Climate and Compliance

THE TIME TO
ENGAGE IS NOW!
Allen Meyer
Eleanny Wernecke
Pippa Black
Climate And Compliance The Time To Engage Is Now!

Climate change is a reality, and one of the most important challenges of this
generation. Financial institutions are exposed through both physical and
transition risks, and have an important role to play in mobilizing resources
for investments in climate mitigation. In most financial institutions, Senior
Management, Risk functions and some business areas are already very
active in climate related efforts. However, thus far we have seen Compliance
only working at the fringes of climate related initiatives and often in a
tactical manner.

While Compliance usually jumps into the action once laws, rules and
regulations are finalized which is not yet the case on climate, it is time for
Compliance to get off the sidelines and into climate efforts. The stakes are
simply too high to wait; missteps today and tomorrow will most certainly
lead to regulatory, reputational and litigation costs in the future. In addition,
Compliance already has many tools in its arsenal to help financial institutions
achieve their climate objectives but needs to deploy them in a strategic way.

The purpose of this paper is to provide a framework for how Compliance

functions can support their institutions to meet their climate objectives and
minimize reputational and regulatory issues going forward.

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Climate And Compliance The Time To Engage Is Now!

RECAP OF CLIMATE APPROACH IN FINANCIAL INSTITUTIONS

Financial institutions are exposed to climate risk in two key areas (i.e., physical risk and
transition risk):

• Physical Risk: Severe weather events may have a direct impact to buildings or other
physical assets of the firm, its third parties, or to the communities it operates in, thereby
altering its operations. Similarly, severe weather events may have a direct impact to the
assets supporting the firm’s loan portfolio, thereby hampering asset value and increasing
the risk of default.
• Transition Risk: As the economy transitions to lower carbon emissions, assets may
incur losses on exposure to firms with business models that are not built around low
carbon strategies. These firms may experience disruption in business, incur higher cost
of funding, litigation or experience lower revenues as policy changes and consumer
demands shift towards a low carbon economy.

Financial institutions also have a critical role to play in the ongoing effort to slow global
warming.1 This includes educating and influencing behavior through client engagement in
order to reduce emissions through higher cost of funding or reduced access to financing,
developing green products that hold true to their labels, and directly reducing the carbon
footprint of the bank. While there has been some financial services regulatory activity in this
space globally and in the US, it is still very much a work in progress.

In light of investor and public sector engagement, many banks have been making “net zero”
pledges, promising to be carbon neutral in financing activities by 2050 or earlier. At COP26, the
Glasgow Financial Alliance for Net Zero (GFANZ) announced that more than 450 firms in the
financial services sector across 45 countries that represent more than $130 trillion of financial
assets have committed to align their activities to transitioning to net zero and to work to
deliver the $100 trillion investment needed to achieve net zero over the next three decades.2
Banks should be able to achieve net zero emission within their own operations, but it will be
much harder to achieve net zero emissions in their financing activities with their clients.3

Furthermore, financial institutions are putting quite a bit of effort into amending their
risk frameworks to consider climate considerations (e.g., integrating climate into risk
measurement). While there is no clear dominant governance and accountability model with
respect to climate risk, we observe that Chief Risk Officers (CRO) often have taken the lead
on this in large financial institutions with a focus on climate risk scenario analysis and risk
quantification. Within Risk most banks have created a Head of Climate Risk that reports to
the CRO or is embedded in the Enterprise Risk Management function (ERM). We also see
that most large financial institutions have appointed a Chief Sustainability Officer for climate
matters who helps define and drive the program of work.

1 “Signatory Directory”, Accessed October 2021, UN Principles for Responsible Investment

2 “Wells Fargo is the last of the Big Six banks to issue a net-zero climate pledge. Now comes the hard part”, Eamon
Barrett, March 9, 2021, Fortune
3 “Wells Fargo is the last of the Big Six banks to issue a net-zero climate pledge. Now comes the hard part”, Eamon
Barrett, March 9, 2021, Fortune

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Climate And Compliance The Time To Engage Is Now!

