in other sectors will also find it useful since fund managers and insurers invest across all industries, and do so internationally as well as in New Zealand.
It is also helpful for non-CRE entities who are looking to better understand the potential physical and transition impacts on their businesses in relation to three climate scenario narratives which would of course affect all businesses, in the short and long term.
What does it cover?
The FSC’s Report is designed to support fund managers, and health and life insurers in the reporting of climate-related risks and opportunities under the framework developed by the External Reporting Board (XRB) following the enactment of Part 7A of the FMCA, and as set out in NZ CS 1, NZ CS 2 and NZ CS 3 – the climate reporting standards issued in December 2022 by the XRB (Standards).
Under the Standards, CREs are required to analyse at least three climate scenario narratives based on increases in the earth’s temperature, over short, medium and long-term horizons, since pre-industrial times, to identify its climate-related risks and opportunities and develop a better understanding of the resilience of its business model and strategy. The Standards make it clear that the scenarios are not predictions, but instead are part of a process for systematically exploring the effects of a range of plausible future events under conditions of uncertainty.
The Report seeks to assist CREs by posing three scenario narratives and horizons to be used in climate-related risk and opportunity assessments and disclosures:
1. “orderly” transition, which is based on a 1.5 degrees Celsius increase in the global temperature. This is specified in CS 1, and broadly assumes achievement of the goals under the 2015 Paris Accord;
2. “too little too late”, which is based on a greater than 2 degrees Celsius increase. CS 1 leaves open to CREs what degree increase to choose their third scenario, so entities may choose this or another scenario; and
3. “hothouse” which is based on a greater than 3 degrees Celsius increase. This is specified in CS 1 and which broadly aligns with the path the IPCC say we are on if current government commitments are met, but no further action is taken.
The Report describes how each of these scenarios may occur, and what may happen if they did, including an approach to identify and assess:
- portfolio level climate-related risks and high-level climate-related opportunities – aimed mainly at fund managers; and
- portfolio level climate-related risks, operational/key product climate-related risks and high-level climate-related opportunities – aimed mainly at life and health insurers
The Report identifies that insurers and fund managers are exposed to climate-related risks and opportunities in two main ways- through their products and operations, and through the portfolios of assets that they invest in.
Our view
As outlined in the Explanatory Note to the Bill which introduced Part 7A of the FMCA, a key purpose and goal of introducing the CRD regime is to provide consumers with the “consistent, comparable, reliable, and clear information about climate-related risks and opportunities” to shift investments towards low emissions sectors. While this is a worthy goal, as New Zealand is a first mover to make CRD mandatory for CREs, the task for CREs is not an easy one, particularly with limited availability of data.
The Report is not only reader-friendly through the use of diagrams and graphs, but it also synthesises, from quite technical information, fund manager and life/health insurer-specific outcomes based on the three scenarios. It is therefore a highly valuable contribution to the resources available to CREs to develop their own disclosure. It sits alongside the comparable reports produced by other industry groups which may also be of use – the XRB has helpfully listed the sector-level scenario analysis and its current status here.
Importantly, there is no requirement that FSC members or others must use the approach outlined in the Report – indeed, they must consider their own circumstances and develop their own climate-related disclosure. Having said this, there is value for investors in comparability and consistency in the assumptions underpinning each CRE’s individual disclosure, and that should facilitate increased competition on an informed basis.
Other CREs (and indeed non-CREs) grappling with how they might approach scenario-setting and what the identification of climate-related risks and opportunities may look like for them should also take advantage of the Report. The scenarios, particularly, the “hothouse” narrative, come as a sobering reminder of what the world may expect in the short, medium and long term if we do not take sufficient steps to mitigate climate change. It will therefore be of interest to all forward-thinking directors and executives as a useful tool for identifying risks and opportunities across various sectors, asset classes and geographies. Because fund managers and insurers invest across all industries, and internationally as well as in New Zealand, they have had to consider a broader range of impacts than other sectors.
The first reporting period for CREs will align with their first financial reporting period starting on or after 1 January this year, with the first climate statements expected to be published as early as March or April 2024. So, many CRE’s (especially those with 31 December or 31 March balance dates) will already be well advanced in understanding their responsibilities under the regime.
See our recent financial services news alerts on CRD below:
FMA red-flags greenwashing
XRB publishes final Climate-related Disclosures Staff Guidance for All Sectors
New Zealand leads with mandatory climate-related disclosures
What next?
The FMA is expected to release its detailed record keeping guidance for consultation this month, with the final due to be published in August this year.
The XRB is also busy, having recently published its guidance for all sectors and currently working on additional specific guidance for managers of registered managed investment schemes, as well as banks and insurers.
Please get in touch with one of our experts if you have any questions on the CRD regime and how it may affect your business.
This article was co-authored by Zena Razoki, a senior associate and Elise Plunket, a solicitor in our Financial Services team.
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