Malaysia’s financial institutions have a new source of data to start planning their response to the risks of financed emissions

• Climate-related financial risks are the largest source of unpriced financial risks facing banks and investors
• Financial institutions have the ability to affect production linked to GHG emissions as well as demand, which provides them a unique leverage point to manage their own risks
• There’s an opportunity for competitive advantage for financial institutions that analyze their risk from financed emissions, while laggards will face growing investor and regulatory pressure

Climate-related risks have become one of the most significant sources of unpriced risk facing the financial sector in Malaysia, and the RFI Foundation has released a report providing some data as a starting point for action to address it. In a top-down analysis of Malaysia’s economy and financial sector, RFI Foundation estimates the sources of financing of Malaysia’s largest direct emitters of greenhouse gas (GHG), as well as key sources of demand for the goods and services behind those emissions.

This ‘production’ view — taking two perspectives of direct and indirect emissions — provides a more complete perspective for Malaysia’s financial institutions and their investors to analyze the most effective way to manage their exposure. The analysis also complements the production view with a perspective on household financing, which accounts for more than half of loans and financing from the banking sector.

In short, the report found that electricity generation (41%), transportation (21%), manufacturing (10%) and waste management (7%) were responsible for the bulk of direct emissions. Of these, all but manufacturing have some of their capacity to decarbonize dependent on end-user demand from industrial, commercial and residential sources.

All-in-all, this is part of what the UN-supported Principles for Responsible Investment (PRI) describes as the “Inevitable Policy Response” in reaction to the ratchet feature built into the Paris Agreement. The ‘Paris ratchet’ is the process of evaluating progress and setting new targets built into the climate accord that will lead to a strengthening of policy response — likely to accelerate between 2023 and 2025 — as emissions trajectories are measured against nationally determined contributions and a new round of national targets is set.

This timeline pulls climate change out of the distant future and into the medium-term horizon for businesses, financial institutions and investors in a way that addresses financial results. Larry Fink, CEO of BlackRock, which manages $7 trillion in assets, succinctly summed up the issue for those coming from a financial perspective. Climate change, he said in the firm’s 2020 letter to CEOs, is “driving a profound reassessment of risk and asset values. And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself.”

This completes the case for why financial institutions should become more active in analyzing the data they already have and incentivizing reporting of new data by their customers. They are facing financial risks from GHG emissions turning from an unpriced externality to a direct cost for their customers. Those customers’ ability to service financing will be affected by internalization of GHG emissions costs that is driven by the ‘Inevitable Policy Response’. The financial institutions’ own investors are starting to factor in these risks to their equity, bond and sukuk investments in the financial sector.

There’s a competitive advantage to be had from getting ahead of the field. There’s also a reduction of systemic risks from collaborating across the financial sector, which is being encouraged by regulatory and industry forums such as Value Based Intermediation and the Joint Committee on Climate Change with development of taxonomies and assessment frameworks. Finally, there’s a responsibility to humanity to contribute to solving the biggest coordination problem that will face the world in coming decades. This report is designed to help move collective knowledge to support action by financial institutions, and RFI is here to be a catalyst to speed the process forward.

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Republished from the RFI Foundation’s weekly newsletter. Subscribe for free here!