Finance leaders from 10 major banks and building societies gathered in London recently for a special ICAEW roundtable on sustainability reporting in financial services.

Held at Canary Wharf, the event looked at how to create climate scenarios when preparing to report in line with IFRS 9 Financial Instruments, with several banking representatives outlining their approaches.

Global sustainability reporting: rapid convergence

To set the scene, ICAEW provided an overview of current global regulatory regimes relating to the adoption of the International Sustainability Standards Board (ISSB) standards IFRS S1 and IFRS S2.. This included a hypothetical example illustrating how a jurisdictional regulatory change could affect an entity’s financial position, performance and subsequent disclosure obligations.

Against that backdrop, ICAEW highlighted that the ISSB requirements encompass both current and anticipated financial effects, based on reasonable and supportable information available at the reporting date and without undue cost or effort.

IFRS 9 scenario modelling: approach and implications for disclosures

The discussion turned to how those considerations are reflected in Expected Credit Loss (ECL) modelling under IFRS 9, and, in turn, how the resulting outputs are reflected in financial statement disclosures. The modelling forms the basis for amounts recognised in the financial statements, including key assumptions, sensitivities and sources of estimation uncertainty.

Attendees confirmed that climate-related risks are increasingly incorporated into ECL modelling, which includes transition risks such aspolicy, market and technological changes, and physical risks, including flood exposure.

For the various financial institutions, risks that affect ECLs within the contractual life of financial instruments vary across portfolios: many exposures are short-tenured (especially unsecured and corporate facilities), whereas longer-dated assets are often secured with observable collateral values.

Specifically, the banking representatives noted that a number of modelling-related factors can limit the extent to which climate-related risks are reflected in recognised amounts and, as a result, in financial statement ECL disclosures in accordance with IFRS 9.

1. Time horizons 

ECL outcomes are influenced by both the contractual tenures of financial instruments and the measurement approach under IFRS 9. Many portfolios are characterised by relatively short contractual tenures.

Separately, under IFRS 9, performing assets are typically subject to a 12-month ECL measurement, whereas lifetime ECLs apply when there has been a significant increase in credit risk.

Banking representatives stated that climate-related risks are expected to materialise over longer periods. As a result, such risks are often assessed as not affecting ECLs within either the contractual life of shorter-term instruments or the relevant IFRS 9 measurement horizon. This can in turn limit the extent to which these risks are reflected in recognised ECL amounts and associated disclosures.

2. Use of reasonable and supportable information 

While ‘off-the-shelf’ climate scenarios are available from organisations such as the Network for Greening the Financial System, there is limited historical data linking climate pathways to credit outcomes. 

There are also challenges translating long-term scenarios into near-terms parameters. This affects the measurement, the extent and specificity of climate-related disclosures.

3. Interaction with existing macroeconomic scenarios 

Alongside risks of double-counting climate effects already embedded in baseline macroeconomic variables, banks highlighted difficulties with isolating incremental climate impacts. 

As such, judgement is required to determine whether climate-related risks are already reflected in existing economic and credit assumptions. Such judgements may be reflected in disclosures about assumptions, overlays or areas of estimation uncertainty.

4. Sector specific data 

Data limitations remain a consistent constraint – particularly for retail portfolios (eg, in relation to property-level exposure to physical risks) and commercial portfolios (eg, differentiation of sector-level transition risk). These data limitations may also be described in disclosures where they represent significant estimation uncertainty.

The above factors highlight the modelling approaches that banks are taking, as well as limitations on the ability to quantify climate-related effects within ECL models. The financial institutions mentioned that these limitations can directly affect the extent to which climate-related risks are reflected in recognised amounts and explained in the financial statements in accordance with IFRS 9.

What are the implications?

Overall, the roundtable highlighted that climate-related risks are increasingly embedded within banks’ risk management and modelling frameworks. However, the extent to which those risks are reflected in recognised amounts within the financial statements remains diverse. 

This is likely to remain an area of focus as supervisory expectations evolve, including through the Bank of England’s supervisory statement SS5/25, which sets out the Prudential Regulation Authority’s (PRA) expectations for firms’ approaches to managing climate-related risks. 

A participant noted that climate-related risks may give rise to more complex and interrelated nature effects over time, which could have implications for risk management and, where relevant, financial reporting.

In addition to the IFRS accounting requirements, ICAEW says preparers will increasingly need to focus on improving transparency in their ISSB disclosures of how climate-related effects are reflected in the resilience of their companies’ business models. It will be vital for entities to think seriously about these non-linear risks and the resilience of their business model, reflecting them in their anticipated financial effects via ISSB disclosures, for example.