The Intersection of Climate and Capital Markets
Happy Earth Day! Earth Day was introduced in 1970 and has celebrated various milestone achievements including expanding globally and leveraging the power of social media to expand climate awareness and action. A great summary and history can be found on earthday.org/history. For those in financial services, climate initiatives are another major market event with far-reaching impact on capital adequacy and compliance regulations.
Finance and Climate Today
There has been an increasing emphasis in the area of Environmental, Social, and Governance (ESG) on a broad scale. Related to financial markets, ESG investing has been on the rise with the last reported figures at $30 trillion, as reported by the gsi-alliance. This brings us to the correlation between climate and financial services entities. Financing and investing activities are facing big impacts as climate initiatives continue to move forward. There are a series of upcoming events that will further help define that impact in the coming months:
- The American Jobs Plan (US) – This plan was announced on March 31st and contains a set of renewable energy initiatives including electric vehicle investment, clean energy investment throughout building and transportation initiatives, tax reform for climate offending organizations, and climate R&D spending.
- Earth Day – Today, as the globe celebrates Earth Day, world leaders will convene for an Earth Day summit. US President Biden is expected to announce an aggressive plan for the US to cut greenhouse gas emissions by 2030. We’ll see what other countries announce too. Stay tuned.
- American Climate Leadership Summit (ACLS 2021) – This event held April 27-29 is the 10th annual event bringing together climate leaders.
- UN Climate Change Conference of the Parties COP26 – This conference will be held November 1-12 and is intended to push forward climate and renewable energy initiatives more aggressively in alignment with the Paris Agreement and the UN Framework Convention on Climate Change.
The combination of these events should all lead to a much clearer definition of the impact to financial services for the years ahead. Without knowing all of the details now, we can expect some major impacts.
What can we Expect
As new announcements come forward and climate change goals are set more specifically, and aggressively, companies around the globe will either be ready to meet those climate requirements or not. As mentioned above, investing with an ESG focus has been gaining traction. There are tools and scores to assess a company’s performance related to ESG, as highlighted in this Forbes article.
The problem will come when an organization does not meet climate initiative deadlines. This will result in a financial hit in the form of a carbon tax or equivalent financial penalty due to a lack of compliance that in turn, will affect financial results and market valuations. Trading desks will need to assess and analyze the impact to their portfolios. Capital adequacy reporting speed and accuracy will undoubtedly come under additional pressure in this evolving climate (pun intended!).
Here is where the ability to understand the impact of climate readiness on a business entity has many similarities to the preparations underway for the Fundamental Review of the Trading Book (FRTB).
FRTB and Climate Readiness are Closely Linked
In a recent FRTB blog post, I wrote about the increased data and compute needs related to ready for FRTB. FRTB will require a variety of data in both batch and real-time fees including pre-trade data (trade/position), reference data such as legal entity and associated portfolio, and market data.
We estimate that the increase in historical data storage will expand by 24x when estimating the 5-year storage requirements. Computational could increase by as much as 30x to support the modeling needs. Firms need to strategically consider the total cost of complying with FRTB with the same historical approach to prior regulations as the demands are so much greater and this will not be efficient.
The ability to assess and compute climate change valuation impacts is very similar and will strain existing risk and compliance platforms similarly. Financial services firms will need to understand their trading book and related capital requirements value against a new set of data that includes climate progress metrics. Climate valuations will assess a variety of data points such as carbon emissions and fossil fuels exposures and management projects and clean technology usage.
Just as with FRTB, this will require
- New data sources – possibly in varied data formats that are not supported currently or are provided by 3rd part sources
- Large quantities of historical data for comparison and trend analysis
- Rigorous and continuous update to models as updates are forthcoming
Therefore, preparing your data infrastructure for FRTB is a stepping stone towards readiness for climate impacted valuations and related regulation that may be forthcoming. An efficient, longer-term view to these regulations is critical.
An Enterprise Data Strategy
Analyzing more data to understand the implications of variable market activity is an ongoing need and challenge for financial services. The plethora of legacy systems combined with the regulatory mandates around how to protect and use sensitive information make compliance requirements extremely costly. Even before the implementation delays of FRTB, the cost was estimated at $200 million per bank by Oliver Wyman. Now, climate change impacts will add to the complexity of measuring capital requirements.
As the Enterprise Data Cloud company, Cloudera enables an end-to-end data platform to support the complex data storage and governance needs of financial services firms. Cloudera Data Platform enables access to centrally managed and secured data while deploying a consistent experience – on-premise or in hybrid and multi-cloud. It supports a financial institution’s complex data landscape with consistent data security and governance so the different business lines can access the information they need efficiently and securely. Cloud deployment options offer flexibility and cost-effective options in support of the large data and compute requirements
To learn more about how Cloudera can help financial institutions and insurers manage risk and compliance, download this solution brief.