PRA sets expectations for managing climate risk

Key Takeouts

  • On 1 July, Deputy Governor of Prudential Regulation and CEO of the Prudential Regulation Authority Sam Woods wrote to regulated banks and insurers to: a) provide feedback on climate risk management implementation plans (SS3/19 implementation plans); b) clarify the regulator's expectations around how firms should manage and disclose the financial risks associated with climate change; and c) set a deadline for full implementation.
  • Mr Woods writes that overall firms are 'making good progress' towards developing their approaches to identifying, managing and disclosing climate-related financial risks and that most have started to 'embed' these considerations into their governance and control structures. However, the letter also identifies a number of 'gaps' e.g. integration of scenario analysis and disclosure (among others). An annexure to the letter provides more detailed feedback on the outcomes of the review and highlights some 'best practice' examples of the way in which specific aspects of climate risk are being managed/approached.
  • Mr Woods said that the regulator's expectation is that all firms should have fully embedded their approaches to managing climate-related financial risks by the end of 2021'.
  • On the issue of disclosure of climate risk, the PRA writes, 'We expect firms to continue to build their capability to disclose how they govern and manage climate-related financial risks and any material exposures. The Government’s Green Finance Strategy stated an expectation that all listed companies and large asset owners will be disclosing in line with TCFD recommendations by 2022. The Bank’s response to the Future of Finance report subsequently supported this position. We also note the FCA’s current policy consultation for Premium Listed firms to produce TCFD disclosures on a comply-or-explain basis, which will capture a significant proportion of larger PRA-regulated banks and insurers'.

Context

In 2019, the Prudential Regulation Authority (PRA) issued a supervisory statement - SS 3/19 Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change - setting out the PRA's expectations of how regulated banks and insurers should manage the financial risks associating with climate change. Chapter three of the statement sets out the PRA's specific expectations.

SS 3/19 also set an October 2019 deadline for firms to have in place an implementation plan, but set no date for full implementation.

Following up: Letter to regulated insurers and banks

The PRA has now conducted a review of a number of implementation plans, and has written to firms to provide feedback, to further clarify the PRA's expectations, and to set a 2021 deadline for full implementation.

This means, Mr Woods writes, that 'by the end of 2021, your firm should be able to demonstrate that the expectations set out in SS3/19 have been implemented and embedded throughout your organisation as fully as possible'.

Outcomes of the PRA's review of implementation plans

Mr Woods writes that overall firms are 'making good progress' towards developing their approaches to identifying, managing and disclosing climate-related financial risks and that most have started to 'embed' these considerations into their governance and control structures.

However, the letter also identifies a number of 'gaps' or improvement areas. These include gaps in: a) governance and board oversight of climate risk; b) risk management (metrics and risk management and monitoring processes); c) scenario analysis (firms have yet to integrate scenario analysis into their broader risk assessments); and d) disclosure (some firms are yet to make 'any associated disclosures' as a result of their limited capabilities'.)

Commenting on the lack of integration of scenario analysis, the letter states that 'the development of a proportionate and integrated approach to scenario analysis by the end of 2021 will require many firms to increase their capabilities materially in the near-term'.

Best practice examples

An annexure to the letter (p5) provides more detailed feedback on the outcomes of the PRA's review and highlights some best practice examples of the way in which specific aspects of climate risk are being embedded by certain firms.

For example on the issue of disclosure, the PRA notes that SS 3/19 encouraged firms to consider reporting in alignment with the Taskforce on Climate-related Financial Disclosures (TCFD) framework. The letter comments that 'more advanced firms are publishing TCFD format disclosures in, or linked to, their annual reports' with some 'now approaching fully comprehensive outputs'.

From a timing perspective, the PRA says that its expectation is that,

'...firms to continue to build their capability to disclose how they govern and manage climate-related financial risks and any material exposures. The Government’s Green Finance Strategy stated an expectation that all listed companies and large asset owners will be disclosing in line with TCFD recommendations by 2022. The Bank’s response to the Future of Finance report subsequently supported this position. We also note the FCA’s current policy consultation for Premium Listed firms to produce TCFD disclosures on a comply-or-explain basis, which will capture a significant proportion of larger PRA-regulated banks and insurers'.

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