On 25 June 2020, the Monetary Authority of Singapore (MAS) launched consultations on a series of Proposed Guidelines on Environmental Risk Management (the Guidelines) tailored to financial institutions (FIs) in three sectors: asset management, banking and insurance. The Guidelines are intended to drive the transition to an environmentally sustainable economy by enhancing the integration of environmental risk considerations in FIs' financing and investment decisions, and promoting new opportunities for green financing.
Our last Legal Update regarding the Guidelines covered asset management. This Legal Update will focus on the Guidelines as they relate to insurers.
Defining Environmental Risk
According to the MAS, the broad category of environmental risk encompasses the following three risk channels:
- Physical risk arising from the impact of weather events and long-term or widespread environmental changes;
- Transitional risk arising from the adjustment to an environmentally sustainable economy, including shifts in public policies, technological developments and shifts in consumer or investor preferences; and
- Reputational risk arising when insurers provide coverage for customers that carry on business activities with a negative impact on the environment, which can adversely affect insurers' abilities to maintain or establish business relationships.
Environmental risk can translate into well-known financial risk types for insurers, including:
- Market risk, as insurers may be exposed to a decline in valuation and increased volatility in their investments as investor preferences shift (e.g., away from carbon-intensive sectors);
- Operational risk, as severe weather events can disrupt business continuity by impacting the insurer's infrastructure, systems, processes and staff;
- Insurance risk, as more frequent and severe natural catastrophe events can lead to higher claims and underwriting losses, as well as higher liability risk; and
- Liquidity risk, as natural disasters can cause widespread damage leading to a surge in the need for funds, increased liquidity stress on insurers and difficulties in liquidating assets impacted by such disasters.
With the multifaceted nature of environmental risk and the potentially significant impact it can have on insurance businesses in mind, the MAS notes that it is crucial for insurers to build resilience against such risk.
The Guidelines will apply to all insurers, including insurers carrying on business in Singapore under a foreign insurer scheme established under Part IIA of the Insurance Act (Cap. 142). The MAS recognises that insurers can vary in terms of scale, scope and business model, and insurers are therefore permitted to implement the Guidelines "in a way that is commensurate with the size and nature of [their] activities". In any event, the Guidelines will apply to both underwriting and investment activities, as well as any other activities that expose an insurer to material environmental risk.
The Guidelines address environmental risk management practices in the following categories:
- Governance and Strategy: The MAS believes the directors and senior management play critical roles in incorporating environmental considerations into an insurer's risk appetite, strategies and business plans. The directors and senior management should take an institution-wide view in maintaining effective oversight of the insurer's environmental risk management. Specifically:
- the board of directors (or a committee thereof) is responsible for approving an environmental risk management framework and related policies, ensuring that environmental risk is addressed in the insurer's risk appetite framework (using both qualitative and quantitative measures, as appropriate), setting the roles and responsibilities of the board of directors and senior management with respect to environmental risk and ensuring that management has adequate expertise and resources for managing environmental risk; and
- senior managers are responsible for developing, implementing and reviewing the environmental risk management framework, establishing an escalation process and allocating resources appropriately.
- Risk Management: MAS Notice 126 (Enterprise Risk Management) requires insurers to put in place an enterprise risk management framework that provides for the identification and quantification of relevant and material risks, including environmental risk. Insurers are required to identify and assess material environmental risks on a sector-specific basis and use a consistent approach across underwriting and investment functions. Environmental risk should be monitored on an ongoing basis, including at a customer level, and the information collected should be supplied to the board of directors as appropriate. Insurers should also develop capabilities in scenario analysis and stress testing (consistent with MAS Notice 126) and institute capacity-building programmes around environmental risk management.
- Underwriting: Underwriters should integrate environmental issues into the underwriting process with reference to data from both publicly available and proprietary sources. In assessing a customer's environmental risk, insurers may refer to external ratings on environmental performance and also develop their own risk assessment and ratings methodology. Transactions with higher risk levels should be subject to enhanced due diligence and internal escalation procedures.
- Investment: Insurers should put in place processes and systems to monitor, assess and manage material environmental risk at the individual investment- and portfolio-level on an ongoing basis. Environmental impacts should be considered from both a "macro, top-down" perspective and a "granular, bottom-up" perspective. As in the underwriting function, insurers may develop their own proprietary mechanisms and metrics to use in the investment monitoring process. Insurers should also consider engaging with individual companies, asset managers and other investors to promote responsible business behaviours.
- Disclosure: Insurers should, at least annually, disclose their environmental risk management approach to stakeholders and are encouraged to disclose the potential impact of material environmental risks with reference to quantitative metrics. Insurers may refer to international reporting frameworks, like the recommendations of the Task-Force on Climate-related Financial Disclosures, when preparing such disclosures.
Responses to the MAS consultations are due by 7 August 2020. The MAS has proposed a 12‑month transition period, beginning once the Guidelines are finalised, for FIs to implement the Guidelines.
A "Force for Good"
Insurers can expect the MAS to continue to pay attention to environmental issues—the regulator notes in these consultations that "climate change is a key priority, as it poses an existential challenge for Singapore". As the effects of climate change become better understood globally, regulators around the world are more likely to turn their attention toward environmental risk management practices as well. Hopefully, the development and implementation of similar guidelines in other jurisdictions will enable more FIs to, as the MAS notes, "act as a 'force for good' in the transition to an environmentally sustainable economy by channelling capital through their financing, underwriting and investment activities."