A Detailed Look at MAS’ Environmental Risk Management Guidelines

Grace Chong at global law firm Simmons & Simmons JWS analyses the key points of MAS’ proposed Guidelines on Environmental Risk Management, and sets out the key practical steps to be taken.

 On 25 June 2020, the Monetary Authority of Singapore (“MAS”) issued a set of three consultation papers on its proposed Guidelines on Environmental Risk Management (“Guidelines”) for banks, insurers and asset managers (collectively referred to as “Financial Institutions” or “FIs”) respectively. The consultations close on 7 August 2020.

The Guidelines set out supervisory expectations for FIs in their governance, risk management, and disclosure of environmental risk. However, each set of Guidelines is tailored to each individual sector and FIs should refer to the Guideline that best applies to their sector.

This article intends to capture some of the key points from the Guidelines, including their scope, practical steps and implementation. Further, this article will consider how these Guidelines can be viewed in the context of current environment-related initiatives, and key points for FIs to note in preparing for implementation of the Guidelines.

A. Overview of the Guidelines

The Guidelines contribute to a growing list of commitments by national and international bodies to combat climate change, the most significant of them being the Paris Agreement on climate change of December 2015.

The Guidelines are expected to be updated as and when appropriate to reflect the evolving nature and maturity of risk management practices adopted by FIs, reflecting a proactive aspect of MAS’ supervisory role.

They were drafted to help FIs address environmental risk, which has been brought about by climate change, loss of biodiversity, pollution and changes in land use. Investment in companies that are not environmentally sustainable may also generate reputational risks, which can adversely affect their ability to maintain or grow their assets under management.

The 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.

B. Scope of the Guidelines

MAS’ proposed Guidelines apply to insurers, banks and asset managers.

Banks with material investment activities are also encouraged to consult the relevant sections of the Guidelines for asset managers for sound practices on the management of environmental risk with respect to investments.

C. Proposed Guidelines

Generally, the prescribed guidelines are divided into broad categories of governance, risk management and disclosure. The underlying principles for each category are:

  • Governance: The board of directors (Board) 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.

Further, since the size and nature of each FI will vary, FIs are encourages to adopt the Guidelines in a manner that is commensurate with its size, scale and business models.

Beyond the aforementioned general principles, specific guidance has also been drafted for insurers, banks and asset managers.

 (i) Insurers

The Guidelines are intended to apply to insurers’ underwriting and investment activities. An insurer should apply the Guidelines to activities that expose it to material environmental risk.

Category Recommended steps
Governance and Strategy The Board of Directors should:

  • Approve environmental risk management framework and policies
  • Set clear roles and responsibilities of the Board and senior management
  • Ensure that environmental risk, where material, is addressed in the insurer’s risk appetite framework

Senior management should:

  • Develop environmental risk management framework and policies, regularly review their effectiveness, and allocate adequate resources to manage environmental risk
Risk Management Insurers should identify, assess, mitigate and monitor material environmental risk at both a customer and portfolio level.

At a customer level, insurers should:

  • Undertake an environmental risk assessment of each customer as part of its assessment process for credit facilities or capital markets transactions, particularly for sectors with higher environmental risk
  • Develop sector-specific policies
  • Undertake enhanced due diligence and escalate to an internal committee or appointed individual for approval for customers with higher environmental risk
  • Scrutinise future transactions to ensure that the insurer’s exposures to environmental risk are well understood and managed

At a portfolio level, insurers should:

  • Include short-term and long-term environmental scenarios into its scenario analysis and stress testing for strategic planning and risk management purposes
  • Use the results of its scenario analysis and stress testing when reviewing its environmental risk management policies and practices
  • Engage high-risk customers to improve their environmental risk profile, and support their transition towards sustainable business practices.
Underwriting Insurers should incorporate environmental risk considerations into the underwriting process, taking into account overall risk management framework and risk appetite.

  • For customers with inadequate risk management policies, the insurer should consider pricing in the additional risk, applying specific limits on underwriting exposure, and re-assessing the relationship with the customer, which may include exiting the relationship.
  • Alternatively, insurers can adopt appropriate escalation and monitoring processes, such as in-depth due diligence and developing tools and metric to monitor its underwriting exposures to environmental risk.
Investment When selecting investments, insurers should monitor the inherent risk in its investment portfolios, which includes the impact of environmental risk.
Disclosures Insurers should disclose their approach to managing environmental risk and the potential impact of material environmental risk on the insurer.

Disclosure should include quantitative metrics such as exposures to sectors with higher environmental risk.

 
(ii) Banks

The Guidelines targeted at banks and finance companies aim to enhance the banking sector’s resilience to and management of environmental risk.

Category Recommended Steps
Governance and Strategy The Board and senior management are encouraged to:

  • Incorporate environmental considerations into the bank’s risk appetite, strategies and business plans
  • Ensure that environmental risk is addressed in the bank’s risk appetite framework so that environmental risk beyond the bank’s risk appetite can be promptly recognised and addressed
  • Develop an environmental risk management framework and policies, regularly review their effectiveness, and allocate adequate resources to manage environmental risk
  • Designate a senior management member or a committee to oversee environmental risk and ensure that such issues are reviewed at a sufficiently senior level
Risk Management Banks should adopt risk management policies are both a customer and portfolio level.

