How should China improve climate disclosure in the finance sector?

China is exploring mechanisms for financial institutions to disclose climate impacts, but can do more by making disclosures mandatory and providing incentives
<p>The People&#8217;s Bank of China, Beijing. China&#8217;s financial sector is beginning to disclose information on climate-related risks, but the industry needs to move much faster in order to meet the country&#8217;s top-level climate goals. (Image: Alamy)</p>

The People’s Bank of China, Beijing. China’s financial sector is beginning to disclose information on climate-related risks, but the industry needs to move much faster in order to meet the country’s top-level climate goals. (Image: Alamy)

In 2020, China announced its dual carbon targets of peak carbon before 2030 and carbon neutrality before 2060. Getting there will require an estimated 138 trillion yuan (US$21.6 trillion) in low-carbon finance over the coming decades – an enormous opportunity for the financial sector. Disclosure of environmental information, particularly relating to climate, will support the finance sector’s efforts, and this is an area in which China’s policies and practices have been developing quickly.

$21.6 trillion

The estimated finance required for China to reach its current climate goals

Over the last two years, financial regulators have hurried to improve mechanisms for environmental disclosures, requiring institutions to make public their low-carbon lending and associated emissions reductions. A mandatory system for environmental disclosures is imminent. Meanwhile, the city of Shenzhen has been trialling compulsory climate disclosures for financial institutions, and some banks have been calculating and publishing the carbon footprint of their funding activity. Climate disclosure is starting to be put into practice.

In December 2021, and with support from the Energy Foundation China, the Beijing Institute of Finance and Sustainability and the Industrial and Commercial Bank of China’s Modern Finance Research Institute jointly published a report on environmental disclosures by financial institutions in relation to the dual carbon targets. The report identified key difficulties and proposed building on existing work by making disclosures mandatory, putting incentives in place, developing methodologies and tools, and building capacity.

Climate disclosure: international trends and challenges

At the corporate level, climate disclosure is essential for the management of climate risks and to ensure adequate funding for the transition to carbon neutrality. The global move towards carbon neutrality will create a US$100 trillion funding gap, but identifying and managing climate risks will help close that. As part of this, climate disclosure by the financial industry is essential for pricing of climate risks and will help market players to seize opportunities and better manage risks.

The objectives of climate disclosure include managing systemic risk, nudging the market from brown to green investments, identifying the risk profile of institutions and supporting the strategic management of the transition, according to a guide published by the Climate Financial Risk Forum, an entity co-chaired by the UK’s Prudential Regulation Authority and Financial Conduct Authority.

The greenhouse gas emissions associated with investments are harder to quantify but essential for decision makers and risk managers

The Financial Stability Board (FSB) stressed in its Roadmap for Addressing Climate-related Financial Risks that firm-level disclosure is a key support for evaluating and tackling climate-related financial risks. It pointed out that ample data and a common disclosure standard are crucial for high-quality climate disclosures.

Global climate disclosure frameworks currently in use around the world include those from CDP (formerly the Carbon Disclosure Project), the Climate Disclosure Standards Board (CDSB) and the FSB’s Task Force on Climate-Related Financial Disclosures (TCFD). The most influential of these is the TCFD’s Recommendations, published in 2017. That document structured disclosures around four areas: governance, strategy, risk management, and metrics and targets, reflecting the actual and potential financial impact of climate factors on the incomings, outgoings, assets and responsibilities of financial institutions, and on capital and investments, ultimately to provide support for risk pricing and capital allocation.

Governance, strategy and risk management information is relatively easy to obtain, as is data on the carbon footprint of a firm’s own operations. Disclosure could also help improve corporate image. But it is not enough for investors to assess risk and reward. Pressure testing of brown assets and the greenhouse gas emissions associated with investments are harder to quantify but essential for decision makers and risk managers. These are also the key to climate disclosures.

Many countries are looking at making disclosures mandatory, in order to obtain fuller data and high-quality disclosures. For example, in 2020 the UK produced its Roadmap to Sustainable Investing, pointing out that by 2025 climate disclosures will be mandatory across the UK economy. This year, on 21 March, the US Securities and Exchange Commission announced rule changes requiring listed companies to report on all their greenhouse gas emissions and climate risks. These emissions are broken down into direct emissions (termed Scope 1), indirect emissions from energy purchases (Scope 2) and upstream and downstream emissions in value chain (Scope 3). The rules also require companies to carry out climate risk assessments, engage in transition activities and set climate-related targets, to enable investors to understand how listed firms are managing climate risks.

But calculating for Scope 3 is a bottleneck, as the emissions of the investment and financing activities of financial institutions are particularly hard to quantify. On 14 March, the European Central Bank issued an assessment of climate and environmental risk disclosure by financial institutions, finding that only 15% of the 109 Eurozone banks it regulates have published data on emissions from their investment and financing. Almost none met the regulatory standards and expectations for climate risk disclosure.

Progress in climate disclosure in China’s finance sector

Recent years have seen valuable trials of climate disclosure policies and practices by Chinese institutions using the TCFD framework, and in green finance reform pilot zones such as the city of Guangzhou. Building upon that, regulators have issued a series of processes and standards for climate disclosure by financial institutions and firms. And climate disclosures are expanding from local voluntary trials, to a nationwide mandatory requirement.

The scope of disclosures and those required to make disclosures is also expanding: from green assets to brown assets, from major emitters to any listed firm, and then to financial institutions. Regulators are looking at how to open up the flow of climate information along financial sector value chains, to push the sector and other industries onto greener and lower-carbon paths.

Back in 2016, seven ministry-level bodies published guidance on building a green financial sector, making clear that environmental disclosures would be mandatory for listed and bond-issuing firms, in order to reduce the information gap hampering green finance. In December 2020, five ministry-level bodies published guidance on making better use of investment and financing in supporting the response to climate change, calling for better climate disclosure standards.

