How seriously are financial services firms taking climate change risks? Recent signs suggest that for those not placing them as a high priority, could well see regulatory trouble ahead.
Gaining an understanding into how climate change risks could impact both an individual firm and the wider economy is becoming a key talking point, with more regulatory guidance expected over the coming months, in particular from the work of the Climate Financial Risk Forum.
Regulators and the industry combine forces
The forum itself was set up in March by the Financial Conduct Authority and the Prudential Regulatory Authority and comprised of some 17 firms from across financial services including banks such as HSBC, JP Morgan and Yorkshire Building Society, insurers including Aviva, Legal & General and Lloyd’s and asset managers with Blackrock, Invesco and Schroders among others. The forum is based around four working groups that are developing guidance in the areas of risk management, scenario analysis, disclosure, and innovation.
The overall aim is to develop ‘practical tools and approaches to address climate-related financial risks’ and it will also access wider expertise, through collaborating with other firms and academia. The working groups themselves will meet more frequently than the Climate Financial Risk Forum which is set to meet three times a year.
What are seen as the main Climate Financial Risks?
These have been identified as:
Physical – the likelihood of more frequent floods, fires and droughts, linked to rising temperatures and sea levels. These will have a disruptive effect on businesses and in particular, put pressure on insurers, which will need to pay out on more claims. Premiums will go up for businesses and where there are repeated incidents. Some may find cover becomes unavailable. This will consequently cause problems as investors and banks will not be able to support businesses that are uninsurable.
Transition – these refer to the adjustments required in moving to a low-carbon economy. The impact could be wide-reaching and in particular affect how assets are valued – those reliant on fossil fuels, for example, could slump, while those which are ecologically sound could thrive.
Liability risks – these will materialize when those parties affected by physical and transition risks will seek to recover damages if losses occur. As an example Lawyers could launch lawsuits against those believed to be responsible for falling share prices, and companies overall can expect more scrutiny and monitoring when it comes to their environmental behavior.
A role for senior managers
Meanwhile in April, the PRA published supervisory and policy statements, ‘Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change.’ These outlined responses to an earlier consultation paper where firms were told they should have an initial plan in place to address expectations and submit an updated senior management function form by 15 October 2019.
While what constitutes best practice in these areas will be covered in more depth in forthcoming guidance, preparatory work should see climate change risks incorporated into a firm’s governance framework and senior managers fully briefed – education and a preparedness for action will be the order of the day for many.
Most recently in July, regulators published a joint declaration to stress they are working collaboratively and produced an update of their activities. The PRA, FCA, the Pensions Regulator and Financial Reporting Council’s statement said they welcomed the recently released Green Finance Strategy from the government. This seeks to ensure that the private financial sector is primed to work in environmentally sustainable ways, supported by the government. There is also an emphasis on competitiveness and for the UK to be seen as leading the field in ‘clean growth’.
Most notably, climate change is not something that any financial services firm can ignore – regulators and firms are working together in this country and globally via the Network for Greening the Financial System, which represents 42 members from businesses and supervisors from five continents. Facing up to – and responding to – the many climate change challenges is now seen as incumbent on all.