15 October 2018
Insurers and banks are to be expected to manage and report their climate-related risks, according to a draft supervisory statement from the UK’s Prudential Regulation Authority (PRA).
The consultation paper, which was described as “a major step for a regulator of a global financial centre”, says the risks from climate change are far-reaching and foreseeable and require a strategic approach.
It is understood that the PRA – which sits under the Bank of England – will look to issue further guidance on best practice 12-18 months after the supervisory statement has been finalised. It will continue to look at further guidance on disclosure “as part of the wider debate”.
It was not clear whether legislation making such reporting mandatory would follow.
Four key areas for action are laid out in the document, which will close for consultation on 15 January:
· Governance: there should be clear board-level engagement and responsibility for managing the risks, including identifying the relevant ‘senior management function holders’.
· Risk management: risks should be assessed through the existing management framework, in line with board-approved appetite, while recognising the approach must be strategic.
· Scenario analysis: the consultation paper says this should be conducted “where proportionate” to help determine the financial impacts.
· Disclosure: Firms should consider the relevance of disclosing information, including engaging with initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD).
These four key points are roughly in line with the TCFD’s own four key points on how it recommends firms approach the problem. The TCFD was formed under the command of Bank of England governor Mark Carney, as part of his role as chair of the G20’s Financial Stability Board.
The latest intervention from the PRA will give a boost to the TCFD, which has seen more than 500 firms sign up since its launch last year.
Scenario analysis and disclosure – which comprise the key pillars of the TCFD and now the PRA’s consultation – was last week attacked by BP CEO Bob Dudley, as potentially “confusing” for investors.
But the paper says that it expects scenario analysis to address a range of outcomes relating to different transition pathways, including a short-term assessment looking at risks within banks and insurers’ existing planning horizon, and a longer term assessment using scenarios such as those that are in line with a 2°C rise in global temperatures, or in excess of 2°C, and scenarios where the “transition to a low-carbon economy occurs in an orderly manner, or not”.
The consultation paper follows a survey by the PRA of the banking sector last month, which found that only 10% of lenders are looking at climate change as a strategic issue, with 30% still viewing it as part of their Corporate and Social Responsibility strategy.
Building on the PRA’s previous surveys of how both the insurance and banking sectors are managing climate risk, today’s paper is part of the Bank of England’s increasing focus on climate change. The Financial Conduct Authority (FCA) is also today publishing a discussion paper on the subject.
The PRA and the FCA have also previously announced that they will set up a Climate Financial Risk Forum to help build knowledge about how to deal with climate risks.
Ben Caldecott, founding director of the Oxford Sustainable Finance Programme at the University of Oxford, said: “The Bank of England is making clear that supervisory expectations are changing and that the regulator will now be factoring climate-related risk explicitly into different aspects of banking and insurance supervision. This is a logical next step as the Bank of England has repeatedly highlighted the potential risks to firm solvency and financial stability from climate change.
“This is a major step for a regulator of a global financial centre. Senior executives being forced to take responsibility for managing climate-change risks and face board-level accountability for doing so will undoubtedly spur greater action.
“Financial institutions now need to develop credible and robust plans for measuring and managing climate-related risks. Among other things, they need to determine what analytical capabilities they require and how they intend to resource them."
Jon Williams, a partner at PwC and a member of the TCFD, said: "In today’s Supervisory Statement, the PRA demonstrates it’s serious about addressing the risks from climate change that threaten the financial stability of banks and insurers.
“The proposed requirement for Boards to better understand financial risks from climate change, including the requirement to appoint a senior manager with responsibility for managing climate risks, will help ensure firms have the right skills and level of oversight needed to respond to this complex problem.
“It’s encouraging that some banks and insurers are now taking climate-related financial risks seriously, but there’s still lots of progress to be made to ensure resilience through the transition to a lower-carbon economy. Given the Intergovernmental Panel on Climate Change (IPCC) recent report on the impacts of global warming and the urgency of reducing carbon emissions, it’s vital that financial institutions both better manage the risks and benefit from the opportunities that addressing climate change will bring.
“The PRA recognises the importance of improving transparency through climate risk disclosures to help make markets more efficient, and economies more stable and resilient. We hope many will consider adopting the framework proposed by the Task Force on Climate-related Financial Disclosures to provide consistent and comparable decision-useful information across the industry.”