A constantly evolving path in Sustainability and Climate Risk obligations for German Banking & Financial Markets – but the direction is unmistakable

Veröffentliche eine Notiz:

To say that the past 3 months brought sustainability and climate risks to the forefront of social and political life in Germany would be an understatement. The most important task right now is to assuage people’s suffering and restore a sense of normality to the areas most affected by the devastating July floods. What should not be forgotten, though, is that the political and economic institutions (both within and outside Germany) have also been evolving quite significantly in the same timeframe, as if to keep apace in a relentless race against time.

On May 5, the federal cabinet adopted the first German Sustainable Finance Strategy[1], with the explicit goals of mobilizing investments that are urgently needed for the broader society and of addressing climate risks as they pertain specifically to the German financial system. The strategy document itself[2] makes for compelling reading, as it specifically prioritizes:

• Improving transparency
• Strengthening risk management and supervision
• Improving and implementing impact assessment methods
• Financing transformation
• Focusing government SCR action in capital markets
• Creating efficient structures for implementing the strategy

Federal foreign trade financing and domestic guarantees are areas where sustainability criteria are expected to be explicitly considered going forward (hence export finance and structured finance houses will need to adapt their own credit approval processes). A German green bond yield curve is also to be established, as a way of incentivizing markets in Green German Federal Securities – which should entice both German and international investment banks as well as asset managers and individual investors.

This is not a mere strategy document, but a well thought-through high-level blueprint that shows that banking and financial know-how was already aligned with political thinking behind the scenes.

Of course, it helps if a strategy document is implemented. This is where the German Federal Constitutional Court already lent a helping hand through a March 24 decision[3] which has been hailed as a landmark one, as it:

• Reinforced that the German Constitution and Laws “compels the state to engage in internationally oriented activities to tackle climate change at the global level and requires it – the Federal Government in particular – to promote climate action within the international framework”.

• Left the door open to individuals living abroad to claim damages against German interests on account of inability to take action, by opining “Although it does appear conceivable in principle, there is no need to decide at this point whether duties of protection arising from fundamental rights also place the German state under an obligation vis-à-vis the complainants living in Bangladesh and in Nepal to take action against impairments caused by global climate change. In their own countries, the complainants are particularly exposed to the consequences of global warming caused by global greenhouse gas emissions. Since greenhouse gas emissions have a global impact, further global warming can only be prevented if all states take climate action. This means that greenhouse gas emissions must be reduced to climate-neutral levels in Germany also.” (passages put into bold-face by the current authors).

Subsequently, the German federal parliament passed on June 24[4][5] an amendment to the 2019 Climate Protection Act, as the aforementioned constitutional court decision had rendered it in effect unconstitutional in parts. The amendment was approved by the Upper House of Parliament on June 25[6], and is already prompting investment action as it

• Makes the target time for climate neutrality earlier (2045) and legally binding

• Introduces stricter greenhouse gas (GHG) reduction targets

• Aligns German climate risk targets with EU ones

The EU, not to be outdone, also created some excitement in matters Sustainability and Climate Risk both collectively and through individual member states. As a minor example, the Conseil d’État (France’s top administrative court) on July 1 issued an uncharacteristically stern warning[7][8] to the French executive that it has 9 months to get its act together and start implementing the international agreements that it already signed. The (also) minor detail that April 2022 just happens to be the time of the next French presidential elections serves to add to the -by now general- excitement. 

Bringing down the excitement level, on June 7, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS[9]) published the second vintage of climate scenarios for forward looking climate risks assessment[10]. Climate policy developments since 2018, updated models and data, and the near-term IMF growth projections considering COVID-19 statistics are also included in the scenarios. These now take an expanded set of macroeconomic variables into account, and, importantly, include country-level granularity (for countries that have opted to take part). Far from being a high-level academic contribution, the scenario set is accompanied by a new website full of practical calculation resources[11] and a dedicated portal[12] for analyzing physical risks.

What is there to read in these developments?

First, there are the developments themselves and, second, there are various important points to be mentioned. For example, it is remarkable to see the degree of awareness exhibited by the authors of the constitutional court judgement about the differences between adaptation and mitigation measures in the context of climate risk. Also, the degree of apparent alignment among political thinkers, regulatory experts and legal professionals when it comes to the necessity to implement sustainability criteria on practically every facet of commercial (and in particular financial) decision making is also rather unusual. It is as if the political, judicial and regulatory institutions have all been methodically doing their homework in preparation for a new world of expectations and obligations on German economic actors, especially banks, but also asset managers.

