Climate change - keeping up the momentum

‘Whilst COVID-19 represents a present risk, minimising the future risks from climate change requires action now’.

This statement, by the UK’s Prudential Regulation Authority (PRA), speaks volumes. Although the UK regulators have pushed back some elements of their original timeline for their climate risk work in the light of COVID-19, their view of the significance of climate risk is unchanged. And whilst banks clearly need to give COVID-19 the immediate attention it needs, they should exercise caution in taking their feet off the pedal of their climate risk programmes, not least because managing climate risks in no way undermines the capacity to manage the former

In addition, with banks having submitted their climate risk management plans and associated actions to the PRA last year, it seems likely that the PRA will return to this area later this year. Moreover, forthcoming regulatory changes, along with growing investor activism and consumer expectations concerning climate change, both underline the importance of boards and senior management maintaining momentum in this area.

Below, we set out recent announcements made by the UK regulators on Task Force on Climate-related Financial Disclosures (TCFD) disclosure proposals and the Climate Biennial Exploratory Scenario (BES) along with recent statements made by banks following climate activism by investors. We conclude by offering thoughts on priority areas for banks’ climate risk management programmes. These cover: governance, risk management, scenario analysis and disclosure.

FCA – TCFD Disclosure Proposals 

Whilst the FCA last week noted that it had extended the deadline for responses to its climate-related disclosure proposals in CP20/3, it also went on to confirm that it plans to implement them in 2021. These ‘high impact’ proposals introduce changes to the Listing Rules through requiring UK premium listed issuers, which include some  banks, to state, on an ongoing basis, whether they comply with TCFD-aligned disclosures and to explain any non-compliance. For those UK premium listed banks which have made little or no progress with TCFD implementation, this is likely to present a significant challenge.

PRA – Climate BES

In tandem with the above, the PRA also announced that the launch of its Climate BES would be postponed from the second half of 2020 until ‘at least mid-2021’. It confirmed however that it was expecting to release guidance on this in the summer and that outputs from the Climate Financial Risk Forum could also be expected to be published within the same time-frame. The cited rationale for the delay to the BES was to provide ‘firms with enough time to invest sufficiently in their capabilities to allow them to deliver to a high standard.’ Indeed, the rigorous and granular bottom-up analysis entailed by the proposals can be expected to necessitate a number of changes and investments for banks, for example, to their data, systems and modelling and scenario capabilities.

The PRA at the same time used its announcement as an opportunity to remind firms that:

Climate change represents a material financial risk to firms and the financial system and is a strategic priority for the Bank [of England]. Whilst COVID-19 represents a present risk, minimising the future risks from climate change requires action now. As such, the Bank will continue its work to better understand and mitigate these risks’

With banks having submitted their Climate Risk Plans to the PRA in October of last year, it seems likely that the PRA will wish to revisit these plans - and importantly the progress that boards and senior management have made with implementing them.

Investor activism 

Simultaneously, commentators have highlighted two recent announcements made by banks as a result of climate investor activism. In one case, a Tier 1 US bank announced a timetable for appointing a new independent director with a view to addressing shareholder concerns about a lack of climate competence. In the second case, a Tier 1 UK bank also put forward its own resolution on its net-zero 2050 ambition following investor engagement. We expect, particularly in the context of the proxy season, to see further developments in this area.

Similarly, growing awareness of climate change by citizens/consumers appears increasingly to be accompanied by a widespread desire  for climate change to be addressed in economic recovery after COVID-19.

Action areas for banks

With the above regulatory and investor trends in mind, we highlight below key action areas that banks should seek to focus on within their climate risk management programmes.

Concluding thoughts 

Whilst UK regulators have announced short pauses in some of their climate risk work on account of COVID-19, banks should be cautious about significantly decelerating progress with their climate risk programmes, not least because managing climate risks in no way diminishes the capacity to manage the former. Having submitted their climate risk plans to the PRA last year, the PRA will expect banks to make progress on them, while allowing for the unanticipated impact of COVID-19. Moreover, forthcoming regulatory changes – in particular around TCFD disclosure, but also the BES, along with the rise in climate-related investor activism and climate awareness in consumers, all underline the importance of continued momentum in this area.  As Frank Elderson, the Chair of the Network for Greening the Financial  System, puts it, ‘any financial institution which is not already doing so, [should] incorporate in the DNA of their financial risk management, the physical and transition risks related to climate change’.