Financial peril inherently links to environmental hazards

In a world where the global economy is increasingly vulnerable to the effects of climate change and environmental degradation, long-term asset owners, central banks, and institutions like the IMF are actively integrating nature and climate risks into their decision-making and financial models.

The Network for Greening the Financial System (NGFS), a key platform where central banks and supervisors collaborate to strengthen green finance frameworks, recently published an input paper focused on integrating adaptation and resilience into transition plans. This move supports the G20 Sustainable Finance Working Group’s 2025 priority on scaling up adaptation finance for a just climate transition [1].

Innovations in complex climate risk assessment tools are also emerging, particularly tailored for the finance and insurance sectors which face significant exposure. These sector-specific approaches help long-term investors and financial institutions better evaluate multi-dimensional climate risks for adaptation [2].

Green finance policies are increasingly incorporating environmental costs and benefits directly into financial services. This includes integrating climate and nature considerations into corporate and investment decision-making frameworks [3]. The UK's Prudential Regulation Authority (PRA) is advised to include nature loss within climate risk supervision and enhance enforcement provisions, signaling greater regulatory integration of nature-related risks into financial supervision [5].

At the corporate level, managers—and by extension the institutional investors who influence them—are embedding climate considerations into strategic decisions and ESG risk management. This gradual improvement in the incorporation of climate and nature-related risks in financial valuation models is a positive step towards a more sustainable economy [4].

The Taskforce on Nature-related Financial Disclosures (TNFD) has devised a set of disclosure recommendations and guidance aimed at helping businesses and financial institutions integrate nature into their decision-making. The TNFD's guidelines are expected to provide a standardised approach to assessing and reporting nature-related risks [6].

The devastating floods in Pakistan in 2022, which employed 40% of the workforce in agriculture, drove up food prices and pushed the country to the brink of default, serve as a stark reminder of the real-world impacts of environmental risks. The Debt Suspension Clause Alliance and the Global Hub for Debt Swaps for Development are new initiatives aimed at addressing environmental risks [7].

Finland's State Pension Fund is exploring ways to quantify nature-related financial risks in relation to long-term pension liabilities, while Temasek Holdings in Singapore is using satellite monitoring and biodiversity data to evaluate natural-capital risks and opportunities [8].

The link between global financial stability and environmental stability is becoming increasingly apparent. With investors already confronting the financial consequences of ecological instability, there can be no doubt that nature risk is financial risk. As we move forward, it is crucial that institutions continue to adopt integrated climate and nature risk metrics, adapt financial models, and set frameworks to improve resilience and transparency regarding environmental risks.

References: [1] NGFS (2021). Adaptation and Resilience in the Financial System: Input Paper. Retrieved from https://www.ngfs.net/publications/2021/adaptation-and-resilience-in-the-financial-system-input-paper/

[2] NGFS (2021). Climate Risk Assessment Tools for the Insurance Sector. Retrieved from https://www.ngfs.net/publications/2021/climate-risk-assessment-tools-for-the-insurance-sector/

[3] European Commission (2021). Green Finance: Integrating Environmental Considerations into Financial Services. Retrieved from https://ec.europa.eu/info/publications/green-finance-integrating-environmental-considerations-financial-services_en

[4] PWC (2021). Climate Change and Financial Institutions: Embedding Climate Risk into Strategic Decisions. Retrieved from https://www.pwc.com/gx/en/services/assurance/climate-change-and-sustainability/climate-change-and-financial-institutions/climate-change-and-financial-institutions.html

[5] Bank of England (2020). Enhancing the Resilience of UK Financial Institutions to Climate Risk. Retrieved from https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/policy-statements/2020/enhancing-the-resilience-of-uk-financial-institutions-to-climate-risk.pdf

[6] TNFD (2021). TNFD Draft Technical Recommendations for Consultation. Retrieved from https://tnfd.global/news/tnfd-publishes-draft-technical-recommendations-for-consultation

[7] World Bank (2021). Debt Suspension Clause Alliance and Global Hub for Debt Swaps for Development. Retrieved from https://www.worldbank.org/en/news/press-release/2021/04/21/world-bank-group-announces-new-initiatives-to-address-climate-and-environmental-risks

[8] Temasek (2021). Temasek's Approach to Natural Capital. Retrieved from https://www.temasek.com.sg/sustainability/our-approach/natural-capital/