Global warming

Climate change is a pressing issue of the World today. The continued burning of fossil fuels and other human activities are causing greenhouse gas (GHG) emissions, which are trapping heat in the atmosphere and in turn cause rising temperature, melting glaciers, rising sea level, and more frequent natural disasters. Hong Kong is similarly affected by climate change. Temperature increased at a rate of 0.28°C per decade from 1993 to 2022 and the mean sea level at Victoria Harbour rose at a rate of 32 mm per decade from 1954 to 2022 on average. In recent years, Hong Kong is also experiencing more extreme weather events such as stronger typhoons and torrential rainfalls. Extreme weather events adversely affect the city’s transportation and communication networks, economic activities, and the well-being of its citizens.

In an effort to combat adverse climate change associated with rising temperature, 196 parties at the United Nations Climate Change Conference adopted the Paris Agreement in 2015. The Agreement sets the target of limiting global warming to below 2°C above pre-industrial levels and pursues efforts to limit the temperature increase to 1.5°C. The Agreement calls upon its signatories to cooperate with, among the others, financial institutions in order to mobilise stronger climate actions in the World.

There is growing recognition that climate risks are a source of risk for the financial sector. Climate risks generally refer to the risks posed by climate change, such as damage caused by extreme weather events or a decline in asset value in carbon-intensive sectors, and can affect the safety and soundness of authorized institutions in Hong Kong (“AIs”) and the broader financial system if not properly managed. Climate risks are broadly classified into physical risk and transition risk.

What is physical climate risk?

Physical climate risk describes the risk of physical damage and disruption to people, property and productivity driven by climate change, such as damage to property and infrastructure due to extreme weather events such as floods, droughts, and wildfires.

Physical climate risks can be driven by short-lived devastatingly impactful climate shocks such as hurricanes or heatwaves and longer-term climate stresses such as changing sea levels or a steady rise in average temperatures. In the long run, they can depreciate the value of physical assets. The resulting damage can have a significant impact on the financial system. Companies affected by flooding or droughts may have difficulty in servicing their debts. Collaterals such as buildings or land might suddenly lose value. These can affect the stability of the financial system.

What is transition climate risk?

Transition risks are business-related risks that follow societal and economic shifts toward a low-carbon and more climate-friendly future. Such risks include:

·           policy and regulatory risks in the restriction of negative contributors to climate change and encouragement of climate-resilient changes to business operations;

·           legal risk arising from instituting lawsuits against organisations in their failure to manage climate risk;

·           technological risks where disruption is driven by the development of new technology to support a low-carbon economy;

·           reputation risk where negative perceptions of an industry or a company in relation to climate change impact its value and access to bank credit and capital markets; and

·           market risks driven by economic and social factors influencing the supply and demand of goods and services.

HKMA published the White Paper on Green and Sustainable Banking

In view of the challenges posed by climate related risks on the banking environment, the HKMA published its “White Paper on Green and Sustainable Banking” in June 2020 to set out its views and supervisory expectations on green and sustainable banking surrounding four areas:

1.      Governance – AIs should develop a governance framework for climate resilience, which the Board of Directors should oversee the development and implementation of the AI’s climate strategy.

2.      Strategy – Climate considerations should be embedded into the strategy formulation process through review and enhancement of organisation structures, business policies, processes through resources availability to ensure effective strategy implementation.

3.      Risk management – AIs are expected to incorporate climate risk considerations into their risk management framework. They should identify the transmission channels and access the impacts of physical and transition risks arising from climate change on their business. AIs should build capability over time for measuring climate risks by using various methodologies and tools, particularly scenario analysis. They should also implement processes to monitor and report exposures to climate risks and carry out measures to control and mitigate the exposures.

4.      Disclosure – AIs should develop an approach to disclosing climate-related information to stakeholders such as regulators, investors, customers and depositors to enhance transparency of risks faced by AIs and the approach taken to addressing such risks. When considering the information to be disclosed, AIs should take the Task Force on Climate-related Financial Disclosures (TCFD) recommendations, which have gained broad support among preparers and users internationally and are also widely recognized, adopted or referenced by regulators and authorities, as the core reference.

Climate Risk Management module of the
HKMA Supervisory Policy Manual

Evolving along the direction described above, the HKMA has formulated module GS-1 on climate risk management in its Supervisory Policy Manual for the purpose of providing guidance to AIs on key elements of climate-related risk management, and to set out the HKMA’s approach to, and expectations in, reviewing AIs’ climate-related risk management. This module is applicable to all AIs. International banking groups operating in Hong Kong should have a framework in addressing climate-related issues appropriate for their Hong Kong operations. If certain processes are centralized at the group or regional level, the AI should assess whether such processes are appropriate in the local circumstances. Whether having its own framework for the Hong Kong operation or relying on the group/parent, AIs should, upon request by the HKMA, be able to demonstrate that the relevant functions are appropriate for the size, nature and complexity of the local operations and are in line with the requirements of the module GS-1 in all material respects.