Since 2017, when Chinese and UK financial institutions started working on trials of climate and environmental disclosure, Chinese institutions have been actively exploring standard-setting, disclosure of brown assets, scenario analysis and pressure testing, alignment with the TCFD framework, and researching routes to carbon neutrality. By the end of May 2021, the number of institutions taking part in the trial had risen to 20 from the original 10, including banks, asset managers, insurers and securities firms. But the Chinese participants were still mainly disclosing environmental information – progress on climate disclosure had been slow. The challenges were inadequate disclosure of information by the institutions and their investment targets; and a lack of practical indices, methodologies, tools and capacities.

In 2021, the People’s Bank of China published and started to implement guidance on environmental information disclosure for financial institutions in areas running trials of green finance reforms, and encouraged institutions to join up. It also required banking institutions in the trial zones to make disclosures covering all three emissions scopes. Although some institutions in Guizhou and Zhejiang provinces and the Guangdong–Hong Kong–Macau Greater Bay Area did issue environmental disclosure reports, as did all municipal commercial banks in Jiangxi province, no climate disclosures seem to be available through public channels.

Meanwhile, Shenzhen has made breakthroughs, both in making environmental disclosures mandatory and in calculating the carbon footprint of investment and financing activity. In March 2021, the city put new regulations in place for green finance, with a section on environmental disclosures. Unfortunately, it did not explicitly require climate disclosures, but did encourage the use of scenario analysis and pressure testing for quantifying the credit, market and other risks arising from different climate, regulatory and sustainable development pressures.

In July 2021, the Shenzhen branch of the Industrial Bank made its first disclosure of the carbon footprint arising from its investment and financing, taking two renewable energy firms as case studies and working out the carbon impact of the bank’s loans. Subsequently, the Shenzhen-based China Merchants Bank disclosed the carbon footprint of funding given to 55 firms working in high-carbon industries, including coal power and cement-making. These two cases indicate that climate disclosure in China is underway.

Improving climate disclosure policies

Over the last two years, financial regulators have been improving environmental disclosure systems, and given more thought to climate factors in statistical and disclosure systems. In June 2021, the China Securities Regulatory Commission wrote that it “encourages voluntary reporting of measures taken within the reporting period to reduce carbon emissions, and the outcome of those measures.” In July 2021, the People’s Bank of China published guidelines for environmental disclosures by financial institutions, encouraging at least one disclosure per year covering environmental target scenarios, strategic planning, policies, actions and outcomes. For the first time, it said reporting could include targets and progress in controlling carbon emissions arising from an institution’s own operations, and in climate change mitigation and adaptation. However, no rules were set for Scope 3 emissions.

Meanwhile, the environmental authorities added climate-relevant information to the existing system for corporate environmental disclosure. On 8 February this year, the Ministry of Ecology and Environment (MEE) started enforcing new rules on the content and format of environmental disclosures. One of the focuses was on carbon emissions: major carbon emitters under the scope of carbon-trading quotas have to disclose carbon emission data, including actual emissions for the current and previous year, and information on quota settlement. It was also made clear that information disclosed will be published on a centralised system which the public will be able to access at no charge. This will make it easier for financial institutions to obtain emissions data from firms they may invest in.

Although the financial and environmental authorities are building climate data into existing statistical, calculation and disclosure systems, disclosure by financial institutions is not yet mandatory, and the scope of disclosures is limited. Carbon emissions data from investment and financing activities (Scope 3) will be essential for directing finance towards the low-carbon transition, but is absent from the existing standards.

The following could be done to build on existing work by financial regulators and the environmental authority.

1. Deeper regulation and a phased rollout of climate disclosures

Currently, almost all climate disclosure in China is on a voluntary basis, with the People’s Bank of China’s guidance mentioning only “optional disclosures” of carbon footprint details. The MEE’s proposals for reform of environmental disclosures say a mandatory system will be in place by 2025; and Shenzhen’s Green Finance Regulations make environmental disclosures mandatory. But neither specify what climate information must be published, or how. We suggest the financial and environmental authorities strengthen their regulatory systems, with timetables and roadmaps for mandatory climate disclosures, along with supporting measures. This would send a “get ready” signal to market players.

2. Improve incentives and restraints, reduce disclosure costs

Gathering and publishing climate information is a major undertaking for a financial institution. It has to be obtained from investees, and the process of disclosure is entirely new. This incurs costs, which reduces enthusiasm. In 2021, the People’s Bank of China said it would implement an incentives and restraints mechanism for banking institutions, based on assessments of their performance on green finance indices, and the outcome of green finance evaluations would feed into the central bank’s overall ranking system. We suggest using this approach and adding performance on climate disclosure into macro-prudential and micro-prudential tools, improving the associated incentive and restraint mechanism.

3. Develop methodologies and tools, open up information channels

Currently, climate information is hard to obtain, and accounting methodologies are not mature. We suggest developing methodologies at the sectoral, firm and project level, and using fintech to improve systems for managing climate data within financial institutions, providing frontline staff with the tools to do carbon accounting and make disclosures. The flow and sharing of information across finance, energy, climate and environmental sectors should also be improved, and specialist third-party providers that offer services to financial institutions should be fostered.

4. Strengthen institutional capacity, keep building disclosure capacities

Climate disclosure requires professional staff who have knowledge of energy and the environment. However, financial institutions currently lack that, reducing the efficiency and quality of their disclosures. We suggest promoting the experiences obtained by participants in TCFD and green finance reform trials and carrying out capacity building on climate disclosure, to train and attract specialists.

The author drafted this article with Dr Du Xuan during the latter’s tenure at the Energy Foundation China.