Net-Zero Transition Plans

A Supervisory Playbook for Prudential Authorities

November 17, 2022Published by LSE Grantham Institute

This report discusses how central banks and supervisors can use prudential transition plans as a “dynamic instrument” to assess and address climate and environmental risks.

It says that while supervisors are currently hindered by a lack of suitable data and overreliance on backward-looking risk management approaches, transition plans can be used alongside scenario exercises and stress testing to help “bring distant financial risks into the present”.

It distinguishes these prudential plans from market-led net-zero transition plans championed by initiatives like the Glasgow Financial Alliance for Net Zero, and mandatory corporate disclosure plans such as those being proposed by the US Securities and Exchange Commission.

Instead, prudential plans would focus on the risk of misalignment with net-zero targets. They would be a regulatory requirement introduced specifically with an eye on micro and macroprudential concerns related to transition risks and the net-zero transition.

The authors suggest that by assessing the quality of institutions’ plans and alignment with the targets within themthose plans, supervisors could identify climate and environmental risks both in the short and long term.

They also suggest the plans could be used to assess alignment with the transition of the financial sector as a whole, and provide the starting point for a discussion of appropriate macroprudential tools to address the relevant systemic risks that may arise.

The paper proposes that prudential regulators:

  • set supervisory expectations for prudential transition plans to ensure they are fit for prudential purposes;
  • undertake supervisory assessment of prudential transition plans to determine whether financial institutions are exposed to risks in the context of alignment with the applicable government’s transition pathway;
  • take steps to mitigate the risks to banks whose plans indicate acute and significant transition risks are exposed, utilising the micro and macroprudential toolbox.

 

This page was last updated November 17, 2022

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