ICAEW insights previously provided a short guide to IFRS S2 Climate-related Disclosures (IFRS S2), including its application to the UK. To help entities implement IFRS S2, the ISSB published industry-based guidance (guidance) in June 2023, which is based on the Sustainability Accounting Standards Board (SASB) Standards and that are now maintained by the ISSB.
In total there are 65 guides across 11 industry sectors, including five guides for the financial services sector: being asset management and custody, commercial banks, insurance, investment banking and brokerage, and mortgage finance. Universal banks may need to look to two or more of the guides, to achieve coverage of all their business.
It is important to note that, as set out in the introduction to the guidance, it “suggests possible ways to apply some of the disclosure requirements in IFRS S2 but does not create additional requirements.” It is, therefore, possible that different disclosures may satisfy the requirements in S2.
Generally, the guidance is helpful but might only be said to supplement a few of the requirements in the strategy and risk management sections of IFSR S2. It does not provide guidance generally for governance, and metrics and targets sections. Care should also be exercised in applying the guidance, as it may not completely address a particular requirement in IFRS S2. For example, IFRS S2 requires disclosure of the risks and opportunities, whereas the guidance tends to focus on the effects of the risks. Or the guidance may not always be coherent: the commercial banking guidance considers the effects of ESG, whereas the mortgage finance guidance focuses on extreme weather events.
The remainder of this article highlights the guidance applicable to commercial banks and mortgage finance providers, including some of the issues which preparers using this guidance might need to think about.
Commercial banks (excluding mortgage finance)
In summary, the guidance suggests providing a description of the approach to including ESG factors in credit analysis.
Some of the more granular matters the guidance suggests disclosing are: how ESG factors are incorporated into assessments of creditworthiness and estimates of credit losses; whether it conducts scenarios analysis that captures the ESG trends; how different sectors or industries are affected; significant concentrations to ESG factors (eg, carbon related assets); quantitative disclosures of the number of loans subject to ESG reviews.
The guidance is focused on the lending activities of the commercial bank, which is where a bank can suffer the most loss, but also have most influence, for example in supporting the transition away from carbon intensive industries. However, banking activities (ie, offering and operation of accounts) and the liability side of the balance sheet should also be thought about in the context of IFRS S2. Facilitating the continuing operation of carbon intensive industries through the provision of banking and payment services may carry reputational risk, or there may be opportunities in supporting new ‘greener’ industries.
The mortgage guidance, described below, uses a 100-year calibration for disclosures and includes quantitative metrics. There is no such threshold or similar metrics within the commercial bank guidance.
Mortgage Finance
This guidance applies to both residential and commercial mortgages.
In summary, the guidance suggests disclosure of:
- The number and value of mortgage loans in 100-year flood zones.
- The expected loss and loss given default as a percentage attributable to mortgage loan default and delinquency because of weather related natural catastrophes.
- A description of how climate change and other environmental risks are incorporated into mortgage origination and underwriting.
The first disclosure relates to mortgages located in a 100-year flood zone. Given the available historic data and changing weather patterns, it is perhaps unlikely that past data will be sufficiently reliable to estimate 100-year events (eg, as ice caps melt and sea levels rise, more low-lying coastal regions become susceptible to flooding). Firms may need to supplement the past data with additional analysis such as scenario modelling to identify potentially relevant zones.
Furthermore, while the guidance provides some examples of flood zones (eg, coastal flood plains), mortgage providers may need to think more widely what other zones might be susceptible. The recent events in Dubai illustrate how unprecedented or extreme weather events are more frequently occurring. Similarly, the degree to which our cities are concrete landscapes which do not allow rapid drainage of heavy rains can lead to flooding (an extended dry period would achieve the same effect outside of cities as the natural ground hardens).
Moreover, consideration might be needed of the frequency and magnitude of the losses or effects to determine whether 100-years is the appropriate threshold to meet materiality expectations.
The accompanying guidance for the second disclosure gives examples of weather-related catastrophes. Mortgage providers should however also think about whether there are more pernicious and gradual incremental consequences from changing weather patterns, that in time may lead to serious issues. For example, frequent periods of wet weather followed by extended dry periods might cause significant subsidence issues, even if individually it is hard to say that each constitutes a catastrophe.
On a related theme, the design and fabric of buildings may not be appropriate to shifting climates leading to building obsolescence. They lack adequate insulation or air-condition for example. For commercial real estate this may affect the ability to let out the building, adversely affecting the ability to repay the mortgage and the collateral valuation.
The third disclosure suggests detailing the approach to loan origination and underwriting. However, explaining how climate change affects the on-going risk management of the mortgage portfolio might also be relevant; in particular, how climate affects how defaults, delinquencies and properties in possession are managed (eg, how does the mortgage provider respond to changes in property or collateral values due to climate