At a customer level, banks should:

  • Undertake an environmental risk assessment of each customer as part of its assessment process for credit facilities or capital markets transactions, particularly for sectors with higher environmental risk
  • Develop sector-specific policies
  • Undertake enhanced due diligence, and escalate to an internal committee or appointed individual for approval where applicable
  • Engage each customer that poses higher risk, to improve its environmental risk profile, and support its transition towards sustainable business practices

For a customer that does not manage its environmental risk adequately, the Guidelines propose a range of mitigating options for banks, including reflecting the cost of the additional risk in the loan pricing, applying limits on the loan exposure, and re-assessing the customer relationship.

Moreover, at a portfolio level, banks are recommended to:

  • Develop tools and metrics to monitor and assess its exposures to environmental risk
  • Develop capabilities in scenario analysis and stress testing to assess the impact of environmental risk on its risk profile and business strategies and explore its resilience to financial losses
Disclosure Banks are encouraged to disclose their approach to managing environmental risk and the potential impact of material environmental risk on the bank. Preferably, such disclosures should be consolidated at the group or the head office level.

 
 (iii) Asset Managers

Lastly, MAS has also introduced several guidelines targeted at asset managers. The Guidelines will generally be applicable to asset managers that have discretionary authority over the investments of the funds/mandates that they are managing.

Category Recommended steps
Governance and Strategy The Board and senior management of asset managers should oversee the integration of environmental considerations into the asset manager’s strategies, business plans and products.

Where an environmental risk is deemed material to the funds/mandates managed, asset managers should designate a senior management member or a committee to oversee environmental risk.

Research and Portfolio Construction Asset managers should develop a risk management framework, and put in place robust policies and processes to manage environmental risk. Material environmental risks should be identified, assessed and mitigated at both an individual investment and portfolio level.

Additionally, asset managers should:

  • Evaluate the potential impact of material environmental risk on an investment’s return potential when carrying out research and portfolio construction
  • Develop sector-specific guidance to aid its investment personnel in understanding their attendant environmental issues
  • Measure and manage environmental risk factors that are present in a portfolio on an aggregate basis, where material
Portfolio risk Management On a portfolio level, asset managers should develop capabilities in scenario analysis to evaluate portfolio resilience and valuation under different environmental risk scenarios. Scenario analysis should incorporate forward-looking information to complement historical data in view of the uncertainties and long-term horizon associated with changes in the environment.

After such risks have been identified, asset managers should make adjustments to the composition of the portfolio or introduce other mitigating measures.

Stewardship The Guidelines also stresses the importance of stewardship. Asset managers are encouraged to exercise sound stewardship to help shape positive corporate behaviour and manage environmental risk associated with investee companies through engagement, proxy voting and sector collaboration.

Other suggestions include:

  • Supporting investee companies’ efforts in the transition towards more sustainable business practices over time
  • Maintaining proper documentation to support their engagement efforts
  • Reporting on their stewardship initiatives
Disclosure Asset managers should make meaningful disclosure of their environmental risk and the potential impact of material environmental risk on the assets it manages.

 
D. Enforcement of Guidelines

 Aware of the initial challenges that FIs are likely to face in implementing the Guidelines, MAS has proposed a transition period of 12 months after the Guidelines are issued. During this transitional period, FIs should assess and implement the Guidelines when they deem appropriate.

Moreover, examples of sound practices in relation to governance, risk management and disclosure of environmental risk are also included in the Guidelines. Such examples are intended to facilitate implementation.

 E. Implications of Guidelines

 MAS’ Guidelines should be welcomed as a continued contribution to Singapore’s efforts to be a green finance hub. This development also follows several key ESG initiatives, including the  Green Bond Grant scheme in 2017 to encourage the issuance of green bonds, and the “Sustainable Bond Grant Scheme” in 2019.

Last year, MAS set up a SGD 2 billion green investments programme targeted at public market investment strategies that have a strong green focus, and had said that it will look out for asset managers that actively incorporate environmental considerations into their investment process and direct capital towards underlying investments that have a greener profile. These developments also follow global developments in the European Union and Asia to put the spotlight on environment and social responsibility.

FIs need to take immediate action and review their ESG strategies, policies and disclosures, as this is expected to be a key area of regulatory compliance and enforcement.

On a practical level, the Guidelines may require FIs to conduct a gap analysis to consider whether the following steps may be required:

  1. Updates to board mandates and agendas, so as to ensure that senior management prioritises the creation of an environmental risk management framework and regularly reviews the effectiveness of organisational initiatives;
  2. Appointments of key project managers to effect ERM project planning;
  3. Undertaking of ERM risk assessments and due diligence;
  4. Updates to ESG and other investment policies;
  5. Reviews and updates to product/fund documentation and account agreements (which may require investor or regulatory notifications / comments);
  6. Reviews and updates to marketing material, ESG-specific website and other resources;
  7. Engagement with external service providers;
  8. Tracking of global regulatory updates and coordination with other offices;
  9. Communication with external stakeholders to share and seek feedback on organisational initiatives.

ESG is increasingly becoming a complex form of corporate governance involving significant legal and regulatory issues. FIs that haven’t already done so should start reviewing and benchmarking their policies and practices early so as to effectively mitigate ESG risk and capitalise on ESG opportunities.

Grace Chong is Of Counsel (Regulatory & ICT) for Singapore and Hong Kong at Simmons & Simmons JWS.

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