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PRA consults on climate risk in banking and insurance

Sandy Trust Sandy Trust

Coinciding with Green Great Britain Week, the PRA has today published its consultation on supervisory expectations in the banking and insurance sectors. This comes following an announcement made in its September 2018 report on The impact of climate change on the UK banking sector.

The consultation follows last week’s report from the International Panel on Climate Change on the challenges and opportunities associated with achieving the Paris goals on limiting global temperatures to 1.5°C. The report highlighted the significant role of investment and lending decisions in funding the transition to a low carbon economy.

As highlighted in The impact of climate change on the UK Banking Sector, the consultation focuses on firms’ governance, strategy and risk management frameworks, the need to appropriately consider the major financial risks associated with climate change in these and the need to incorporate climate change into strategy. The consultation also highlights the need to conduct scenario analysis, to build an understanding of the ways in which both the physical and transition risks associated with climate change could affect firms; and the need to develop appropriate disclosure mechanisms for these risks and opportunities.

The proposal also announces the establishment of a Climate Financial Risk Forum, a joint venture with the FCA, to support innovation around both risk quantification and product development.

The consultation runs until 15 January 2019.

Governance

The PRA proposes a number of supervisory expectations around climate change . In particular, the PRA expects that boards should be aware of the financial risks associated with climate change and have clear responsibilities for managing the risks, with clear individual responsibilities for relevant senior manager function holders.

Risk management

The PRA proposes that firms should use their existing risk management frameworks to manage climate risk, by incorporating climate impacts into these appropriately. Firms should articulate risk appetites and develop the usual suite of policies, management information and board risk reports.

Within the consultation, the PRA specifically mentions physical and transition risks and gives a number of examples of the way in which these have the potential to affect lending and investment portfolios. The PRA specifically mentions the potential for excessive accumulation of financial risk from climate change in insurance investment portfolios.

Scenario analysis

The PRA proposes that firms should incorporate climate change into their stress and scenario testing frameworks and highlights the need to consider a range of potential climate pathways and a range of timescales. In interviews with Insurance sector chief risk officers earlier in 2018, the PRA mentioned it had asked firms to consider timescales out to 2030.

The PRA has not mandated a standard set of scenarios, such as a 2°C high transition risk scenario, but has acknowledged the need for firms to consider a range of scenarios.

Disclosure

The PRA proposes that companies should disclose appropriately on climate change-related risks and opportunities, in line with its previous support for the Financial Stability Board’s Task Force recommendations on climate-related financial disclosures (TCFD). It specifically recommends that firms should engage with TCFD and other wider initiatives.

Next steps

There are many possible climate pathways. Where we will end up on the spectrum between rapid de-carbonisation of our economy (with associated transition risks, such as stranded assets) and significant climate change (with associated physical risks) is unclear.

What is absolutely clear is that there will be significant change which brings with it material risks and opportunities for financial services firms, risks which must now be more formally managed by firms in line with the draft PRA supervisory expectations.

However, rather than viewing this as an additional regulatory burden, firms should see this as an opportunity to incorporate climate change into their overall strategy and develop an approach that is informed by robust financial analysis, mitigating the risks and positioning well for the opportunities.

What is critical now is to begin. Firms that fail to recognise the importance and magnitude of this change risk far more than their reputation if they are slow to adapt.

To find out more on the consultation contact Sandy Trust

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