Asia-Pacific Financial Regulatory Practices for Climate Risk Management

The co-authors of this article are Nels Ylitalo, VP, Director of Product Strategy for Regulatory Solutions at FactSet, and Pooja Khosla, Ph.D., Chief Innovation Officer at Entelligent. 

Stress testing, scenario analysis, and transition risk considerations are crucial for Asia-Pacific asset managers seeking to mitigate the financial risks of climate change. Proper consideration of climate issues allows asset managers to identify investment opportunities that are more resilient to the physical and transition risks associated with climate change—creating long-term value for clients and investors.

Climate risk is a growing international theme in financial regulation and supervision, with heightened scrutiny following the 2008 financial crisis. The globally focused Financial Stability Board (FSB) launched the Task Force on Climate-Related Financial Disclosures (TCFD) in 2015, the same year as the signing of the landmark Paris climate agreement.

In the years since the TCFD published recommendations on disclosure—addressing governance, strategy, risk management, and metrics and targets—they’ve been adopted by thousands of organizations and used in the sustainable finance and regulatory frameworks of many countries.

Climate risk financial regulation, like climate risk itself, has multiple drivers and transmission channels:

• Initiatives of bodies such as the FSB and the International Organization of Securities Commissions (IOSCO)

• Binding accords such as the Paris agreement

• Regional and national net zero goals

• Voluntary associations such as the Network for Greening the Financial System (NGFS)

• Myriad regulatory requirements, supervisory exercises, and guidelines

Asia Pacific: A Survey of Supervisory Approaches

Below are highlights of initiatives focused on climate risk management requirements:

Japan: In tandem with a raft of initiatives in relation to corporate TCFD disclosures, green bond standards and data, carbon credit trading and transition finance, the Financial Services Agency (FSA) published guidelines in 2021 for financial institutions on climate-related risk management and client engagement.

Australia: The members of the Council of Financial Regulators—the Reserve Bank of Australia (RBA), Australian Prudential Regulation Authority (APRA), Australian Securities and Investments Commission (ASIC) and the Treasury— are developing and implementing climate risk management regulations for listed issuers, banks, superannuation funds, and insurers. APRA issued a climate risk prudential practice guide in 2021 that sets expectations for how institutions should manage climate-related risks.

Singapore: The Monetary Authority of Singapore (MAS) published guidelines in 2020 on environmental risk management for banks, insurers, and asset managers. They set expectations on identifying, assessing, and managing environmental risks, including from climate change.

Hong Kong: The Securities and Futures Commission (SFC) published in 2021 a circular, Management and Disclosure of Climate-Related Risks by Fund Managers,” establishing standards for compliance with an amended Fund Manager Code of Conduct (FMCC).

These guidelines exist in a larger ecosystem of efforts to address climate risk in the financial system, including larger-scale climate scenario analysis and stress test exercises across these jurisdictions.

Divergences and Commonalities

Examining the variation among the regulatory approaches:

• Japan’s FSA guidelines place a heavy emphasis on engagement between financial institutions and clients, fostering cross-pollination of expertise, insights, and practices.

• Singapore’s MAS guidelines delineate between expectations for different financial industries and participants.

• The Hong Kong SFC circular is accompanied by a flowchart and informative practices guide.

The requirements across jurisdictions also share common elements that map to the TCFD framework:

• Governance

• Strategy

• Risk management

• Scenario analysis and stress testing

• Disclosure

Overall expectations, tone, and areas of focus for climate risk across Asia Pacific supervisors and regulators are captured succinctly in the Japan FSA’s Strategy on Sustainable Finance:

“It is also important for financial institutions to recognize that how to respond to climate change is a management challenge and to establish an appropriate preparedness for addressing it. Specifically, financial institutions are expected to establish a governance system for climate-related risks, develop business models and strategies that take into account the risks and opportunities of climate change, establish a process for recognizing, assessing and managing climate-related risks, and utilize scenario analysis.”

The guidelines generally incorporate concepts of proportionality and recognize the need for capacity building within firms based on differing materiality of climate risk across financial industries. While expressing awareness of the challenges around climate risk data availability—and the need to further develop methodologies for climate scenario analysis and stress testing—they express a common theme toward increasing rigor and formalization of climate risk management over time.

For example, in the climate scenario analysis section, the MAS guidelines indicate that scenarios may be both near term and long term and should assess exposure to both physical and transition risks, such as exposure to sea level rise or increases in the cost of doing business due to higher carbon prices.

In this broad context of supervisory pressures, increasingly formalized requirements, challenging data availability, and burgeoning awareness of financial risk from climate change, what approaches can firms now take to address climate risk in their investment processes and portfolios?

Addressing Risk with Data and Analytics

Taking advantage of a directional score that estimates the return spread for equities across Paris-aligned and business-as-usual scenarios, FactSet partner Entelligent’s T-Risk (a factor identifying sustainability risk) can help asset managers identify securities or construct portfolios that are likely to outperform in a low-carbon future. When T-Risk is added to investment portfolios such as MSCI World Climate Change Risk Index, the portfolio’s carbon exposures and footprint are reduced as well.

In the chart below, when global economic conditions and the business environment move toward low-carbon scenarios (T-Risk orderly under 2.0), the MSCI All Country Asia-Pacific screened portfolio (green line) outperforms the benchmark. Considering upcoming APAC regulations, outperformance is likely to be more significant in the future. The green line also depicts the top 25th percentile leaders in climate transitions as recorded by Entelligent T-Risk, while the red/pink line shows the 25th percentile laggards.

MSCI All Country Asia Pacific (USD)

Source: FactSet PA Analytics

About the Authors

Nels Ylitalo is VP, Director of Product Strategy for Regulatory Solutions at FactSet. Previously, he worked in signals intelligence in the United States Navy prior to attending law school at Yale where he earned a JD in 2007. Following law school, he was a corporate/M&A attorney representing VC and PE funds as well as corporate clients in M&A transactions. Mr. Ylitalo’s portfolio covers a broad range of financial services regulations with a current focus on buy-side regulatory requirements and challenges, globally.

Pooja Khosla, Ph.D., is Chief Innovation Officer at Entelligent. She is an economist, econometrician, mathematician, and thought leader in the sustainability and climate finance space, and she has deep knowledge of building sustainable investing solutions. She has extensive experience in predictive modeling, microfinance, and designing impact investment tools. Dr. Khosla has been working on impact solutions since 2003, both nationally and internationally. Since 2016, she has been an inventor of and helped develop Entelligent’s Smart Climate technology and business, Smart Climate indexes, and additional climate risk-related products with partners such as Societe Generale and UBS. Dr. Khosla earned a Ph.D. in economics and has master's degrees in four disciplines.

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