The Effects of Mandatory ESG Disclosure around the World

10 December: We examine the effects of mandatory ESG disclosure around the world using a novel dataset. Mandatory ESG disclosure increases the availability and quality of ESG reporting, especially among firms with low ESG performance. Mandatory ESG reporting helps to improve a firm’s financial information environment: analysts’ earnings forecasts become more accurate and less dispersed after ESG disclosure becomes mandatory. On the real side, negative ESG incidents become less likely, and stock price crash risk declines after mandatory ESG disclosure is enacted. These findings suggest that mandatory ESG disclosure has beneficial informational and real effects.

Working Group on Banking Supervision and Sustainable Development in the Americas

Banking regulations are known to have substantial leverage on the real economy for the simple reason that finance permeates everywhere. By the same token, they are a suitable instrument for improving the preparedness of the real economy for climate change. We convene a working group of prominent practitioners from among the collectivity of bank supervisors and regulators in the Americas, along with recognised experts in the field in order to review the state of practice regarding the incorporation of climate change into micro prudential regulatory frameworks.

For purposes of ordering the discussion, existing and potential practices will be grouped into four categories:

  • Those where the authorities provide finance by instruction.
  • Those where the authorities provide incentives for desired types of finance.
  • Those where the authorities reduce financial risk by socialising potential losses by means of insurance, direct payments, or exceptional access to citizens’ own assets.
  • Those where systems are set up to prevent, contain, and abate negative externalities.

To assist the working group’s deliberations, we will provide reference documents on existing practices, as well as on plausible modifications in existing regulations that can have important positive impacts for climate change and adaptation. The working group will also be asked to discuss the feasibility of specific innovations for making regulations more climate-friendly, and to review potential obstacles, barriers, and resistance to the implementation of such potential change. The document emerging from the working group’s deliberations will provide policy recommendations and, where appropriate, a further research agenda.

Working Group members:

Management of Climate Risks in the Financial Industry of a Resource Based Economy: A Canadian Scenario Analysis

Although some studies exist on how the financial industry is affected by climate risks and how it might manage them, no such studies exist for a country with an economy that is mainly based on carbon-intensive resources, such as oil, gas, and mining. We conduct a scenario analysis based on an impact matrix that uses both physical and transition risks to model impacts on the financial portfolio of Canadian chartered banks. We will complement findings about climate-related risks and opportunities in Europe, Asia, and Africa that are different from climate change-related risks to North America and that are in countries with different regulatory frameworks.

Our research will be based on a formative scenario analysis and an impact matrix will be created based on the Intergovernmental Panel on Climate Change climate scenarios and climate scenarios for Canada. Based on different data sources, we will conduct a MICMAC analysis (a system of multiplication of matrices applied to the impact matrix) to calculate both direct and indirect impacts on Canadian banks’ financial risks. The expected results will help policymakers in countries with carbon-intensive economies to create financial policies, regulations, and supervision regimes that could be applied by central banks and other financial regulators to mitigate climate risk for the financial industry without creating otherwise significant negative impacts for these countries’ economies.

The results of this INSPIRE research will help banks to implement strategies to reduce their exposure to climate-related financial risks. Consequently, negative impacts on the Canadian financial industry could be avoided. This is important given that the Canadian banking sector is dominated by five chartered banks that are similar with regard to their businesses.

The Effects of Mandatory Environmental, Social and Governance (ESG) Disclosure Around the World

In recent years, due to the dramatic increase in demand for ESG information to prompt sustainable growth, many countries and jurisdictions have issued regulations that mandate firms and financial institutions disclose their ESG situations and activities. But what are the real impacts of such mandatory ESG disclosure regulations on financial markets? We address this question by examining the financial stability of firms in 44 countries around the world over a sample period of 2000 to 2017.

To assess the stability of a firm, we measure the volatility of equity return and the likelihood of stock price crashes. Using multivariate regressions, we find equity return volatility is lower after mandatory ESG disclosure, and within this, systematic and idiosyncratic volatility are also significantly lower. We find stock price crash risk declines after the enforcement of mandatory ESG disclosure.

Our findings support calls for mandatory introduction of ESG disclosure requirements. In particular, stock exchanges should increase their ESG disclosure policies, as we show that mandatory disclosure improves the information environment. Moreover, our findings on financial stability are of interest to central banks and the enactment of mandatory ESG disclosure enhances the stability of the financial market by improving the ESG informational environment.

Environmental and Social Risk Management in Brazilian Banking: From an Environmental and Social Management Structure to Climate Scenario Analysis Development

The Central Bank of Brazil is taking encouraging steps for greening the country’s financial system. In 2014, the Brazilian National Monetary Council issued Resolution 4327, a principle-based resolution that required all Brazilian financial institutions to develop an Environment and Sustainability (E&S) management system with a comprehensive scope.

