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Climate related risks for firms bearing capital markets

Rashim Arora Rashim Arora

The Financial Conduct Authority (FCA) has recently put forward updated proposals for climate related risks, including new climate related disclosure requirements for firms bearing capital markets. Rashim Arora looks at the proposals and explains best practice for firms.

The FCA has published a new CP(CP21/18) for firms to extend climate risk disclosure requirements and set ESG expectations for capital markets firms. The proposal seeks to incorporate climate scenarios into corporate disclosure to improve capital allocation and asset pricing for firms. By incorporating these adjustments, they aim to improve the quality and quantity of disclosure by firms and create a greener economy in the UK.

This approach follows the government’s cohesive roadmap to obligatory climate risk disclosures by 2025. This follows on from regulation introduced in December 2020 requiring premium-listed companies to improve their disclosure practices. However, in its current state, the FCA believes that current financial disclosure for standard listed companies fails to meet investor needs and must be enhanced across the investment chain. The aim is to reflect those earlier proposals and increase the scope of disclosure requirements, with mandatory TCFD-aligned disclosures to be in place by 2023.

The value of transparency

A core aim for the FCA is increasing transparency across industry for firms and how they outline ESG topics. The regulator proposes statements from the issuers of standard listed companies in their annual financial reports: detailing the content of their climate related disclosures and how closely they align with the recommended disclosures of the TCFD. Any inconsistencies must be explained, including details of how the firm will meet disclosure expectations in the future.

Outlining more detailed and coherent climate-related information would enable firms to make more informed business, risk and development decisions with greater transparency on their capital market framework. This information would benefit others in the investment chain and reduce risks involving assets, increasing market integrity and create benefits for customers.

The FCA also highlights how fulfilling disclosure expectations will help firms support their customers. The updated infrastructure of improved climate related disclosures, with concise climate metrics, will help firms enhance their understanding of climate exposures and develop greener financial products. This will help firms meet client expectations, reducing the risk of mis-selling and staying competitive.

Benefits for businesses

The FCA recommends that increased transparency would support investments and capital allocation decisions by managing climate related risks and opportunities effectively. This disclosure would also have a greater impact on firms by supporting the transition to a net zero economy through improved management and a mobilised capital.

Market transitions

Creating a stable climate related infrastructure would also have beneficial long term effects for firms. The FCA points to the continual effects that refined disclosure on standard listed companies will have on industry and how this could improve the market as we reach a net zero emissions economy. For example, they could generate more efficient market outcomes by creating a more detailed investment chain for firms.

Improved infrastructure will also increase oversight in capital markets, alongside more effective decision making processes and pricing strategies.

It's important to note that implementation is ongoing, and the FCA is liaising with the industry to analyse the impact of these disclosure proposals. Firms are recommended to keep up to date with regulation and potential changes that will come to fruition before meeting the 2023 deadline.

Managing climate-related risks

The FCA also advises firms to consider both physical and transitional climate risk when making their disclosures, including financial losses risk.

Capital markets firms may be affected by the rise in extreme weather conditions. They need to be prepared for how this may affect company operations, supply chains and investments. It's likely that there might also be some transitional risks as companies adapt their climate related disclosure and measures to meet regulation and net zero emissions. A firm’s strategic and economic infrastructure might be impacted by these risks, so it is important to take this into account when implementing disclosure processes.

As developing proposals on climate related regulation come into action regarding capital markets, it is sure to be further enhanced by government legislation and transitional changes relating to global warming. Keeping this in mind, it's important that firms act now to prepare effective climate risk disclosures and increase transparency.

Staying up to date with TCFD regulation and meeting best practice mitigates any transitional or financial risks in the future, and gives assurance that information is appropriately disclosed. These practices can be developed over time as processes evolve and mature.

For more information on climate related risk and climate related disclosure for firms bearing capital markets, contact Rashim Arora.

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