Building a climate risk framework for a small balance sheet

Corrado Pistarino, CIO of Foresters Friendly, prefers numbers to words. In today's world this can be a challenge for anyone trying to build a climate risk management framework, where words are (too often) the golden standard. Interview by Vincent Huck

During Insurance Asset Risk's real asset conference in June 2021, Corrado Pistarino, chief investment officer (CIO) at Foresters Friendly, questioned whether asset managers are ready to provide investors with meaningful sets of metrics and reporting which can be easily consolidated into an internal risk management system.

After the event he tells Insurance Asset Risk it is not only a question of data transparency, it is also a question of knowledge base at this point in time.

"Everyone says they've signed up to the Principles of Responsible Investment and that they take environmental, social and governance (ESG) criteria very seriously," he says. "But when you question [asset managers if they have] a set of KPIs, a set of well-defined metrics that underpins their investment process and that they use to monitor these investments, many players are still very much behind the curve in my view."

In this context, for a small insurer like Foresters Friendly, with a balance sheet of £250m ($346m), building a climate risk management framework becomes a real challenge, Pistarino says.

"We need a framework which is implementable, simple, that can be delivered in a short amount of time and with limited resources, but that can also be actionable, otherwise it becomes a pointless exercise," he says. "By actionable, I mean if I see a deviation between what the framework prescribes and the evolution of my portfolios, I need to take corrective actions."

Constructing such a framework is "incredibly difficult at this point in time", Pistarino laments, because sourcing "even very simple data" is challenging.

He takes the example of a "simple metric" like tonnes of CO2/$m associated to investments, singularly or at portfolio level. Asset managers can provide it for some funds but not for others, he argues. "I've had discussion recently on this topic, and when I ask 'what can you provide? What is the timeline?' – well the answers are quite vague."

While it's all a work in progress, Pistarino faces the issue of building a risk management framework for Foresters Friendly with the uncertainty of what data will ever be available and when.

"Calibration is critical. Our plan considers as a first step measuring our current position with respect to climate-related risks, looking at the result of the Bank of England stress test due in 2022 to work out an industry average, and from there highlighting the potential gap between us and the industry average," he says. "Identifying that gap will also help us in the process of defining our risk appetite, and take action where we see substantial variance."

This is a difficult process, Pistarino argues. "There are a lot of externalities that we have to consider in designing an effective risk management framework, and I envisage this to be a long process of adaptation, with significant resources deployed over next 12 to 18 months. I'm sure that down the line, [integrating meaningful ESG data in the investment process] will become mainstream, but it may take a few years."

For now, it's about building what he refers to as 'the scaffolding', i.e. "what is it I'm trying to tackle".

"Everyone talks about 'climate change', but without a well-defined risk management framework what exactly we are trying to achieve remains loosely defined," Pistarino says. "And then there is the reality of a small firm like us, where we cannot build something which is overambitious – something we will never be able to build entirely, or monitor and use effectively – so we need reduce the problem to its very core."

That very core, he explains, is the Paris Agreement's goal to keep the rise in global average temperature to 1.5 °C above pre-industrial levels, linked to a number of CO2 emissions.

"There is a consensus that the only way we can tackle the increase in temperature is by cutting greenhouse gas emissions. I just want to focus on one number based on which I can create a statement of risk appetite that says 'on average this portfolio can be associated to X amount of emissions and not more'," Pistarino says. "Do I easily get this number from the [asset management] industry at present? The answer is no."

The fact that few people can provide that number today is staggering, he says. "There is a lot of noise around climate change, temperatures, emissions, ESG criteria... But then when we cut to the very core of this matter, and I'm asking the very simple question 'how much CO2 is this building emitting?' I'm told 'We don't know yet'...."

There is no doubt in Pistarino's mind that this is all work in progress, that five years down the line there will be an answer to those questions, and it will be mainstream. "We are at the very beginning of this process, and because of that we also need to be able to maintain a sense of reality and proportions in order to not get ahead of ourselves and then fail to deliver on things we said we were going to do."

Beyond the identification of the metrics, Pistarino highlights a potential lack of homogeneity across methodologies as a challenge, in particular for smaller insurers. Although two asset managers may come up with a figure on tonnes of CO2/$m invested, they may have computed that number in different ways, "can I reasonably establish that the methodologies are homogeneous, and if not then what do I do?".

He has faith that homogenisation will come through industry initiatives, such as the Net-Zero Asset Owner Alliance, rather than prompted by regulators or policy makers.

"We all face the same challenge, so the industry as a whole should find a common ground and that will address the issue of homogeneity of methodology and transparency as the data will be shared across the board," he says.

But the industry will still be dependent on the disclosures of companies they invest in. Will companies provide the same level and quality of disclosures?

"One problem at a time," Pistarino replies, adding that auditors and the asset management industry will be vetting those disclosures, so there will be an ability to investigate the quality or veracity of those.

"I'm confident for the long term, and rather cautious about the short term," he says. "I'm slightly cynical about the wave of "do-gooders" across the industry when it comes to affirming ESG credentials. It takes little investigation on questions of substance to discover that ... well it's work in progress! How can one actually make an investment decision without well-defined metrics?"

A common ground across standards and processes will be found, Pistarino believes. "I'm optimistic, don't paint me in any other way. It will take a few years. But we don't have much time, given the consensus that the key policy actions need to happen between now and 2030."