RECAP OF GLOBAL CLIMATE REGULATORY EFFORTS

The United Nation’s Intergovernmental Panel on Climate Change has emphasized the need
for action across public and private sectors to support the implementation of the ambitious
actions required to limit global warming.4 Governments are working to address this global
issue and chart a path forward. At COP26 the Network for Greening the Financial System
(NGFS) announced that 100 central banks, including the European Central Bank, Bank of
England, Federal Reserve, and Bank of Canada, have now joined their network and signed the
NGFS Glasgow Declaration5, which included a continued commitment to advance supervisory
practices. Additionally, the IFRS Foundation announced the formation of a new International
Sustainability Standards Board (ISSB)6, which seeks to develop a comprehensive global
baseline of high quality sustainability disclosure standards to meet investors’ information
needs — building further upon the work of the Task Force for Climate-Related Financial
Disclosures (TCFD), which will continue to be taken forwards in 2022. Approaches are more
developed in Europe, the UK, and (increasingly) the US and Canada (i.e. OSFI has signaled
a principles-based approach aligned with global standards while considering the Canadian
context).7

Exhibit 1: Global Climate Regulatory Efforts at a Glance

European Union
United Kingdom
United States

4 “Global Warming of 1.5°C”, 2019, IPCC

5 The NGFS Glasgow Declaration is available here.
6 Details on the International Sustainability Standards Board (ISSB) are available here.
7 “OSFI Summarizes Responses to Its Climate Risk Discussion Paper”, 2021, OSFI

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Climate And Compliance The Time To Engage Is Now!

EUROPEAN REGULATION

The European Union has been at the forefront of creating sustainability focused regulation
for the past few years. Their three-pronged approach includes the Green Taxonomy, the
Sustainable Finance Disclosure Regulation (SFDR), and the Corporate Sustainability Reporting
Directive (CSRD).8 The Green Taxonomy serves as a foundation for the SFDR and CSRD. It has
six environmental oriented objectives and looks to classify what is sustainable. First enacted
in March 2021 and subject to further change, SFDR applies to financial services organizations
such as asset managers, pension funds, and insurers and requires them to disclose how
Environmental, Social, and Governance (ESG) factors fit into their investment decisions.9
Adopted in April 2021, the CSRD will fully come into effect in 2023 and will apply to all “large”
companies and all companies (other than micro-companies) with securities listed on
EU-regulated markets (almost 50,000 companies), requiring them to report how their
businesses affect the environment and their stakeholders.10 In addition, the European Central
Bank (ECB) published a Guide on climate-related and environmental risks in November 2020,
which, among other things, required banks to conduct a self-assessment against the ECB’s
supervisory expectations and develop action plans. During 2021, the ECB has benchmarked
the self-assessments and plans and in 2022 will conduct a full supervisory review.

UK REGULATION

Climate regulation in the United Kingdom has required climate metrics such as greenhouse
gasses and energy usage to be reported for publicly traded companies.11 COP26 signaled a
greater emphasize, with the Bank of England announcing that it will shift gears to actively
supervise firms on climate-related financial risks12, and the UK announcing the intention
to become the world’s first net zero aligned financial center, with a new requirement for
mandatory net zero transition plans for UK financial institutions and companies. A new task
force will be established in the UK government to develop standards before the end of 2022
with the expectation that firms will be required to publish transition plans in 2023, and that
this will cover both public and private firms.

US REGULATION

While the Biden administration has made climate change a priority, the impending regulation
will likely be more measured. In October 2021, the Financial Stability Oversight Council (FSOC)
which is the coordination body for US regulators released a report identifying climate change

8 “New EU ESG Disclosure Rules to Recast Sustainable Investment Landscape”, Jennifer Laidlaw, August 3, 2021, S&P Global
9 “New EU ESG Disclosure Rules to Recast Sustainable Investment Landscape”, Jennifer Laidlaw, August 3, 2021, S&P Global
10 “Proposed EU Directive on ESG Reporting Would Impact US Companies”, Sander de Boer and Julie Santoro, June 7,
2021, Harvard Law
11 “ESG Regulations: What UK Organizations Must Know to Comply”, Helen Hopper, August 9, 2021, Diligent
12 PRA’s 2021 Climate Change Adaptation report is available here.

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Climate And Compliance The Time To Engage Is Now!

as an emerging and increasing threat to US financial stability requiring member agencies

to, among other things, assess climate related financial risk through scenario analysis and
enhance climate related disclosures. The Federal Reserve Board (FRB) has already commented
on the financial risks posed by climate change and they recently announced they will conduct
“scenario analyses” on banks to measure the impact of climate related risks.13 The Securities and
Exchange Commission (SEC) has also made ESG a priority and created a Climate and ESG Task
Force to identify instances where companies are misrepresenting their ESG related disclosures
or ESG investing strategies and misleading investors.14 In addition SEC Chairman, Gary Gensler,
commented that the Commission is considering a phased approach in mandating climate related
disclosures.15 In fact, it is clear that the SEC has already begun investigations relating to climate
and ESG claims so this is already an existing compliance challenge and not just a theoretical
one.16 While all of these developments are relatively new and have only occurred within the
last year, they signal a shift in the broader US regulatory landscape as the key regulators
acknowledge there is financial and investment risk imposed by climate change.

