Finance regulators consult on climate change risks
On 15 October 2018, the Prudential Regulation Authority (“PRA”) and the Financial Conduct Authority (“FCA”) each began consultations on climate change risks and the latter also on the greening of finance. The measures proposed seek to achieve a harmonised approach regarding definitions, benchmarking, assessment and quantification of climate change risk in financing decisions. This is part of a wider movement relating to the embedding of environmental, social and governance issues (ESG).
The PRA’s consultation paper entitled “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change” seeks comment on its draft supervisory statement which sets out the PRA’s expectations regarding financial markets’ approaches to managing financial risks from climate change. The FCA issued a Discussion Paper entitled “Climate Change and Green Finance” and this seeks views on how the FCA can work most effectively with others to meet investor demand for green investment opportunities and encourage those raising capital and investing to pursue sustainable outcomes. Both the FCA and the PRA documents are designed to address perceived barriers to growth of green financial services in the UK.
Financial risks from climate change
The PRA’s findings in its recent report on 'The impact of climate change on the UK banking sector’ (published in September 2018) suggested that only 10% of banks are taking a comprehensive strategic approach on how climate change today affects future financial risks. Significant differences are highlighted in banks’ responses to financial risks from climate change.
Financial risks from climate change in the PRA’s consultation paper are considered to be those arising from two primary channels: physical risks (e.g. weather events and long term shifts in climate) and risks in the transition towards a low-carbon economy (such as stranded assets, climate-related policy and regulation, credit exposure of banks and lenders etc.). Both channels of risk are seeing climate-change related litigation.
Views invited on draft supervisory statement
The consultation seeks views on the draft supervisory statement. The purpose of supervisory statements is to set expectations, rather than mandatory requirements. If, however, regulated organisations do not meet the expectations, they may need to provide explanations. Should those explanations be unsatisfactory the PRA may take measures against the organisation by imposing higher capital charges for certain assets. This is a form of self-governance.
The draft supervisory statement sets out the PRA’s proposed expectations around the following factors: governance, risk management, scenario analysis and disclosure. Briefly these are:
Governance: The PRA would like to see more full board-level engagement and accountability for managing financial risks from climate change. The PRA expects there to be clear division of responsibilities for managing these risks.
Risk management: Expectation that the risks be identified, measured, monitored, managed and reported.
Scenario Analysis: Scenario analysis (not prescribed) is expected so that impacts of climate change risks on current business strategy can be assessed.
Disclosure: the PRA expects financial services firms to formulate an appropriate approach to disclosing climate-related financial risks. It is expected that the approach will be based on the recommendations of the Financial Stability Board’s ‘Task Force on Climate-related Financial Disclosures’ (TCFD) - see link.
The FCA published its own Discussion Paper on ‘Climate Change and Green Finance’ which seeks to stimulate discussion and debate on proposed measures. The Discussion Paper sets out how the impacts of climate change are relevant to the FCA’s statutory objectives and its short and long-term goals. It is intended that responses will inform FCA policy, rules and expectations regarding management of financial risk from climate change.
The Discussion Paper highlights four areas in which the FCA considers greater regulatory focus is required in the short-term. These are: (1) pension investments; (2) green finance products; (3) disclosure to investors; and (4) new reporting requirements.
Here the FCA’s intention is that those making pension investment decisions take account of climate change risks. Particular focus is paid to the Independent Governance Committees (IGCs) which provide independent oversight of workplace personal pension schemes. The FCA intends to launch a consultation in the first quarter of 2019 on the following issues:
- potential rule changes to require IGCs to report on financial services firms’ policies regarding evaluation of ESG considerations, including climate change.
- introduction of guidance for providers of workplace pension schemes that would clarify how they should consider climate change and ESG risks in investment decisions.
- potential changes to the remit of IGCs.
Green finance products
The FCA is considering steps to boost innovation in specialist green finance products. The FCA is to consider ways in which the Global Financial Innovation Network (GFIN) could be used to promote green finance. GRIN is a network which seeks to provide efficient ways for firms to interact with regulators and help innovative firms navigate international regulation and encourages sharing of ideas and experiences.
The Discussion Paper invites comment on whether issuers of securities admitted to trading on a regulated market require greater encouragement to disclose adequate information on the financial impacts of climate change risks to investors, so as to facilitate informed investment decision making. One method which the FCA suggests may achieve this is through adopting a ‘comply or explain’ approach. This would require issuers to provide investors with a statement explaining whether they have complied with the TCFD recommendations on disclosure (and if not, why not).
The FCA seeks views on whether to introduce a new requirement for financial services firms to report publicly on how they manage climate risks and whether this can be done through a ‘climate risks’ report’.
Responding to the PRA consultation and FCA Discussion Paper:
The PRA consultation is open until 15 January 2019 (responses may be provided by email to the PRA at: CP23_18@bankofengland.co.uk). The FCA discussion paper is open until 31 January 2019 (responses can be emailed to the FCA: firstname.lastname@example.org)
The wider economy has been impacted by climate change law and policy for many years. Various economic sectors are at various stages of transition to low carbon (and potentially lower resources) economies. These sectors have gone through exercises not dissimilar to ones at hand, for instance in terms of trying to formulate common terms and definitions and risk management measures. To this extent, the PRA and FCA appear to be reflecting an existing wider concern relating to transparency concerning approaches to climate change and ESG risks. Much more activity in this area can be expected.
- PRA Consultation Paper 23/18 – ‘Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change - October 2018’. here.
- PRA: ‘Transition in thinking: The impact of climate change on the UK banking sector – September 2018’. here.
- FCA Discussion Paper DP18/8 – ‘Climate Change and Green Finance – October 2018’. here
Co-authored by William Caruana.