Introduction
Considerable attention has been directed at climate change and its impact on the environment in recent years. At a global level, this attention resulted in the Paris Climate Accords of 2015, an international treaty containing prescriptions on climate change mitigation, adaptation, and finance (Paris Climate Accords).
Kenya ratified the Paris Climate Accords on 28 December 2016. Implicit in the Paris Climate Accords is the fact that climate change signals a shift in economic activity and priorities. The Paris Climate Accords were recently perfected at the 26th UN Climate Change Conference (COP26 ) – held in early November – through the adoption of the Glasgow Climate Pact which enlarges the role of public and private sector financing in limiting the impact of climate change.
As a result, the principle of sustainability in operations has been adopted by numerous corporates, with some reporting climate-related risks and action under a framework developed by the Task Force on Climate-Related Financial Disclosures (TFCD). Established by the Financial Stability Board the TFCD makes proposals for “more effective climate-related disclosures that could promote more informed investment, credit, and insurance underwriting decisions and, in turn, enable stakeholders to understand better the concentrations of carbon-related assets in the financial sector and the financial system’s exposures to climate-related risks.”
On 15 October 2021, the Central Bank of Kenya (CBK) issued its Guidance on Climate-Related Risk Management (CBK Guidance). Based on the content in the CBK Guidance, it is apparent that the CBK drew on the aspirations contained in the Paris Climate Accords which were domesticated in Kenya through the Climate Change Act, No. 11 of 2016. Recent discussions at COP 26 will only bring these aspirations and resultant prescriptions into much sharper focus. It is aimed at providing direction to financial institutions to better manage climate-related risks by integrating them into their business decisions and activities. The premise of the CBK’s Guidance is that the push by countries to limit the impact of climate change will affect financial flows, shift economic activities, and resource allocation.
Building on recent strides in climate-related risk management and reporting such as TFCD, the CBK Guidance seeks to lay down the basic requirements for financial institutions’ identification, management and reporting of climate-related risks. These risks include transition risks, meaning those arising from the adoption of climate change mitigation policies, and risks posed to physical assets such as destruction in the event of natural disasters. For financial institutions, these risks may be particularly acute as their level of exposure may be higher than other organisations. For instance, lenders must grapple with the risk of borrowers defaulting based on climate change-related impact.
Purpose and Responsibility
The purpose of the CBK Guidance is for banks and other financial institutions under the CBK’s purview to:
To realise these objectives, the CBK Guidance requires the board of directors and senior management of financial institutions to formulate and implement climate-related financial risk management strategies, policies, procedures and guidelines.
Specific Requirements
Oversight and Management
The CBK Guidance provides that, financial institutions must adopt an effective governance structure that enables them to identify, manage, monitor, and report climate-related risks. There are distinct roles in the CBK Guidance spelt out for boards and senior management.
Boards are required to assess the institution’s risk exposure and oversee the development of the strategy in response to climate-related risks. In carrying out this function, boards are meant to set the pace for their organisations by reviewing and approving the risk appetite statement recommended by senior management which ought to outline desirable risk levels and guide the development of risk management strategies. It is recommended that the strategies should set out the process of identifying, measuring, monitoring, reporting, controlling, and mitigating climate-related risks.
For financial institutions, these risks may be credit-related, legal, reputational, or strategic, in addition to the obvious risks posed to liquidity. The board should also define and allocate roles and responsibilities for the implementation of these climate-related risk management strategies. In keeping up with the board’s oversight role, the CBK Guidance prescribes that boards of financial institutions set the climate risk appetite, approve climate-related risk management strategies, and ensure the allocation of adequate resources to the mitigation or management of climate-related risks.
Senior management, on the other hand, is primarily responsible for the implementation of a climate-related risk management strategy and would be required to report internally to the board on progress made.
Disclosure and reporting
The CBK Guidance also requires financial institutions to develop suitable approaches to disclosing their climate-related risks to enhance transparency. This may be through an annual report, a sustainability report, a report under the TFCD framework, or a special climate-related risk report. While the design of this disclosure framework is left to financial institutions, the CBK Guidance suggests that the TFCD framework of making disclosures relating to governance, strategy, risk management and metrics and targets, as a desirable one. Some financial institutions in Kenya have recently launched sustainability reports with a view of enhancing the Environmental, Social and Governance principles of their corporate governance.
In addition to the internal reporting by senior management to the board, banks are required to develop and submit to the CBK a time-bound plan of how they intend to implement the CBK Guidance by June 30 2022. This plan should be approved by the board and signed by the chair of the board and the Chief Executive Officer. Thereafter, financial institutions – particularly banks – are required to submit a quarterly report to the CBK on the progress of the implementation of its approved plan after the end of every calendar quarter from the quarter ending 30 September 2022.
Conclusion
With the issue of the CBK Guidance, it is imperative for financial institutions to familiarise themselves with its contents and begin to implement its prescriptions. Below is the schedule for the implementation of the CBK Guidance:
The CBK Guidance as at 6 December 2021 is accessible here.
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Read the original publication at Anjarwalla & Khanna