Following the Monetary Authority of Singapore's (MAS) announcement in June this year that it would be setting supervisory expectations to steer financial institutions' (FIs) transition planning processes to facilitate credible decarbonisation efforts by their clients, MAS issued on 18 October, a set of consultation papers, proposing guidelines on transition planning ("TPG") for FIs to enable the global transition to a net zero economy. The consultation closes on 18 December 2023. This update provides a brief overview of the proposed TPG.
Introduction
The proposed TPG describes transition planning as the internal strategic planning and risk management processes undertaken to prepare for both risks and potential changes in business models associated with the transition. They supplement its 2020 guidelines for environmental risk management by FIs and are the latest initiative by MAS under its Finance for Net Zero (FiNZ) Action Plan, which expands the scope of its Green Finance Action Plan to include transition finance and sets out MAS' strategies to mobilise financing to catalyse Asia's net zero transition and decarbonisation activities in Singapore and the region. The TPG come amidst the increasing global attention from regulators around the world, international standard setters, and voluntary market initiatives to the importance of transition plans as a key tool for an orderly economy-wide transition, and the ongoing exploration of the Network for Greening the Financial System (NGFS), chaired by Mr Ravi Menon, Managing Director of MAS, on the relevance of FIs' transition plans to micro-prudential authorities and their supervisory toolkit and in the overall prudential framework.
MAS expects banks and finance companies, insurers, and asset managers (including real estate investment trust managers) to have sound transition planning processes to build climate resilience and facilitate robust climate mitigation and adaptation measures by their customers and investees.
FIs that have made their own net-zero commitments and set decarbonisation targets may have reservations in financing the transition of customers in carbon intensive hard to abate sectors to net zero through loans or investments in cleaner technologies. Such financing may see a short-term increase in the FIs' financed emissions and draw pressure and criticism from investors and stakeholders.
The proposed TPG supports FIs' efforts to actively support businesses to progressively decarbonise their activities through credible transition plans, even if these plans result in short-term increases in financed, facilitated, or insurance-associated emissions, provided these plans support climate positive outcomes consistent with a net-zero pathway. Only with credible transition plans will FIs be able to explain how their transition financing is consistent with their net-zero commitments and decarbonisation targets.
Scope
MAS proposes to apply the TPG to banks' extension of credit to corporate customers and underwriting for capital market transactions; insurers' underwriting and investment activities; and asset managers that have discretionary authority over the portfolios that they are managing; and other activities that expose them to material environmental risk. As the scale, scope and business models of FIs differ, they are expected to implement the TPG in a way that is commensurate with the size and nature of their activities as well as their risk profiles. As asset managers ultimately manage assets on behalf of customers, they should also adhere to customers' priorities over how the investments should be made. As responsible fiduciaries of customers' assets however, they should engage or educate customers on the importance of considering climate-related risks in their investment portfolios.
Expectations
MAS' proposed key supervisory expectations include:
Using engagement, rather than divestment, as the key lever for FIs to steward their customers and investees to transition in an orderly manner.
Taking a multi-year risk perspective to facilitate a more comprehensive assessment of climate related risks. Adopting an integrated approach to climate mitigation and adaptation measures by working closely with their customers and investees to enable better discovery of risks to portfolios.
Considering environmental risks, including loss of nature capital and biodiversity beyond climate-related risks, along with the important inter-dependencies between climate and nature as well as the potential trade-offs in terms of environmental degradation arising from the pursuit of climate solutions.
Disclosing meaningful and relevant information to help stakeholders understand how they are responding to material climate-related risks, and the governance and processes for addressing such risks.
The specific guidelines for the common elements of transition planning, include:
Governance and Strategy
Decisions by FIs' board of directors and senior management around business strategies and risk appetites should consider how the current and future operating environment will impact their risk profiles. Senior management should also ensure that their climate-related business strategies and risk appetites are effectively embedded within their operations and establish mechanisms to regularly refine FIs' existing approach to respond to climate-related risks.
