“Climate risk always means economic consequences for the company”, – Oksana Volchko

“Climate risk always means economic consequences for the company”, – Oksana Volchko

“Climate risk always means economic consequences for the company”, – Oksana Volchko

21 October 2022

Oksana Volchko, member of the Supervisory Boards of Ukrgasbank and Ukrposhta, joined the Supervisory Board of Chapter Zero Ukraine and Caucasus. We have discussed with Oksana her work experience in financial institutions in dealing with climate risks for business, progress in climate risk management in our country, as well as the most necessary and urgent measures for the development of this area.

What role does the borrowing company’s climate risk management play in the bank’s decision to issue a loan?

One of the key role. When a client applies to Ukrgasbank for credit funds, the assessment of the company’s work in the area of social and environmental risks is mandatory. Depending on the result of this analysis, cooperation may be postponed or stopped.

Do you often have to refuse loans?

In fact, very rarely. Those borrowers who apply to us, — these are mainly large companies, have already managed to establish work on environmental and social risk management. I mean manufacturing companies, agricultural sector, export-oriented companies. But this also concerns service companies. For instance, we ask retailers how they heat their premises, how they save electricity, etc. That is, today all industries to some extent face environmental and social risks. 

And what do you ask manufacturing companies?

Managers of the relevant department start with the most obvious things. If the company’s activities are regulated, subject to certification, permits are foreseen – this is the list of mandatory documents that are foremost required.

However, a comprehensive assessment that turns this data into climate risks is based on our own competencies, because there is no regulatory framework in this matter.

Ukraine has a global document – the Strategy of Environmental Security and Adaptation to Climate Change for the period up to 2030. Yet there is still no “regulation” that each ministry should develop according to its profile. Financial institutions really need a legislative framework that, firstly, will identify risks, secondly, will form ways to reduce them and, thirdly, will establish penalties for non-compliance with these norms. Today we do not even know the basic information – how much land is degraded, what is its water consumption, the percentage of soil depletion, the level of deforestation, the volume of water absorption, how much phosphate fertilisers we have in the soil, etc. Bankers should know this, because in order to demand compliance with certain norms from the borrowing company, it is necessary to refer to the legislation. And here there is a kind of trap for us as a financial institution, which I hope will be closed soon.

How do banks act in a situation when this regulatory framework is not formed?

As we have already discussed, we are guided by our experience, creating our own questionnaires, where we cover all risk groups. In general, we distinguish four groups of transactional risks within the framework of environmental and social legislation within the framework of banking requirements in Ukraine.

What are they?

The first group is political and legal risks. They include taxes on CO2 emissions, mandatory reporting on emissions, potential litigation of the borrower company. All this can lead to an increase in operating costs for the client, to write-off of assets due to changes in regulatory policy, fines may be issued to the client. And fines can be unbearable and cause a temporary suspension of the company’s activities.

The next group is technological risks. This is, for instance, the need to replace goods and services with similar ones with less pollution or unsuccessful investments in new technologies. For example, a company has invested in equipment, but due to changes in legislation, the purchased filters no longer meet the standards. As a result, the payback period of the investment will be much longer than planned.

Another type of technological risk is the need to replace the technology with a more environmentally friendly one. This immediately increases the cost of R&D, which is currently a significant item of expenditure for manufacturing companies. In addition, we have an increase in capital expenditures for the introduction of new technologies, which will further entail the cost of new software.

We must take into account market risks – changes in consumer behaviour, demand and rising prices for raw materials. For example, if eco-friendly packaging is required to maintain customer loyalty (and sales), then we must consider that it costs more. Accordingly, the cost increases, and, as a result, the value of assets changes.

Reputational risks are one of the most important. No matter how much is invested in new technologies, in treatment facilities, but reputation problems can often cross out everything and often very quickly, literally instantly. After all, a reputational climate crisis can lead to a decrease in demand for products or even a rapid loss of customers, which will obviously reduce the planned level of financial flows.

I know many cases when financial institutions, both Ukrainian and international, refused to cooperate with companies because of their poor “climate disreputation”

The list of risks sounds convincing and large-scale.

That is why the foundations of environmental and social risk management in the company itself should be laid at the level of non-executive directors [a position that provides for the strategic management of the company, often non-executive directors are members of the Supervisory Board of the company – author’s note] or at the level of members of the Supervisory Boards — at the strategic level.

After all, if you give it entirely to the competence of the CEO of the company, who is usually appointed for 3-5 years, then truly systematic work will not work. Climate, environmental and social risks of business are unlimited in time. Therefore, they should be dealt with by the Supervisory Board, which takes care of the company’s strategy. Further, it is necessary to broadcast on the management vertical – to the executive bodies, then – to individual specialists who already deal with these issues in a very narrow specialisation.

That is, non-executive directors need to become specialists in climate risk management?

In fact, yes. However, we still have a certain trap. Often, the competence of environmental and social risks is concentrated at the management level more than at the strategic level. Managers who have good knowledge in climate management lack a strategic approach. Instead, members of Supervisory Boards who have broad competencies lack this narrow knowledge of climate risks. Therefore, today absolutely everyone involved in climate risk management should be trained.

In general, I see very big challenges for the members of the Supervisory Boards. It is necessary to solve their tasks – strategy development, implementation, and monitoring – in very difficult conditions. The first is the speed with which changes are taking place in our environment, and the second is the complexity of the business. Speed requires good intuition and creativity. And complexity requires logic and discipline. This is extremely difficult to combine, that is why a large number of Supervisory Boards members speak about the lack of knowledge, in particular, regarding ESG issues.  

Does this apply to Ukraine, or is it a global issue?

Global. As one of the confirmations – the report Designing Sustainability Governance Board structures and practices for better ESG performance, for which non-executive directors were surveyed at the global level. 85% of these said that they need to improve their knowledge of climate risks. 75% of board members shared the opinion that the issue of sustainability and climate risks is very important. And they are committed to monitor these risks and together with the company’s management to help reduce environmental and social risks.

What can you say about the level of Ukrainian companies in the field of climate risk management?

I can declare that we are just a little behind. I have been working in the banking sector for many years. I can say that the topic of climate risks for business has been very acute for the last three years. However, ten and even fifteen years ago, I met quite a few Ukrainian and international companies (operating in our market) that paid active attention to their environmental and social risks and proposed ways to reduce them.

The level of corporate governance in Ukraine is also far from being in its infancy. A lot of companies have Supervisory Boards and know who the non-executive directors are, what their functions, responsibilities, and KPIs are. It all started with those few companies that are listed on international stock markets, they were among the first to introduce corporate governance. The second group is companies that sought financing from large banking groups. It was at the request of banks that they built the company’s management structure. And the third group is those large Ukrainian companies that are very actively developing. They were the most active in attracting the competence they needed in climate risk management through supervisors or through advisory boards. In turn, smaller companies that cannot afford to maintain a Supervisory Board engage advisory boards, which include non-executive directors.

Thus, we have the established level, potential, and even experience to continue to successfully contribute to the reduction of climate risks.

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