How has the German banking world been preparing for this new world?

According to a recent analysis by a German consulting house specialized in ESG[13], as per 2021 only 5 out of 119 evaluated credit institutions have implemented clear and detailed sustainability criteria in their lending policies. Of the 5, 2 are German subsidiaries of major foreign banks which have already implemented blanket group-wide policies. So, it might be argued that the answer to the above question is that the German banking world is de-facto not yet preparing to align, neither with the international trend nor with the German government’s stated sustainable finance strategy.

Will German Banks and Asset Managers need to formulate and execute own sustainable finance strategies?

IBM believes that the real question is not if, but rather how soon will German banking and financial markets participants be compelled (if not obligated) to demonstrate Sustainability and Climate Risk (SCR) alignment in terms of actual capabilities spanning the entire gamut from strategy to operationalization and IT implementations, complete with risk management and regulatory reporting setups. The political, economic, indeed societal, expectations for a financial system that understands SCR problems and offers practical financing and investment solutions are already high and can only grow with time. The discussion about physical risks and how best to finance hedging them now occupies the evening news and the parliamentary committees, soon most probably also the electoral rallies[14]. Private individuals needing loans to cover climate change-related home renovations, corporates needing to harden existing infrastructures or to make new SCR-conforming physical investments in Germany and abroad, financial advisors needing to align with goal-based portfolio mandates, investors needing advice on how to screen green financial instruments conforming to their own liquidity needs are all going to be demanding timely, adequate and optimized solutions by banks and financial markets participants alike – and this sooner than anyone expected.

Failure to provide such solutions will be not only a failure to align with market expectations, but in all probability also with legal and regulatory ones.

How can IBM help German Banks and Asset Managers on their Sustainability and Climate Risk journey?

IBM is a proven supplier of capabilities at all levels of Sustainability and Climate Risk implementations for Banking and Financial Markets:

• Development of your Sustainability Strategy and Roadmap, particularly leveraging IBM’s Sustainability Garage Methodology

• Integration of ESG data; Tools to support Quantification & Mitigation of Climate Risks, Target Asset Re-Valuation (e.g. Automated ESG Corporate Scoring, Carbon Footprint Calculator, etc.)

• Sustainable Banking Products & Proposition Design 

• Building a Sustainable Banking Operating Model (e.g. Net Zero Banking Platform)

• ESG Regulatory Reporting & Compliance

If you would like to discuss your strategic vision or tactical needs in the area of Sustainability and Climate Risk, please feel free to contact us.

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Authors

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References

[1] https://www.bundesfinanzministerium.de/Content/EN/Standardartikel/Press_Room/Publications/Brochures/sustainable-finance-strategy.html

[2] https://www.bundesfinanzministerium.de/Content/EN/Standardartikel/Press_Room/Publications/Brochures/sustainable-finance-strategy.pdf?__blob=publicationFile&v=6

[3] https://www.bundesverfassungsgericht.de/SharedDocs/Entscheidungen/EN/2021/03/rs20210324_1bvr265618en.html

[4] https://www.bundestag.de/dokumente/textarchiv/2021/kw25-de-klimaschutzgesetz-846922

[5] https://www.bundesregierung.de/breg-de/themen/klimaschutz/climate-change-act-2021-1936846

[6] https://www.bundesrat.de/SharedDocs/drucksachen/2021/0501-0600/576-21(B).pdf?__blob=publicationFile&v=1

[7] https://www.conseil-etat.fr/actualites/actualites/emissions-de-gaz-a-effet-de-serre-le-conseil-d-etat-enjoint-au-gouvernement-de-prendre-des-mesures-supplementaires-avant-le-31-mars-2022

[8] https://www.euractiv.com/section/climate-environment/news/french-council-of-state-gives-government-9-months-to-get-in-line-with-climate-objectives/

[9] https://www.ngfs.net/en

[10] https://www.ngfs.net/en/communique-de-presse/ngfs-publishes-second-vintage-climate-scenarios-forward-looking-climate-risks-assessment

[11] https://www.ngfs.net/ngfs-scenarios-portal/faq/

[12] https://www.ngfs.net/ngfs-scenarios-portal/data-resources

[13] https://www.zielke-rc.eu/en/csr-reports-banken-de/

[14] „Floods drive climate to heart of German election campaign“, https://www.ft.com/content/7e4ab1bd-b3dd-49bc-b903-166eb4c45977