Climate Finance Regulation: Seek inter-regulatory coordination and consensus on taxonomy

Climate change requires polycentric approaches by multiple sectors and regulatory authorities.

Climate change, a defining challenge of our times, is a ‘collective action problem’ – requiring collaborative action between individuals, groups and nations, yet such coordination is elusive given misaligned incentives. It is a misnomer that climate action contracts economic growth – research indicates the contrary. Focussing on Net Zero could add $371 billion and four percentage points to India’s GDP, creating 12 million new jobs by 2030 according to a report by the Asia Society Policy Institute, relying on modelling by Cambridge Econometrics. A World Economic Forum-AT Kearney report goes further, stating that India’s transition to a net-zero economy could create over 50 million jobs and contribute more than $1 trillion in economic impact by 2030 and 15 trillion by 2070.

Climate change requires polycentric approaches (as Elinor Ostrom, the economies Nobel laureate has stated in papers) by multiple sectors and regulatory authorities. The financial system is not insulated from climate risk which impacts financial stability. Financial regulation enables investment to be directed towards green sectors and away from brown industries. Central banks and banking regulators must be cognizant of financial stability risks caused by climate change, as well as channelling credit in ways that mitigate it.

It could be argued that central banks do not have an explicit legal mandate to address climate change since their primary objective is to secure monetary stability, or they should simply coordinate with governments’ climate policies. Research by multilateral organisations like International Monetary Fund, Bank for International Settlements and Financial Stability Board has reaffirmed the need for financial regulators to decisively address climate change. Several regulators have centred climate action in their regulatory mandate. The Bank of England, which was previously accused of over-stepping its mandate by regulating for climate action, recently as part of a recent future regulatory review framework, specifically established a smarter regulatory framework responsive to emerging threats, including sustainable finance. Jurisdictions like Russia, Malaysia, Singapore, Nepal, Philippines, and South Africa among others specifically recognise sustainable economic growth in the mandates of their respective central banks.

Central banks have also sought to take collective action through coalitions such as the Network for Greening the Financial System which the RBI recently joined. The RBI’s constituent statutes – the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949 – are wide enough to incorporate sustainability within its powers to regulate the credit and monetary system, its actions have been subject to judicial challenge and intervention recently and therefore an explicit acknowledgement of climate risk in the financial system may be valuable to validate and legitimise recent climate action taken by it.

The RBI recently issued the framework for green deposits – a remarkable first. The framework sets out parameters for green investments (into an illustrative list of sectors, including renewables, waste management, clean transport and energy efficiency) from funds raised through green deposits, taking into account consumer protection issues, including disclosure norms. Additional concerns for the RBI to consider include deposit insurance (given recent events and valid concerns about bank failure and resolution), asset-liability mismatches and maturity transformation risks (given divergent tenors of the deposit and investment). This is an evolving regulatory space, requiring continuous monitoring, analysis, stakeholder feedback and policy inputs to align with global benchmarks.

On disclosure, in a recent paper indicating future action, the RBI has rightly recommended Task Force on Climate-related Financial Disclosures (TCFD) as a standard for regulated entities for disclosures. Yet it would also be important to consider the International Sustainability Standards Board (ISSB) standards, which may replace TCFD for certain systemically important industries.

The inconsistency in international taxonomy necessitates harmonised international standards. India holds the Presidency of the G20 this year and could use this opportunity to forge a consensus on taxonomy and alignment between TCFD and ISSB. Further, it could raise the issue of proportionate application of the TCFD to emerging economies like India, and facilitate the flow of sustainable finance from developed to developing countries.

Listed banks, since they are governed by the RBI, will have to comply with the RBI guideline as also Business Responsibility and Sustainability Report requirement imposed by SEBI. This highlights the need for inter-regulatory coordination to develop consistent, comparable, uniform and globally aligned disclosures on climate-related financial risks, to obviate dual compliance and limit the cost of investment in resources and technology.

Board oversight and supervision, with directors’ liability, are critical to ensure internal supervision as well as foster accountability. The RBI had recognised that the board of directors would also have to exercise effective oversight on risk management and ensure that sufficient internal/external expertise is available for managing the financial risks arising from climate change. ‘Tone at the top’ means that it would be prudent for regulated entities to invest in capacity building, and upskilling senior management to implement climate strategy.

A ‘comply or explain’, solution-oriented, flexible, forward-looking approach of the RBI coupled with principle and trust-based regulations provides agility to regulated entities. As we consider the scale and breadth of the problem of climate change, central banks and financial regulators are important partners on the road to mitigation and adaptation.