Climate and environmental risks: what are the effects of a sustainable transition?
Bank of Italy regulations on climate and environmental risks: focus on physical and transition risk.
ESG: this issue is now a benchmark for the new regulations, which outline an approach aimed at corporate sustainability. ESG issues are at the heart of a transition that is now becoming inevitable. But, as far as companies of both small and medium sizes are concerned in the sustainability issue, is it an unequal battle or a shared necessity?
ESG ratings: why companies should have them
Let's start with an assumption: flanking a company's credit rating with a sustainability rating is not only an ethical choice; it's also a profitable one. A company that decides to be assessed also from the sustainability point of view can become more attractive in the eyes of financial institutions and have a greater competitive advantage.
However, the financial analyst must be able to detect risks and opportunities arising from the sustainable transition. Concerning the ESG rating, they have to reveal whether the company can cope with any risks related to environmental emergencies or whether it is eased in terms of compliance with regulations on social conduct and governance.
In this regard, we would like to take a closer look at the current regulations governing the integration of climate and environmental risks into a company's business strategy.
The Bank of Italy's new regulations on climate and environmental risks
In April 2022 it was published the Bank of Italy's document "Supervisory Expectations", which is based on what has already been proposed by the European Commission and the ECB. The document regards the involvement of the financial system in the sustainable development program promoted by the EU.
This is a perspective based on three main objectives concerning the orientation of capital flows toward sustainable investments, the integration of sustainability criteria into risk management, and the promotion of transparency.
In particular, the regulation proposed by the Bank of Italy proposes the integration of risks related to the sustainable development process within risk management, corporate strategy, control, and governance systems and disclosure for the so-called less significant banks and large companies.
This prospectus allows us to understand the negative effects that climate change, ecosystem degradation, and biodiversity loss may have on economic and corporate performance.
In particular, the main focus is on two types of risk defined in the Bank of Italy document: physical risk and transition risk.
Physical risk refers to the economic impact that an increase in natural disasters - which can be 'extreme' or 'chronic' - can have on a company and the stakeholders involved.
Transition risk, on the other hand, refers to the economic impact a company may have in terms of sustainability, like reducing Co2 emissions to favor the usage of renewable energy.
The proposed material also clarifies the role of Rating Agencies, as the proposed sustainability assessments must consider the context in which the company operates as a variable of the risks associated with the ongoing sustainable transition. Certified Rating Agencies must provide an assessment that also covers the risks connected with sustainability issues. These could be risks deriving from environmental emergencies such as the degradation of ecosystems, the loss of biodiversity, and the increase in natural disasters, or economic issues deriving from the transition process towards more sustainable activities, integrated within corporate strategy and governance.
The market's needs are increasingly stringent and demanding on E, S, and G criteria, and it is fundamental to take action by equipping oneself with tools that can establish the level of awareness of a company and its ability to cope with climate and environmental risks.
modefinance is producing advanced modeling to place sustainability ratings alongside traditional ratings and to establish the impact of the sustainable transformation operations implemented by companies. Precisely, Credit Rating Agencies are willing to cope with the regulations that are likely to become mandatory very soon for both companies and financial institutions.
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