By Jim Mc
On 15 October 2021, the Central Bank of Kenya (CBK) announced the issuance of Guidance on Climate-Related Risk Management to commercial banks and mortgage finance companies.
The Guidance is intended to enable banks to integrate the opportunities and risks arising from climate change into their governance structure, their strategy and their risk management frameworks and disclose what they do about climate-related risks.
Each bank resident in Kenya must develop and submit to CBK a time bound Plan approved by the institution’s Board of Directors on how the Board and management plan to implement the guidance. The Board of Directors must have approved the Plan by June 30, 2022, and have the Plan signed off by both the
Chairman of the Board and the Chief Executive Officer. Thereafter, each Bank must submit a quarterly report to CBK on the progress of its implementation of the Plan within 10 days after the end of every calendar quarter; the first such quarterly report must be for the quarter ending 30 September 2022.
From the accountant’s perspective, the most important aspect of the guidance is that it will guide these institutions in disclosing climate-related information to their stakeholders. The CBK points out that Kenya and other African countries do not contribute significantly to the greenhouse gas emissions responsible for the adverse global consequences of climate change; CBK claimed on 15 October 2021 that African countries had borne the brunt of climate change – droughts, floods and wildfires – but one year on these phenomena have occurred in Australia, China, Europe, India, Pakistan, and North and South America. The CBK states that Kenya’s banking sector has been on a journey towards working for and with Kenyans since the issuance of the Kenya Banking Sector Charter in 2019. The Charter is anchored on four pillars: they are (i) customer centricity; (ii) risk-based credit pricing; (iii) transparency and (iv) ethical banking. Under the ethical banking pillar, banks have been integrating environmental, social and governance considerations into their operations. The issuance of the Guidance will accelerate the path towards integrating environmental considerations in banks’ business models.
In December 2015, nearly 200 governments agreed to strengthen the global response to the threat of climate change by “holding the increase in the global average temperature to well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels,” referred to as the Paris Agreement. The agreement aims to increase the ability of countries to deal with the impacts of climate change, and to make finance flows consistent with a low greenhouse gas emissions and climate-resilient pathway. The Paris Agreement entered into force for Kenya on 27 January 2017, and as set out in Article 2(6) of the 2010 Constitution of Kenya, the Paris Agreement now forms part of the laws of Kenya. The Climate Change Act, 2016 is the main legislation guiding Kenya’s climate change response
to climate change in Kenya.
The Guidance argues that climate-related financial risks can significantly increase banking sector credit risk as a result of severe floods, drought, landslides and wild fires that destroy borrowers’ assets or impair supply chains. In emerging markets there is a high reliance on physical collateral in lending; credit risk
is increased from collateral assets that may become damaged. Extreme weather events can also increase operational risk for banks due to disrupted business continuity from the negatively impacted bank’s infrastructure, systems, processes and staff.
The Guidance requires the Board of Directors and senior management of a bank to formulate and implement climate-related financial risk management strategies, policies, procedures, guidelines and set minimum standards for an institution. Climate risk is: (i) Physical risk: the impacts of climate and weather-related events and longterm progressive shifts of climate; (ii) Transition risk: the financial risk related to the process of adjustment towards a lower-carbon economy which can be prompted by, for example, changes in climate policy, technological changes or a change in market sentiment; and (iii) Liability risk: the risk associated with emerging legal cases related to climate change, including those seeking compensation from financial institutions which are held responsible for loss and damages resulting from the effects of climate change, or which finance companies with activities having negative environmental impacts.
The Guidance states that the Board of Directors has the primary responsibility to oversee effective management of the climate-related risks of an institution. To fulfil this responsibility, the Board should consider climate-related risks when developing the institution’s overall business strategy, business objectives and risk management framework and to exercise effective oversight on their implementation. In particular, The Board and senior management should: (i) Assess and quantify the institution’s exposure to climate-related risks arising from its various lines of business; (ii) Oversee development of a climate
risk strategy; (iii) Define and formally allocate roles and responsibilities, as appropriate, within the organisational structure for implementation of the institution’s climate-related risk management framework and in line with its risk profile. In turn, senior management should: (i) implement the institution’s climate risk strategy through regular updates; incorporate the climate risk strategy into the institution’s risk management framework; and (ii) implement strategies in a manner that limits climate related risks associated with each business strategy.
Guidance states that the Board of Directors has the primary responsibility to oversee effective management of the climaterelated risks of an institution. To fulfil this responsibility, the Board should consider limaterelated risks when developing the institution’s overall business strategy, business objectives and risk management framework and to exercise effective oversight on their implementation.