Risk Management
FIs should have a structured process to steer customers' and investees' transition, particularly those identified as vulnerable to transition and/or physical risks, by actively engaging them to credibly manage the climate-related risks that they face. Credible responses by customers and investees should comprise actionable strategies to adequately tackle the climate-related risks faced by customers, with such strategies spanning short-, medium- and long-term time horizons depending on the nature of customers' risk profile.
Insurers should also have a structured process to manage the exposure to climate-related risks in their investment portfolio. They should engage and steer their asset managers to proactively manage climate-related risks of their investment portfolio on an ongoing basis.
FIs should regularly engage customers, investees, (and in the case of insurers) asset managers on a risk-proportionate basis to accelerate timely action by customers and investees that aligns with FIs' risk appetite, commitments, and ambitions.
In developing their product offerings and investment management strategies, asset managers should consider the potential adverse impacts or shocks that could manifest from a delayed response in supporting transition or from misalignment with national, regional and/or global decarbonisation pathways.
In managing their loan/underwriting/investment portfolios, FIs should take a differentiated approach for sectors posing higher climate-related risks in its transition planning to take sectoral specificities into account. For more effective engagement, they should have differentiated strategies that cater to customers, investees, and (in the case of insurers) asset managers exposed to different levels of climate-related risks, and who are at different stages of readiness.
FIs should consider the adequacy of customers', investees', and (in the case of insurers) asset managers' response (or lack thereof) to address climate change as part of the customer onboarding, credit application, credit review, underwriting, asset manager selection, and review processes, and put in place risk mitigating measures as necessary. This should include consideration of the potential reputational and litigation risks that such customers and climate-sensitive investments expose the FIs to.
While engagement as a risk management strategy is emphasised and prioritised, divestment still plays a role in transition planning. In the case of banks and insurers, where customers or investees do not have credible roadmaps to address transition and physical risks, FIs should consider a range of mitigating options such as reflecting the cost of the additional risk in the loan pricing or premiums, applying limits on the loan exposure or underwriting limits, and re-assessing the customer relationship, including declining future transactions and exiting the relationship. Asset managers should establish an escalation framework with appropriate consequences when engagement is ineffective and make known these consequences to the investees. They should consider using available stewardship levers, such as voting against directors, remuneration policies and annual reports or exercising financing levers, such as ending support to the investees' future capital-raising efforts, or divesting.
A range of forward-looking tools, such as scenario analysis and stress testing, should be employed in FIs' transition planning process for risk discovery and quantification. Metrics and targets should also be set to track progress towards strategic goals and supplemented with additional information as necessary. Where there is a misalignment between FIs' espoused risk appetite and actual trajectories, they should have structured processes in place to explain the variance. All relevant risk indicators should be reviewed periodically for continued relevance and monitored using a multi-year risk perspective.
Disclosure
FIs should disclose meaningful and relevant information to enable stakeholders to understand how they are responding over the short-, medium-, and long-term to material climate-related risks they face, and governance around processes for addressing such risks. Disclosures should be in accordance with well-regarded international reporting frameworks and standards, such as the International Sustainability Standards Board (ISSB) standards to improve comparability of these disclosures. To manage and mitigate potential reputational and greenwashing risk arising from their financing activities, they should clearly communicate their risk management strategies and approaches for different sectors, and how their financing activities relate to their publicly committed climate objectives.
For product-level disclosures, asset managers should consider the appropriate level of disclosure of climate-related considerations embedded in every product, to reflect how their overall climate-risk strategy cascades to the product level, and to help stakeholders understand how these products contribute to overall climate objectives. They could also consider the use of credible and well-regarded green and transition taxonomies in their product-level disclosures.
Implementation Period
MAS proposes to provide an implementation period of 12 months after the TPG are issued, for FIs to assess and implement the guidelines as appropriate.
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