Knowledge Highlights 9 July 2020
On 25 June 2020, the Monetary Authority of Singapore (“MAS”) issued three consultation papers on proposed Guidelines on Environmental Risk Management for banks, insurers and asset managers (collectively, “proposed Guidelines”). The consultation closes on 7 August 2020.
The proposed Guidelines aim to enhance the resilience of banks, insurers and asset managers (“FIs”) to environmental risk and strengthen the financial sector’s role in supporting the transition to an environmentally sustainable economy in Singapore and in the region. This is part of MAS’ Green Finance Action Plan to become a leading global centre for green finance.
Co-created with FIs and industry associations, the proposed Guidelines set out MAS’ supervisory expectations for banks, insurers and asset managers in their governance, risk management and disclosure of environmental risk. They cover three broad areas as follows:
- Governance and strategy: Boards and senior management of FIs are expected to incorporate environmental considerations into their strategies, business plans, and product offerings, and maintain effective oversight of the management of environmental risk.
- Risk management: FIs should put in place policies and processes to assess, monitor, and manage environmental risk.
- Disclosure: FIs should make regular and meaningful disclosure of their environmental risks, so as to enhance market discipline by investors.
This article provides an overview of the three proposed Guidelines:
- Guidelines on Environmental Risk Management for Banks (“proposed Guidelines for Banks”)
- Guidelines on Environmental Risk Management for Insurers (“proposed Guidelines for Insurers”)
- Guidelines on Environmental Risk Management for Asset Managers (“proposed Guidelines for Asset Managers”)
A draft version of the proposed Guidelines can be found in the relevant consultation paper.
MAS proposes a 12-month transition period after the three Guidelines are issued for FIs to assess and implement the Guidelines.
Supervisory approach to environmental risk
In the consultation papers, MAS explains that environmental risk gives rise to reputational concerns for FIs and bears a financial impact on FIs and the assets they manage on behalf of their customers, through physical and transition risk channels. The intention of the proposed Guidelines is to enhance FIs’ environmental risk management practices.
Hence, the financial sector should take concerted action to address the impact of environmental risk and support a smooth transition to an environmentally sustainable economy. It is crucial for FIs to build resilience against the impact of environmental risk as part of their business and risk management strategies. FIs should implement robust environmental risk management policies and processes, and effectively monitor, manage and disclose their exposures to environmental risk. MAS adds that FIs can act as a “force for good” in the transition towards an environmentally sustainable economy by channelling capital through financing, underwriting and investment activities.
The proposed Guidelines serve as a call to action for FIs to help drive the transition to an environmentally sustainable economy by enhancing the integration of environmental risk considerations in FIs’ financing and investment decisions, and promoting new opportunities for green financing. The proposed Guidelines will be updated as appropriate to reflect the evolving nature and maturity of risk management practices.
Applicability of proposed Guidelines
The FIs to which the proposed Guidelines will apply is set out below. Banks, insurers and asset managers should implement the proposed Guidelines in a way that is commensurate with the size and nature of their activities and risk profile.
The proposed Guidelines for Banks will apply to licensed banks, merchant banks and finance companies (collectively, “banks”).
The proposed Guidelines for Banks will apply to the extension of credit to corporate customers, underwriting for capital market transactions and other activities that expose it to material environmental risk. Banks with material investment activities should refer to the relevant sections of the Guidelines for Asset Managers for sound practices on the management of environmental risk in relation to investments.
The proposed Guidelines for Insurers will apply to all insurers, including insurers carrying on business in Singapore under a foreign insurer scheme.
The proposed Guidelines for Insurers will apply to insurers’ underwriting and investment activities. Insurers should apply the Guidelines for Insurers to other activities that are exposed to material environmental risk.
The proposed Guidelines for Asset Managers will apply to holders of a capital markets licence for fund management (LMFC) and real estate investment trust management (REIT), and registered fund management companies (RMFC).
The proposed Guidelines for Asset Managers would generally be applicable to asset managers that have discretionary authority over the investments of the funds/mandates that they are managing. MAS clarifies that the proposed Guidelines for Asset Managers are not intended to prohibit or restrict asset managers from complying with and discharging their fiduciary duties and other legal obligations to their customers.
Governance and strategy
The consultation papers propose responsibilities of the Board of an FI to include approving an environmental risk management framework and policies, and setting clear roles and responsibilities of the Board and senior management. For banks and insurers, environmental risk, where material, should be addressed in the bank’s or insurer’s risk appetite framework.
The consultation papers propose imposing responsibilities on senior management to oversee environmental risk management, including developing environmental risk management framework and policies, regularly reviewing their effectiveness, and allocating adequate resources to manage environmental risk. In particular, where environmental risk is deemed material to an FI, the FI should designate a senior management member or a committee to oversee that environmental risk.