The Guidance further requires the Board to exercise oversight over the institution’s exposure and responses to climate-related issues, including adequately embedding climate-related risks into
the institution’s risk management framework. This is clarified by stating that the Board should effectively develop and implement a climate strategy by playing an active role in overseeing the development and implementation of the institution’s climate strategy, including: (i) ensuring that the institution’s strategic
goals are in line with its vision; (ii) setting the institutions’ climate-related financial risk appetite and obtaining assurance that the risks are effectively managed and controlled; (iii) approving the climate strategy recommended by senior management, having regard to relevant local, regional and global developments (including economy-wide, nation-wide and internationally agreed goals); (iv) ensuring that there are appropriate resources, processes, systems and controls to support the implementation of the strategy; and finally, (v) cultivating a risk culture from the top that embeds climate-related considerations into the business activities and decision-making process. To ensure that oversight is effective, the Board should regularly be provided with relevant management information, as well as updates on major policy initiatives and developments concerning climate-related issues.
The Board is responsible for setting the institution’s overall risk appetite and approving the Risk Appetite Statement (RAS) recommended by senior management. It should review and consider whether and how climate risks should be integrated into the existing risk appetite framework. The RAS should identify: (i) the strategic goals; (ii) risk-taking capacity; and (iii) results of any materiality assessment, climate risk stress testing and scenario analysis. Institutions should develop appropriate key risk indicators and set appropriate limits for effectively managing climate-related risks in line with their regular monitoring and escalation arrangements. If deemed to be appropriate, climate risks should be reflected explicitly in the
RAS in an appropriate manner. While the consideration of climate risks in the RAS may be qualitative initially, institutions should consider adopting quantitative metrics to facilitate tracking and reporting. The RAS should be reviewed at least annually, considering the evolving physical and transition impacts arising from climate-related issues, as well as the circumstances of the institution such as data availability and
capability in the assessment.
The Guidance requires institutions to embed climate considerations throughout their strategy formulation
process, from strategic assessment to action plan development. A proper strategic assessment process is key to the formulation of strategy in addressing climate-related issues. In evaluating the institution’s strategic position, considerations should be given to relevant internal and external factors. Institutions should monitor the material internal and external factors, which will impact the business activities in which
they are active, as well as those relating to their individual business lines. Institutions are expected to identify risks arising from climate change at the level of key economic sectors and the business lines in which they are active. Institutions are expected to determine which climaterelated risks impact their business strategy in the short, medium and long term, for example by using appropriate metrics and yardsticks. The institution’s business strategy and its implementation should reflect climate-related risks, for example by setting and monitoring key performance indicators (KPIs) that are cascaded down to operational business areas. A comprehensive strategic assessment could benefit from involving relevant stakeholders to gather their views and insights. The stakeholders that an institution should engage typically include regulators, the government, investors, depositors, clients, counterparties, industry associations, standard setting bodies, suppliers, employees and the general public, subject to the specific situations facing the institution. Engagement efforts should aim at enabling the institution to better understand the key concerns and expectations of the stakeholders, and conversely inform them about how the institution is positioning itself in the light of climate-related risks and opportunities. Climate-related risk considerations over different time horizons (short, medium and long term) should be incorporated into the strategy formulation process.
Engagement efforts should aim at enabling the institution to better understand the key concerns and expectations of the stakeholders, and conversely inform them about how the institution
is positioning itself in the light of climate-related risks and opportunities. Climate-related risk
considerations over different time horizons (short, medium and long term) should be incorporated into the strategy formulation process.
Where the accountant will play a major part is in the institution developing an appropriate approach to
disclosing climate-related information to enhance transparency. Climaterelated disclosure is an important
avenue for different stakeholders of an institution to understand relevant risks and opportunities faced by it and its approach to addressing such issues. The Task Force on Climate related Financial Disclosures (TCFD) recommendations are considered a desirable framework for institutions to benchmark their proposed disclosure frameworks. Using a common framework facilitates consistency and comparability among institutions. The TCFD recommendations for disclosure of climate-related risks are: (i) Governance: Disclose the organization’s governance around climate-related risks and opportunities; (ii) Strategy: Disclose
the actual and potential impacts of climate-related risks and opportunities on the organization’s businesses,
strategy, and financial planning where such information is material; (iii) Risk Management: Disclose how the
organization identifies, assesses, and manages climate-related risks; and (iv) Metrics and Targets: Disclose
the metrics and targets used to assess and manage relevant climate-related risks and opportunities where such information is material.
Merging the suggestion given by the Guidance as to where climate-related information should be disclosed
with the requirements of IFRS S1 General Requirements for Disclosure of Sustainability-related Financial
Information, the climate-related information should be Included as part of the Annual Report.
It can be seen that the ESG governance and disclosure have come of age.
Accountants have to become masters of this area of knowledge.
Dr.Mcfie is a fellow of ICPAK.