13 “Fed moving forward with plans to test banks’ climate risk: Brainard”, Hannah Lang, October 7, 2021, American Banker
14 “SEC Announces Enforcement Task Force Focused on Climate and ESG Issues”, March 4, 2021, SEC
15 “SEC Eyes Phased Approach to Climate Reporting, Gensler Says”, Andrew Ramonas, October 5, 2021, Bloomberg Law
16 “ESG Asset Managers and Investment Funds — Near-Term SEC Enforcement Risk”, August 3, 2021, Wilmer Hale

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Climate And Compliance The Time To Engage Is Now!

INCORPORATING CLIMATE INTO THE COMPLIANCE FRAMEWORK

We see that Chief Compliance Officers (CCO) are increasingly realizing that climate is an
important area for Compliance to weigh in on, but there is a lack of clarity on what the
engagement model should be as the regulatory environment continues to evolve. While the
roles of other executives are becoming clear, the role of the CCO is still quite undefined as it
relates to climate.

Due to the importance of the issue and the lack of clarity of the CCO role, we believe that
Compliance ought to develop a top-down strategy for climate, rather than waiting for it to
materialize in a bottom’s up manner. This strategy should be coordinated with the CRO’s so
as to establish clear roles and responsibilities across the 2nd line of defense and appropriate
coordination to optimize the control environment of the firm and avoid duplication. The
Compliance effort should be guided by the principles of being pragmatic and specific, (i.e.
not highly conceptual), avoiding duplication with other areas (e.g., Risk, Legal) and dynamic
as this area is subject to quite a lot of fast paced change so, in other words, the perfect will
likely be the enemy of the good in the case of climate.

The remainder of this paper will focus on the “First Wave” of actions that Compliance
functions should prioritize as they seek to engage in and support their bank’s climate
strategy and risk management efforts. In Exhibit 2 we have outlined the OW Compliance/AFC
risk management framework and highlighted these First Wave focus areas.

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Climate And Compliance The Time To Engage Is Now!

Exhibit 2: First wave of impact across Compliance/AFC Risk Management Framework

Governance
& People
Regulatory
Technology
Change &
& Data
Inventory

Surveillance Risk
Metrics &
Reporting
Assessment
Know & Annual Plan
Testing Your
Controls Customer
processes

Issue Mgmt. Policy &

& Escalation Monitoring Sanctions
Procedures

Controls
Training
Mgmt.

Key Advisory
First Wave
Other elements

Source: Oliver Wyman analysis.

RISK ASSESSMENT & ANNUAL PLAN

Climate issues may bubble up in the normal Compliance risk assessment and annual
planning process in distinct areas like product misrepresentation or misleading marketing
materials, but this bottoms up approach will likely only lead to a tactical and incremental
response. To address the importance of the issue and the amount of emerging regulatory
activity, this area may require a bolt-on strategy on top of the normal risk assessment
process. The strategy should consider current regulations and regulatory initiatives, and the
firm’s climate strategy, products and public commitments. These considerations should be
evaluated in connection with the bank’s existing Compliance/AFC framework to develop a
dedicated First Wave action plan that can be incorporated into the overall Compliance plan.
We have found that a workshop approach with the Compliance leadership team, executives
leading different aspects of the firm’s strategy (central and business aligned) and Risk
stakeholders can be a very effective way to jump start the program. The exam questions
for these sessions are what can Compliance do now and in the forseeable future to help
limit regulatory and reputational risk relating to climate and what is the near term role of
Compliance taking into account the roles of other stakeholders in the 1st and 2nd line.

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Climate And Compliance The Time To Engage Is Now!

GOVERNANCE AND PEOPLE

The maintenance of a Compliance climate program is dependent on staying plugged into what
is going on at the firm as it relates to climate. The CCO or a senior deputy (i.e., MD level) will
need to be directly connected to the firm’s climate steerco or the equivalent body and have
a seat at the table with the firm’s leadership on this topic. This is appropriate since climate is
already, and will undoubtedly continue to be, one of the most significant regulatory challenges
facing banks. It will enable Compliance to provide appropriate challenge to the firm’s strategy
and public commitments. For example, Compliance could challenge whether there is sufficient
granularity around the plan to support the financial institutions’ “net zero” pledge and whether
there is enough progress being made against that plan.