Banks and insurers
At the customer level, MAS proposes that banks and insurers undertake an environmental risk assessment of each customer as part of their assessment process for credit facilities or capital markets transactions, particularly for sectors with higher environmental risk. To inform its assessment, the bank or insurer should develop sector-specific policies which articulate its expectations towards customers in sectors with higher environmental risk. For transactions with higher environmental risk, MAS proposes that the bank or insurer undertake enhanced due diligence, and escalate to an internal committee or appointed individual for approval where applicable. Further, MAS proposes for banks and insurers to engage each customer that poses higher environmental risk to improve customers’ risk profile and support customers’ transitions towards sustainable business practices.
For a customer that does not manage its environmental risk adequately, the proposed Guidelines for Banks contain a range of mitigating options, including reflecting the cost of the additional risk in the loan pricing, applying limits on the loan exposure, and re-assessing the customer relationship.
For banks and insurers at the portfolio level, MAS proposes that banks and insurers develop capabilities in scenario analysis and stress testing to assess the impact of environmental risk on their risk profile and business strategies, and explore their resilience to financial losses. These scenarios should incorporate forward-looking information to complement historical data, as the latter might systemically underestimate potential risks, in view of the uncertainties and long-term horizon associated with changes in the environment.
The proposed Guidelines for Banks set out the expectation for banks to develop tools and metrics to monitor and assess their exposures to environmental risks. Some tools proposed by MAS include metrics that may be used to assess the bank’s portfolio exposures to geographical areas and sectors with higher environmental risk, measuring the carbon intensity of customers in high-risk sectors, or considering the impact of environmental risk on its collateral valuations.
MAS proposes that asset managers put in place appropriate processes and systems to monitor, assess and manage the potential and actual impact of material environmental risk on individual investments and portfolios on an ongoing basis.
MAS also proposes that asset managers develop capabilities in scenario analysis to evaluate portfolio resilience and valuation under different environmental risk scenarios. These scenarios should incorporate forward-looking information to complement historical data, as the latter might systemically underestimate potential risks, in view of the uncertainties and long-term horizon associated with changes in the environment. In relation to conducting scenario analysis, the proposed Guidelines for Asset Managers contain examples of possible metrics that asset managers could use to assess the potential impact of physical risk and transition risk on the assets in the portfolios.
MAS proposes that an FI disclose, at least annually, its approach to managing environmental risk and the potential impact of material environmental risk on the FI. Such disclosure may be consolidated at the group or head office level.
MAS also proposes that an FI take reference from international reporting frameworks such as the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, to guide its environmental risk disclosure.
Proposals specific to insurers
MAS proposes that insurers incorporate environmental risk considerations into the underwriting process, taking into account the insurers’ overall risk management framework and risk appetite. Where the insurer has an existing relationship with a customer who does not manage the environmental risk adequately, the proposed Guidelines for Insurers provide that the insurer should consider various options such as pricing in the additional risk, applying specific limits on underwriting exposure, and re-assessing the relationship with the customer.
For customers assessed to have a higher environmental risk profile, the proposed Guidelines for Insurers set out escalation and monitoring processes that the insurer should undertake, such as in-depth due diligence and developing tools and metrics to monitor underwriting exposures to environmental risk. Such tools would enhance the insurer’s capacity to measure the impact of environmental risk on its business, and take appropriate mitigating measures to manage significant risk in its portfolio. For example, MAS explains that these metrics may be used to assess the insurer’s underwriting exposures to geographical areas and sectors with higher environmental risk, or measure the carbon intensity of customers in high-risk sectors.
From an asset selection perspective, MAS proposes measures an insurer should undertake to ensure that it can monitor the inherent environmental risk in its investment portfolios. The insurer should also take into consideration the impact of environmental risk on its investment portfolio under various stress scenarios and time factors. The proposed Guidelines for Insurers also aim to promote responsible business behaviour by encouraging insurers to work on environmental related issues with companies who are particularly exposed to such environmental risk.
Proposals for asset managers
Research and portfolio construction
MAS states that it expects asset managers to evaluate the potential impact of material environmental risk on an investment’s return potential when carrying out research and portfolio construction. To inform the asset manager’s assessment, the asset manager should apply appropriate tools and metrics to identify sectors with higher environmental risk. For such sectors, asset managers should develop sector-specific guidance to aid their investment personnel in understanding their attendant environmental issues. For portfolio construction, MAS expects asset managers to measure and manage material environmental risk factors in a portfolio on an aggregate basis.
To assist asset managers in incorporating environmental risk considerations in their investment approach, examples of how asset managers can consider environment risk for different asset classes and investment strategies are set out in the proposed Guidelines for Asset Managers.
Given that asset managers are well positioned to influence the actions of investee companies, MAS expects asset managers to exercise sound stewardship to shape positive corporate behaviour and manage environmental risk associated with investee companies through engagement, proxy voting and sector collaboration. This includes supporting investee companies’ efforts in transitioning towards more sustainable business practices. MAS proposes that asset managers maintain proper documentation to support their engagement efforts and report on their stewardship initiatives.
- Consultation Paper on Proposed Guidelines on Environmental Risk Management for Banks
- Consultation Paper on Proposed Guidelines on Environmental Risk Management for Insurers
- Consultation Paper on Proposed Guidelines on Environmental Risk Management for Asset Managers
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