Climate-related financial risks | Turning aspiration into action

Sarah Breeden, Executive Sponsor for Climate Change at the Bank of England (BoE), told financial services firms last week that it is time for the financial system to turn aspiration on climate into action. Banks and insurers now have until end-2021 to implement fully the supervisory expectations set in 2019 by the Prudential Regulation Authority (PRA).  She acknowledged that responding to climate change is an unprecedented challenge for firms – and recognised that there are currently several limitations, such as the availability of data – but her message was clear: “Imperfection is not an excuse for inaction”. Firms need to make a start.

With supervisory expectations in place and firms having developed plans to be able to meet them, the BoE’s strategy is to help firms understand the “how”. In a “Dear CEO” letter to banks and insurers published on the same day as Sarah Breeden’s speech, the PRA set out thematic feedback from its review of firms’ plans and clarified its expectations. Earlier in the week, the Climate Financial Risk Forum (CFRF) launched a Guide to climate-related financial risk management.

This push by supervisors comes against the backdrop of increasing activity across the EU and internationally to tackle climate-related financial risks. Supervisors have barely broken step during the COVID-19 pandemic on their plans related to climate change, whilst for other supervisory topics and activities COVID-19 has caused disruption and delay.

Practical guidance on implementation

Established in March last year, the CFRF is an industry group convened by the PRA and Financial Conduct Authority (FCA). The Guide draws on the experience of the CFRF’s members. It does not constitute regulatory guidance for firms, but it does complement existing frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD) recommendations. Alongside the feedback in the PRA’s letter to CEOs, firms will find the Guide useful in meeting supervisors’ expectations.

The Guide’s chapters on risk management, scenario analysis, disclosures and innovation offer practical guidance for firms on implementation. For example, the chapter on disclosures emphasises the importance of information being “decision useful” for users – a point Sarah Breeden reiterated in her speech. The chapter on risk management highlights the importance of “tone from the top” to drive firms to ask the right questions, of training, and of organisation-wide availability of data to drive integration of climate change financial risk in existing risk management frameworks.

The chapter on scenario analysis will be particularly useful for banks and insurers preparing for the BoE’s delayed 2021 Biennial Exploratory Scenario (BES) stress-testing exercise on the financial risks from climate change. Andrew Bailey, Governor of the BoE, set out in a letter to the Chancellor last week that the BoE expects firms to use the extra time due to the delay to be able to do better when it comes to the stress-testing exercise. He wrote that “[the delay to the exercise] … reflects a desire to maintain the ambitious scope of the exercise, whilst giving firms enough time to invest sufficiently in their capabilities to allow them to deliver to a high standard.” Banks will also find it helpful to look carefully at the "Dear CEO” letter sent by the PRA to insurance firms earlier last month on the findings from the PRA’s 2019 Insurance stress-testing exercise. The letter highlighted that the climate scenario had indicated significant gaps in insurers’ capabilities to evaluate climate-related scenarios, including gaps in data, tools, processes, and technologies. We anticipate that these gaps will be just as prevalent in banks.

More to come

The CFRF will reconvene in mid-July and agree a strategy for the next year.  The PRA and FCA expect the future work of the CFRF to include thematic work on data, metrics and targets, noting that there is significant interest in sharing expertise on these topics.  The BoE will also issue additional guidance and material such as scenarios prior to the launch of the 2021 BES stress-testing exercise.

The BoE thinks that disclosures should be made mandatory, and soon.  Together with other regulators, it is exploring how this can be achieved.

More generally, climate-related financial risk will be integrated within supervisors’ regular supervisory activities, and supervisors will continue to discuss climate risk and progress on implementation programmes with firms.