5 December 2019

Sustainability: to regulate or not to regulate?

Financial regulation has a role to play in tackling climate change, but it cannot be a silver bullet. So the time has come for policymakers to step up their game, delegates at the Insurance and Climate Risk conference heard. Vincent Huck reports

Regulation is a bit like religion, a topic to avoid if one wants to steer clear of discord. There is not one way to look at it, no right or wrong, only different visions of what it is and what it should be.

Regulatory approaches to managing the financial risk of climate change are still in their infancy, but insurance regulators, in Europe at least, are increasingly picking up on the topic of sustainability.

This year alone, in Germany, BaFin highlighted sustainability as a focus for 2019; the French prudential regulator and the country's financial regulator have set up joint commissions to assess the climate-related commitments taken by firms they supervise; the UK's Prudential Regulation Authority became the first regulator to publish its expectations on how banks and insurers should manage climate risks; and the European Insurance and Occupational Pensions Authority (Eiopa) published its opinion on sustainability within Solvency II.

For the very reason this is new ground, it is fertile for disagreement. Should regulation play a role in tackling climate change? If so should it be the main driver? Should it impose incentives and/or penalties in the form of capital charges? Can it bridge the gap of availability and quality of data? What disclosures should it require from financial stakeholders?

These were the questions addressed by a panel session at Insurance and Climate Risk Conference held by Insurance Asset Risk in partnership with sister publications Environmental Finance and InsuranceERM earlier this week.

Panellists agreed regulation has a role to play, but there was no consensus on how far it needs to go.

Gabrielle Siry, green finance specialist at the French regulator ACPR, noted the insurance industry was constrained in its action against climate change because of its primary mission to make money.

"Financial regulators and supervisors require insurers to remain profitable, so there is a limit to what we can ask them to do," she said. "However, there is scope for broader regulation, from a political sense, to develop policies to fight climate change and protect the environment, and that policy response can be the main driver."

Green capital charges

For insurers, the capital charges they incur on their investments is major consideration on their strategic asset allocation decisions. Therefore, one of the key questions is whether capital charges will one day be lowered for "green" assets or raised for "brown" ones.

So far, Eiopa has said it is not feasible. "We face a few hurdles here because we need to demonstrate that brown assets are riskier or that green assets are less risky in order to raise or lower the capital charges," Siry said.

For brown assets, although we know they are riskier, there is not enough data to support the calibration of the charge and demonstrate when the risk will materialise, she continued. "For green assets there are very few data before 2009 and so we don't know how these assets behave in times of crisis."

Also on the panel, Hugh Savill, director of regulation at the Association of British Insurers, said capital charges could be changed. However, the basis of valuation in Solvency II is the market. "Every time you move away from that, you create an impression of artificiality which I think is unhelpful," he said. "And because we don't have enough data, regulators are likely to get it wrong, so we are not ready to do it yet."

Solvency II as a risk-based regime, is the go-to argument for the industry when it comes to the question of climate-related capital charges. But one could argue Solvency II is also used as a political tool by the European Commission. EU government bonds have no capital charge, and charges for infrastructure have been lowered without compelling risk-based evidence. There is now a push by politicians, mainly French, to lower charges for equity investments.

Asked about these political interferences, Tobias Buecheler, head of regulatory strategy at Allianz, replied: "You are right there is political influence. But it was supposed to be a market-based system and the less political influence we have, the better it will be."

According to Savill, the changes to capital charges have always been based on some element of a market-value justification.

But Siry argued it comes back to the political will to prove the justification: "Because if you had the political will, you can always prove something one way or the other."

Green assets are not necessarily less risky, she conceded, but policy makers could take a political stand to raise capital charges for brown assets in order to push for transition.

"That is not something supervisors can do on their own because we are going to be limited by the fact that we will have to prove that it makes sense from a risk-based point of view - and if we can't prove that, then it is a political decision to make," Siry said.


One area where financial regulation can press forward is on disclosure. And according to Siry this is going to be the main regulatory focus in Europe in the next few months.

The three European financial supervisory authorities – namely the European Banking Authority, the European Securities and Markets Authority and Eiopa – are working on disclosures of adverse impact of investment portfolios, across financial sectors, which will be published for consultation in Q1 next year, Siry announced.

"It will make it compulsory for insurers, banks and asset managers to have, probably, an annual report, on the adverse impact of their investment decision," she said. "They will have to mention in which sector they invest, what are their CO2 emissions."

It will be an extension of the French article 173 – the corporate climate disclosure law – to the whole of the EU, according to Siry. And it will address the issue of lack of data, as well as allow NGOs and civil society to hold stakeholders to account.

"I'm thorn on this," Savill replied. "Because of course there should be more disclosures, but on the other hand there is a risk of disclosing rubbish if we don't have the right things to disclose."

He took the example of the Solvency and Financial Condition Report insurers have to publish under Solvency II, arguing insurers have "wasted huge amount of money publishing [them] and it never gets read".

"Let's get the disclosure right, let's not go for volume of disclosure. If we happen to wait another year to get it right, I think that is important," Savill said.

Tomorrow's regulation

Asked their thoughts on tomorrow's regulation, panellists said they expect more regulation. But to be efficient, it will have to apply across the economy and driven by policymakers rather than financial supervisors.

"If we want to be serious about it, we need to talk about the real industry, so we need to talk about CO2 pricing, etc. Financial services can help, but we can only get so far," Buecheler said.

The sentiment was echoed by Siry who concluded: "I would agree with the idea of getting into CO2 pricing as we see there are limitations both from the industry and the supervisors to resolve the question of climate change. We have a role to play and there is a lot to do, but it also has to come from the wider regulation, and policymakers."