Principles for the effective management of climate-related financial risks

CBUAE Classification: Public UAE Sustainable Finance Working Group Principles for the effective management of climate-related financial risks

CBUAE Classification: Public CONTENTS Page Subject A. INTRODUCTION 1 B. APPLICATION 2 C. GENERAL CONSIDERATIONS 4 D. THE PRINCIPLES 5 Principle 1 – Oversight and responsibility of climate-related financial risk exposures 5 Principle 2 – Incorporation of climate-related financial risk exposures into overall business strategy 6 Principle 3 – Assigning climate-related financial risk management responsibilities within the organization 7 Principle 4 – Incorporation of climate-related risks into risk management framework 8 Principle 5 – Monitoring and reporting of climate-related financial risks 11 Principle 6 – Incorporation of climate-related financial risks into capital and liquidity adequacy processes 13 Principle 7 – Scenario analysis of climate-related financial risks 13 ANNEX 16

1 CBUAE Classification: Public 1 Principle One of the Guiding Principles, available here. 2 Principle One of the Guiding Principles, available here.

A. INTRODUCTION

1. The UAE Sustainable Finance Working Group (SFWG) was established in 2019 to enable the UAE’s economic transition and encourage the adoption of sustainable finance at the national level. This is in line with the Paris Agreement ratified by the UAE in 2016 and domestic acts and initiatives, such as the UAE Green Agenda 2015-2030, the National Climate Change Plan of the UAE 2017-2050 and the UAE Net Zero by 2050 Strategic Initiative.

2. The members of the SFWG include ministries (Ministry of Finance, Ministry of Economy, Ministry of Climate Change and Environment, the Office of the UAE's Special Envoy for Climate Change), financial services regulators (the Central Bank of the UAE, the Securities and Commodities Authority, the Financial Services Regulatory Authority of Abu Dhabi Global Market and the Dubai Financial Services Authority), and UAE exchanges (Abu Dhabi Securities Exchange, Dubai Financial Market and Nasdaq Dubai).

3. In 2020, in its Guiding Principles on Sustainable Finance in the UAE, the SFWG committed to developing standards for the financial sector to integrate ESG factors into corporate governance, strategy and risk management. In its First Public Statement published in November 2021, the SFWG set out its roadmap and refined its focus setting out three interlinked work areas including on ESG reporting, corporate governance and risk management, and taxonomy. In November 2022, in its Second Public Statement, the SFWG reported on the progress of its three workstreams. In particular, the Workstream Two on Sustainability-focused Corporate Governance announced it would start working on developing enhanced standards to help embed and address climate-related risks in corporate governance and risk management in financial services entities in the UAE.

4. This document is the result of the efforts of Workstream Two and contains Principles for the effective management of climate-related financial risks (the Principles) which are issued in accordance with the relevant laws in each jurisdiction. The Principles have been developed in consideration of a number of standards on this topic published by international standard-setters. The key standards used for the purpose of the Principles include the Principles for the effective management and supervision of climate-related financial risks from the Basel Committee on Banking Supervision (BCBS) and the Guide for Supervisors Integrating climate-related and environmental risks into prudential supervision by the Network for Greening the Financial System (NGFS). A more complete list of international standards covering, for example, risk scenarios or details of the insurance sector is included in the Annex.

B. APPLICATION 5. The Principles constitute a declaration of common understanding among the SFWG members on the minimum standards that they expect to implement in their respective jurisdictions and in line with their legal frameworks in the area of climate risk management.

6. While the Principles are endorsed by the entire SFWG, it is understood that they are primarily relevant for those members who are financial services regulators. The ministries and exchanges may consider them in the context of their activities, where relevant.

7. For the purposes of the Principles, financial sector entities are referred to collectively as ‘financial firms’ without drawing distinctions between the various financial service activities offered by these entities. While it is recognised that the BCBS and the NGFS standards are primarily designed for the banking and insurance sectors, the Principles are drafted to cater for a wider spectrum of financial firms and taking into account differences in business models.

8. It remains in the discretion of each of the financial services regulators to determine the financial firms in scope of the Principles, how to apply each of them and the timeframe to do so in their jurisdictions. However, the relevant financial services regulators intend to commence application of these Principles in respect of their firms not later than from November 2023. The financial services regulators may also introduce additional details relevant for specific types of financial firms, in particular based on the standards cited in the Annex.

9. It is recognised that several standards in this area are still evolving at international level. This fact has been reflected in the drafting of the Principles allowing for the necessary flexibility and adaptations to future developments.

