Financial services and climate change

Is your financial services business ready to meet its requirements for managing climate risk by the end of 2021?

Over the course of a turbulent year, managing the effects of COVID-19 has been the main priority for most financial services firms – but climate change has unfortunately not come to a standstill.

According to a recent UN report, the gap between where greenhouse gas emissions are going and where they need to be is now larger than ever.

While greenhouse gas emissions are expected to fall by the largest amount on record in 2020 as a result of COVID-19 lockdowns, this alone is not nearly enough to slow the effects of climate change. To make any real impact, action is needed right now.

For banks, insurers and other financial services firms, it’s not just about meeting a moral responsibility to protect the environment. Climate change also poses several very real risks to the sector.

Physical events like floods, storms, heatwaves and rising sea levels all have direct financial impacts on banks and insurance firms, for example. Added to that are the risks involved in adjusting to a low-carbon economy. As policy changes, new technology emerges and public sentiment shifts, firms need to be ready to adapt.

Earlier this year, the Bank of England’s Prudential Regulation Authority (PRA) set financial services firms a deadline of the end of 2021 to “implement and embed” a strategic approach to climate-related risks.

As we near the end of 2020, are you prepared to put your plans into action?

Planning for climate risks

In April 2019, the PRA tasked firms in the financial services sector with putting together strategic plans to tackle the risks of climate change.

In a supervisory statement, it set out its expectations of those plans, focusing on areas of governance, risk management, scenario analysis, and disclosure.

The plans had to be completed by October 2019, but firms now have until the end of 2021 to fully implement them.

PRA deputy governor Sam Woods wrote to firms earlier this year, telling them that by the deadline, they should be able to demonstrate that they have met the expectations set out in the supervisory statement “as fully as possible”.

“In doing this, you should continue to take a proportionate approach that reflects your institution’s exposure to climate-related financial risk and the complexity of its operations,” he added.

Identifying the gaps

A year on from the deadline to draw up your plans for climate risk, now is a good time to review your progress towards implementing them.

Every firm will have different priorities, but if you’re not sure how well your strategy matches up to best practice, the following areas highlighted by the PRA are a good place to start.

Governance and understanding risks

In its review of firms’ implementation plans, the PRA said their strategic responses need to be clearer, and that they need to “continue developing tools that inform business decisions”.

It added that firms should better demonstrate an appreciation of the “far-reaching breadth and magnitude” of climate-related financial risks.

Risk management metrics and processes

The PRA found that metrics and quantification were “the most challenging aspect of assessing climate risks”. This is partly because there are some things we just don’t know – and some things that we can’t predict with current scientific knowledge.

In those cases, firms have been advised to use “reasonable proxies and assumptions” to estimate the risks.

Data and tools for scenario analysis

The review found “significant gaps” in firms’ capabilities, data and tools when it came to scenario analysis. Most have not integrated this into their risk assessments more widely.

Your scenario analysis should include both a short-term assessment of your firm’s exposure to climate risks, and a long-term assessment that looks at a range of scenarios.

Getting ready for climate disclosures

Finally, the PRA said firms’ capabilities for making disclosures on climate-related risks need to be “materially improved”.

With the Financial Conduct Authority planning to introduce mandatory climate risk reporting by the end of 2022, it’s particularly important to ensure you’re ready to make those disclosures in time for those obligations.

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