How financial institutions can assess environmental risk

Environmental risk management demands a systematic and integrated approach by financial institutions. Climate change is making parts of the world uninsurable, the degradation or collapse of ecosystems is disrupting supply chains, water insecurity is already impacting companies through stranded assets, and air pollution affects the costs of debt.

Our entire economic system and lives rely on nature; over half of global economic value generation (circa $58 trillion) is moderately or highly dependent on natural systems. This is a significant increase from 2020, when the World Economic Forum highlighted the crucial importance of nature. Failure to act on environmental concerns poses substantial material risks. The World Economic Forum has consistently ranked biodiversity loss and ecosystem collapse among the top risks facing the world in the next 10 years.

Increasing nature loss presents a threat to the long-term sustainability of businesses, their investors and creditors, and the global economy as a whole. Nearly $33 trillion could be lost from global GDP by the end of the decade without concerted action to protect biodiversity and ecosystems.

The US Department of Agriculture found that pollinators underpin one in every three bites of food eaten on the planet. Bees cannot be replaced if driven to extinction. They are a reminder that the economy is a wholly-owned subsidiary of the environment and not the other way around.

Today’s global environment is characterized by change and uncertainty, and the onset of climate change, combined with nature loss, is expected to accelerate and amplify these factors. At the United Nations Environment Programme Finance Initiative (UNEP FI), we have been working with banks, insurers and investors on risk since 2017. We are working to develop approaches and resources to help financial institutions identify, measure, disclose and manage climate-related risk, in line with the FSB’s Task Force on Climate-Related Financial Disclosures (TCFD) recommendations, which are now included in the ISSB’s Standards.

As the impacts of environmental risks intensify, they lead to substantial economic costs and asset devaluations, affecting the stability of financial systems worldwide. Moreover, the transition to a low-carbon economy, while necessary, brings its own set of risks for industries or companies that are unprepared for mitigation measures, such as the transition away from fossil fuels, including stranded assets and market volatility.

The UN climate change conference outcome in Dubai brought to the forefront what those working in the nature community already knew: action on climate needs to go hand-in-hand with action on nature. The failure to mitigate and adapt to climate change, along with large-scale environmental damage, are seen as significant threats to our economies and financial systems.

The lessons learned from TCFD implementation have informed our work with financial institutions to test the draft Task Force on Nature-Related Financial Disclosures (TNFD) risk management and disclosures framework. This work has brought to the forefront the need to get a better handle on the economic impacts of the triple planetary crisis of climate change, pollution and biodiversity loss.

The tools to integrate the science of climate change and biodiversity and ecosystem change into risk modelling are still in their infancy. Over the next decade, the focus intensifies on advancing methodologies to climate change impact, biodiversity loss and ecosystem collapse, alongside the urgent need for comprehensive climate and environmental strategies and transition plans to ensure global stability and security.

Central banks and financial regulators are beginning to understand the importance of identifying nature risk and acting on nature loss; the Network for Greening the Financial System (NGFS) published a technical document in 2023 that underlined the importance of central bankers, supervisors and financial actors at large being armed with tools that allow them to accurately estimate the plausible impacts of nature-related hazards and policies on the financial system.

We are seeing the financial sector stepping up. Over 330 banks are implementing the Principles for Responsible Banking, the UN-convened sustainability framework for the global banking industry, which includes a commitment to manage risks to people and the environment, resulting from their activities, products and services. Many signatories are working towards setting biodiversity targets that complement their climate targets.

The complex linkages between climate, nature and pollution require more research and collaboration between forward-looking organizations. Addressing climate change in isolation overlooks broader environmental risks. Integrating biodiversity and ecosystem health into financial risk assessments can ensure a more comprehensive understanding and management of the interconnected challenges.

During the 2024 World Economic Forum meeting in Davos, UNEP FI announced it will establish a new Risk Centre. This will be a one-stop-shop for financial institutions to manage climate, nature and other sustainability risks and offer integrated solutions and resources to address the triple planetary crisis.

The Risk Centre will aim to develop and build on practical tools, case studies, guides and frameworks for financial institutions to analyse and manage risks across areas, including climate change, nature, pollution and social issues. In 2024 the UNEP FI Risk Centre will provide materials and resources for knowledge sharing and convene working groups to advance analytics and approaches to hot topics, such as climate stress tests and nature risk assessments. Building on UNEP FI’s extensive work with its network of over 500 financial institutions and 150 supporting institutions worldwide, this will help empower the financial sector to actively integrate climate and environmental risk into decision-making.

Advancements in understanding environmental risk also have the potential to catalyse action on risk, and the Risk Centre will be providing UNEP FI members with state-of-the-art knowledge and convening space for peers and leading partner organizations to make sure they can take action with the best available, science-based information.

In today's complex and fragmented world, we need risk sharing now more than ever to find shared solutions. Although our perception of risk and trust has evolved, we are all well aware that you cannot have one without the other. The theme of this year’s World Economic Forum Annual Meeting, Rebuilding trust, underlines the need for unparalleled collaboration and risk-sharing on a global scale.

Register your interest at www.unepfi.org/risk