The 2024 World Economic Forum report reveals that climate-related dangers form five out of the top 10 global financial risks. Private equity investors increasingly evaluate climate-related financial risks (CRFR) when making investment decisions. There is therefore a growing need for standardised and comparable data across industries and companies.
The draft standard CRFR disclosure framework for regulated entities (RE) (guidelines) issued by the Reserve Bank of India (RBI) in February 2024 seeks to address the paucity of CRFR information. The guidelines largely follow the Business Responsibility and Sustainable Reporting principles that the Securities and Exchange Board of India introduced in 2021. If they are implemented in their current form, the guidelines will apply to all scheduled commercial banks other than local area banks, payments banks and regional rural banks, all top-layer and upper-layer non-banking financial companies and certain other financial institutions. Other REs may voluntarily adopt the guidelines.
Under the guidelines, REs must make climate-related disclosures that relate to governance, strategy, risk management and target setting. Such disclosures include forward-looking information involving financed emissions, the impact climate has on business models, risk considerations when setting capital buffers, the manner in which information is collected from clients and considerations of climate factors when setting remuneration.
While the disclosures by REs are likely to be an important source of information for stakeholders such as financial investors, the guidelines present several implementational challenges. Previous surveys conducted by the RBI have shown that REs do not have adequate expertise to identify and analyse CRFRs. While some lack skilled human resources, others face difficulties in measuring the risk due to the non-standardisation of methodologies and inadequate data, among other factors. This lack of expertise may materially degrade the accuracy and completeness of disclosures and undermine their value.
The guidelines require REs to provide information relating to their portfolios, which may include diverse entities, each with its own methodologies for measuring CRFRs. A detailed comparative assessment is thus likely to be cumbersome. REs may also need to try and test various quantitative and qualitative methodologies to calculate a counterparty credit risk incorporating data from physical risk analysis, that is direct damage to assets, including a loss of biodiversity and disruption of supply chains, and transition risk analysis, risks related to the process of adjusting to a low carbon economy. Consequently, because of the absence of streamlined and standardised methodologies for entities in the portfolio, REs may find the finalising of disclosures expensive and time-consuming.
If REs submit non-standardised data, the RBI will face logistical challenges in consolidating and comparing disclosures. It may even be difficult for the RBI to identify REs that are not complying with the guidelines.
The RBI has proposed a staggered approach towards adopting the guidelines, although most REs are required to have them in place by FY 2027-2028. The RBI should take advantage of the period during which the guidelines are only voluntary. It must ensure sufficient capacity by using experts to implement streamlined and standardised methodologies for each industry to the greatest extent possible. The RBI may consider conducting knowledge sessions; issuing clarifications from time to time; creating a forum to discuss practical challenges and feasible solutions, and enabling stakeholders to raise queries. The RBI may seek the help of research bodies to create detailed guidance notes covering key drivers, methodologies and metrics for CRFR disclosures.
Before the guidelines are implemented, REs may proactively adopt a governance structure clearly defining the roles and responsibilities of the board and management. They should undertake periodic reviews of CRFRs; hire skilled personnel, experts and advisers to evaluate CRFRs and follow internal CRFR policies in line with the guidelines.
While the guidelines are a step in the right direction, given the greater global emphasis on sustainability, REs must begin laying the groundwork for compliance as early as possible.
Vandana Pai is a partner and head of the investment funds practice and Hardik Dave is an associate at Bharucha & Partners.