C. GENERAL CONSIDERATIONS 10. Transitioning to a low-carbon, and subsequently zero-carbon, economy entails both risks and opportunities for the financial sector. Strong corporate governance can drive and enable financial firms to identify and take the strategic steps necessary to develop and deploy new and more sustainable approaches and technologies, to strengthen business models and to improve both business and sustainability metrics. Importantly, enhanced risk management is critical for financial firms to identify and manage these risks better and to be able to demonstrate this to their clients and supervisors.

11. Climate-related financial risk refers to the financial risks arising from climate change, including physical, transition and liability risks. Such risks could impact the viability and soundness of individual financial firms and have broader implications for financial stability.

12. Physical risk refers to potential economic and financial losses from climate and weather-related events and the long-term progressive impact of climate change.

13. Transition risk refers to 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 change in market and social sentiments.

14. Liability risk refers to climate-related compensatory claims and/or direct legal actions against financial firms. Liability risk can be considered as a separate risk but can also be treated as a subset of physical and transition risks.

15. Climate-related financial risks are not bound by timelines and can emerge within the short, medium, and long-term. They can materialize through transmission channels in the balance sheets of financial firms and within the traditional categories of financial risks, including credit, market, operational, underwriting, reputational and liquidity risks.

16. The reference to the board and senior management throughout the Principles is to be understood in accordance with their respective roles and responsibilities and is meant to include the members of the board of directors (or equivalent) and senior management. The Principles do not presume or endorse a specific board or senior management structure, nor do they advocate for a specific approach to assigning climate-related financial risk responsibilities within a financial firm.

D. THE PRINCIPLES Principle 1 – Oversight and responsibility of climate-related financial risk exposures

1. The board and senior management of financial firms should have an appropriate understanding of the organization’s climate-related financial risk exposures and their potential impact to facilitate effective oversight.

1.1 The financial firm should ensure that the board and senior management have an adequate understanding of climate-related financial risks and that senior management is equipped with the appropriate skills and experience to manage and oversee these risks.

1.2 Financial firms should have in place a sound climate-related financial risk management framework as part of their overall business strategy, including considering the risk appetite specific to climate-related financial risks. The risk appetite should be defined, approved and overseen by the board. The board should be able to provide evidence of its ongoing oversight of these risks, particularly when they are deemed to be material.

1.3 Certain functions related to the management of climate-related financial risks may be delegated, but, as with other risks, the board is ultimately responsible and accountable for monitoring, managing and overseeing climate-related risks for the financial firm.

1.4 Where required, financial firms should ensure that the board and senior management actively keep up to date to develop and maintain sufficient knowledge and skills to understand and assess the impact of climate-related financial risks on the financial firm and the broader financial sector, including by providing training. In addition, financial firms should also provide capacity building and training to relevant personnel to enhance management of climate-related financial risks.

Principle 2 - Incorporation of climate-related financial risk exposures into overall business strategy 2. The board and senior management of a financial firm should consider material climate-related financial risk exposures when setting the organization’s overall business strategy.

2.1 In developing and executing the financial firm’s overall strategic plan, the board and senior management should ensure that all risks including material climate-related financial risks and the ensuing opportunities are considered. Please refer to Principle 4 for considerations on materiality.

2.2 Any climate-related strategies or objectives should align with and support the financial firm’s broader strategy, risk appetite, and risk management framework.

2.3 It is recognised that the incorporation of material climate-related financial risks into various planning processes is evolving as measurement methodologies, models, and data for analysing these risks mature over time. The board and senior management should ensure that climate-related financial risks are documented and periodically reviewed. Any climate-related strategies or objectives should be continuously improved based on the lessons drawn from measuring, analysing and monitoring of these risks.

Principle 3 – Assigning climate-related financial risk management responsibilities within the organization 3. The financial firm’s board should assign climate-related financial risk management responsibilities throughout the organization.

3.1 Responsibilities for identifying and managing climate-related financial risks should be clearly assigned to either board committees or appropriate senior management to ensure climate-related financial risks are appropriately considered as part of the financial firm’s business strategy and risk management framework.

3.2 As outlined in Principle 1, while the financial firm’s board remains ultimately responsible and accountable for the oversight of the management of climate-related financial risks, the assignment of responsibilities in line with Principle 3 should be formally documented.

3.3 Such roles and responsibilities should be clearly defined to ensure there is clarity over functions, accountability, governance structure, escalation processes and reporting procedures across the financial firm in relation to climate-related financial risk management.

3.4 Where dedicated climate-related roles or departments are established, their responsibilities and interactions with existing governance structures should be clearly defined and documented.