Three years later, Resolution 4557 was published, requiring risk management and structure for capital management of Brazil’s financial institutions, and in 2020, the Central Bank of Brazil joined the NGFS. In this study, we assess and benchmark the impacts of the Central Bank of Brazil’s Environmental and Social Risk Management policy by conducting interviews with Brazilian large- and medium-sized public, private, and development financial institutions. Central Bank of Brazil staff were also interviewed to gain clearer understanding that what kind of methodologies, tools, and practices would be better to assess financial institutions based on Brazilian Monetary Council (CMN) Resolutions 4327 and 4557.

Based upon our findings, we developed a self-assessment tool that will provide a checklist to help banks grasp the concepts behind the principles-based approach of the national E&S regulatory framework. We found Tropicalisation of international benchmarking from oversight bodies and market players (mainly those related to Taskforce on Climate-Related Financial Disclosures recommendations) is a way to improve E&S risk management process in Brazil (and potentially in other Latin American countries). Similarly, since 2020, high-level management engagement has enabled the Central Bank of Brazil to begin a better integration of E&S and climate issues into its regulation and supervision.

Politica Regulatoria Financiera Verde para America Latina en el Post-Corona

Por más de un año, la pandemia del COVID-19 ha presionado a gobiernos, economías y la salud publica a un punto de quiebre.  Solamente en Sudamérica, ha habido más de 25 millones de casos registrados y 679,376 muertes asociadas al COVID-19, siendo el brote epidemiológico en Brasil el tercero mas intenso en el mundo. En medio de este gran sufrimiento humano y económico, la Latinoamérica también enfrenta un riesgo económico substancial, a lo cual se les suma una alta exposición a conflictos socioambientales, emergencias climáticas y al cambio climático a largo plazo.

¿Cómo América Latina puede recuperarse de la pandemia del COVID-19 y, a la vez, enfrentar de la mejor manera las debilidades sistémicas en el sector regulatorio financiero? ¿Qué herramientas de política están disponible para los reguladores financieros? ¿Cómo pueden incorporarse en el futuro los riesgos climáticos en la política de regulación financiera?

Durante el otoño boreal del 2020, el Global Development Policy Center de Boston University (GDP Center) convocó un Grupo de Trabajo compuesto por reguladores bancarios, banqueros de desarrollo y otros expertos afines de América Latina para revisar las herramientas de regulación financiera disponibles y definir una hoja de ruta a seguir. El nuevo reporte elaborado por Daniel Schydlowsky, Investigador Distinguido del GDP Center, resume las discusiones y recomendaciones del Grupo de Trabajo hacia una política financiera y regulatoria “verde” en América Latina post COVID-19.

Dentro de las recomendaciones del Grupo de Trabajo resalta la necesidad que los agentes financieros no solo tomen en consideración los efectos directos de sus acciones, sino también los efectos indirectos de estas. Asimismo, que el sector financiero, en su conjunto, adopte políticas que ayuden la internalización de los riesgos externos. En ese sentido, el Grupo de Trabajo recomendó que se adopte y centralice un sistema de Manejo de Riesgos Ambientales y Sociales (ESRM, por sus siglas en ingles) en todo el diseño de la política regulatoria financiera en América Latina. Originalmente desarrollado para la aplicación en la industria de financiamiento de proyectos y plasmado en los Principios del Ecuador, la aplicación de un sistema de ESRM de manera obligatoria en todo el sistema financiero aseguraría que cualquier entidad financiera incluya en la evaluación proyectos no solo el efecto de las actividades circunscritas al negocio a financiar, sino también aquellas en vinculadas a un contexto económico más amplio. Esto incluye consideraciones acerca del impacto del proyecto en trabajadores, sus familias y comunidades, proveedores y clientes; así como requisitos para manejar quejas por parte de trabajadores, vecinos y otros, y compromisos de acciones correctivas donde se pueden anticipar daños socioambientales.

De igual manera, el sistema de ESRM debería estar apoyado por otros instrumentos de política regulatoria específicos para afrontar riesgos climáticos particulares. Esto es importante para las política medioambientales y climáticas de corto, mediano y largo plazo, así como para las políticas relaciones con la respuesta ante desastres naturales. La recuperación de la pandemia del COVID-19 requerirá, de igual manera, del diseño de políticas especificas que tomen en cuenta las circunstancias económicas particulares creadas a raíz de esta pandemia.