We also believe that a small group should be built to support the Compliance accountable
executive to assist in the maintenance of the program (i.e. Climate Centre of Excellence). This
group would be responsible for coordinating the Compliance response to climate, including
the following activities:

• Collecting climate related regulatory horizon scanning information to provide a clear view
on potential changes and the implications of future regulation.
• Keeping a heat map of all the climate related activities occurring in the bank which will
enable Compliance to be engaged in the appropriate places where activity is occurring.
• Educating the rest of the Compliance function on climate related matters and driving the
incorporation of climate into their activities/functions.
• Serving as the advisory/coverage team for the Firm climate accountable executive and
the team supporting that individual(s), and the primary interface with the accountable
executives in Risk and other functions (e.g., Legal).
• Keeping risk related metrics, lessons learned from issues and other trend data on the
outputs of the Compliance processes to enable a better understanding of the potential
regulatory risk the financial institution is running with respect to climate.

POLICY STANDARDS, ADVICE AND CHALLENGE

To date, most Compliance functions provide targeted piecemeal advisory support to the
various business units developing climate related products, especially in asset management
and wealth businesses. Compliance should work with the business to help drive a cohesive
approach to product name designations and related disclosures so there is clear guidance
and consistency across the businesses. Compliance should consider whether it is necessary
to amend policies or standards to cover these issues.

It is clear that there will continue to be a bevy of new and enhanced products for all types of
clients that incorporate climate related aspects. We are in the early days of the development
of new and innovative products in this area. Accordingly, Compliance will need to continue to
be very active in all aspects of the new business process to provide challenge and help ensure
the policy standards are upheld. Compliance will need to be at the table early on as products

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Climate And Compliance The Time To Engage Is Now!

are being developed, as well as, when they make it to the formal new business process. As
the financial institution climate frameworks evolve, it will be essential to have an engaged
and informed set of Compliance busines coverage teams to avoid regulatory and reputational
pitfalls. As referenced above, the climate COE can help educate business coverage Compliance
teams and monitor climate product developments at the firm-wide level.

As is normally the case, Compliance should not only drive policy standards and provide
advice and challenge but should also use its substantial control toolset for climate.

COMPLIANCE CONTROL PROCESSES

Compliance already has quite a few existing tools that can be deployed to mitigate risk in the
climate space. The climate COE will need to help define which tools/processes should be used
and help upskill the employees in these groups so that they are able to meaningfully engage
on this topic. It is essential that Compliance consider the full set of control processes in its
arsenal to obtain the optimal level of risk management as the climate challenge develops.

Probably the most impacted area is the marketing material review function in Compliance.
This area will see the marketing materials related to climate and can help ensure that they
meet the policy standard referenced above and are fair and balanced. Another area that
will be highly impacted is the group in Compliance that does electronic communications
surveillance. The lexicons and review logic will need to be upgraded in order to capture
potential misstatements or exaggerated claims regarding climate. The COE can provide
assistance in developing an appropriate lexicon/tagging logic.

There may be other control processes in Compliance that should be deployed. For
example, in some institutions Compliance is responsible for guideline monitoring in
asset management businesses. This will be very important to ensure that climate related
guidelines are honored by portfolio managers. Similarly, there may be trade surveillance
for institutional businesses and “best interest” related surveillance for wealth management
businesses that can be upgraded to cover climate related risks. Compliance leadership
should also consider how the substantial monitoring and testing program can be utilized to
support the institution’s climate strategy.

There may also be other processes that can be enhanced to help in the broader climate
effort. For example, the KYC process can be utilized to obtain a better understanding of
the underlying business of potential customers (e.g., subsidiaries that have a high carbon
footprint). Also, watch and restricted lists could be leveraged to help the firm limit business
relationships with climate unfriendly customers.

As referenced above, the COE ought to gather data on the outputs of the processes
established for the “First Wave” risk management activities and support the CCOs effort to
escalate emerging risks, as well as, iterate the future waves of the program as Compliance
learns as it goes, and regulations change.

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Climate And Compliance The Time To Engage Is Now!

CONCLUSION
While regulation around climate change is ramping up, many bank leaders have made
climate a top priority for their institutions and have crafted and began executing on their
own climate strategies. In light of the pace of change driven from regulatory, media and
societal perspectives, financial institution governance and control processes may not yet
have caught up to the leadership’s articulated ambition. Compliance should not wait for
the regulatory process to further evolve or the governance processes to further develop
to engage in the climate efforts. The Compliance group can be an essential participant
as they will be able to leverage/enhance their existing processes to support the bank’s
climate strategy. Not only will these efforts give banks a head start on complying with
new regulations, but it will allow them to more effectively manage their risk, showcase
their climate competencies to their clients and do their part to address the climate
challenges ahead.

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AUTHORS

Allen Meyer Eleanny Wernecke

Partner Partner
[email protected] [email protected]

Pippa Black
Principal
[email protected]

Copyright ©2021 Oliver Wyman

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