En resumen, la adopción de un sistema de ESRM y de instrumentos de política específicos conllevaría a políticas de regulación financiera que puedan asegurar la solidez del sistema financiero a largo plazo y también contribuir a la evolución sostenida de la economía por una senda mas consistente con los requerimientos medioambientales y del cambio climático.

Miembros del Grupo de Trabajo:

  • Evasio Asencio, Commissioner Owner, Comisión Nacional de Banca y Seguros, Honduras
  • Carolina Benavides-Piaggio, Senior Capacity Development Officer, FMO, The Netherlands
  • Keron Burrell, Head Methods, Analysis and Quality Review Department Bank of Jamaica
  • Ethel Deras, President Comisión Nacional de Banca y Seguros, Honduras
  • Rafael Del Villar, Advisor to the Governor Banco de México, Mexico
  • Alan Elizondo, Director General FIRA Mexico
  • Mariana Escobar, Head Sustainable Finance Group Superfinanciera Colombia
  • Daniel Gomez Santeli, Risk Manager Comisión Nacional de Banca y Seguros, Honduras
  • Kemar Hall, Assistant Director (Acting) Policy, Research, Methodology, and Development Department Bank of Jamaica
  • Patricia Moles, Advisor Banco de México, Mexico
  • Sheriffa Monroe, Director Policy, Research, Methodology, and Development Department Bank of Jamaica
  • Carlos Alberto Moya, Consultant
  • Carmen Navarro, Senior Social and Environmental Officer, FMO, The Netherlands
  • Angel O’Dogherty, Co-General Director Sector Intelligence, FIRA, Mexico
  • Pascual O’Dogherty, Secretary General, Association of Banking Supervisors of the Americas, Mexico
  • Daniel Schydlowsky, Boston University Global Development Policy Center, USA
  • Guilherme Teixeira, Manager Sustainable Finance, Sitawi, Brazil

Green Financial Regulatory Policy for Latin America in the Aftermath of COVID-19

For over a year now, the COVID-19 pandemic has strained governments, economies and public health to within breaking point. In South America alone, there have been over 25 million recorded cases of COVID-19 and 679,376 deaths, with an outbreak in Brazil that is the third largest in the world. Amid this great human and economic suffering, Latin America also faces substantial risk of economic shock and exposure to socio-environmental conflicts, climate emergencies and long-term climate change.

How can Latin America best recover from the COVID-19 pandemic and address systemic weaknesses in the financial regulatory sector? What policy tools are available for financial regulators? How can climate risks be incorporated into Latin America’s financial regulatory policy moving forward?

In the fall of 2020, the Boston University Global Development Policy Center convened a Working Group of Latin American bank regulators, development bankers and related experts to review the financial regulatory policy toolbox available to regulators and map a way forward. A new report written by GDP Center Distinguished Scholar Daniel Schydlowsky summarizes the Working Group’s discussions and recommendations to green Latin America’s financial and regulatory policy in the aftermath of COVID-19.

Chief among the Working Group’s recommendations is that financial agents take into account not only the direct effects of their actions, but also the indirect effects and that the sector as a whole adopt policies that support the internalization of external risks. To this end, the Working Group recommends that an Environmental and Social Risk Management (ESRM) system be adopted and centralized throughout the design of financial regulatory policy in Latin America. Originally developed for application to the project finance industry and embodied in the Equator Principles, the application of an ESRM system on a compulsory basis across the financial system would ensure that any individual financier include in their evaluation the effect of a project’s activities not only on the enterprise financed, but also on its broader economic context. This includes considerations of project impacts to workers, their families and communities, suppliers and customers, as well as requirements for grievance procedures by workers, neighbors and others, and commitments for remedial action where socio-environmental harm can be anticipated.

At the same time, the ESRM system should be supported by other regulatory policy instruments specific to addressing particular climate risks. This is important for the short, medium and long-term environmental and climate policies, as well as policies concerned with responding to natural disasters. Recovering from the COVID-19 pandemic will also require designing specific policies that take into account the particular economic circumstances created by the pandemic.

Put together, the adoption of an ESRM system and targeted policy instruments would cumulate in financial regulation policies that can ensure the long-term soundness of the financial system and also contribute to the sustained evolution of the economy on a path more consistent with environmental requirements and climate change.

Case Studies of Environmental Risk Analysis Methodologies

This Occasional Paper presents a detailed and in-depth discussion of the tools and methodologies for Environmental Rish Analysis (ERA) through case studies conducted by over 30 organizations. This paper aims to inform the financial community of the ERA methodologies and inspire interested institutions to further develop or enhance them. Views expressed in the Occasional Paper are those of the individual authors and do not necessarily reflect the views of the members and observers of the NGFS.