Following a dramatic week of USA Election news culminating with the calling of Joe Biden as President-elect, the expectation is that the United States will seek to re-enter the Paris Climate Agreement and shift to driving forward the leadership agenda in this space. This morning, Andrew Bailey, Governor of the Bank of England (BoE) further outlined the climate risk agenda for financial services in a speech to the Corporation of London Green Horizon Summit.
Bailey’s speech drew out several key points that signal the direction of travel for financial services firms:
- Climate commitments and COVID-19 adaptability – “The UK government has made a firm commitment to transitioning the economy to net zero by 2050. Physical events from climate change (record wildfires in Australia and California, record-breaking temperatures in the Arctic Circle) create a reminder of the need for sustained action. The UK’s experience with COVID-19 has shown the ability for firms to adapt, making the inevitable transition challenges achievable.”
Takeaway 1: The BoE has signalled this is not going away – if this isn’t high on your 2021 agenda, you should have a very strong reason and evidence for not including it – i.e. extensive impact assessments already conducted.
- Complexity of climate change risks means firms need to invest in understanding them – “Compared to the financial crisis and the pandemic, the risks from climate change are even bigger and more complex to manage. “
Takeaway 2: Climate risk is transverse and cuts across several different risks in the organisational risk management framework. Risks cover significantly longer time periods than most organisations currently assess. Understanding and developing existing frameworks for climate risk is critical.
- Use existing guidance frameworks – “The Taskforce for Climate-related Financial Disclosures (TCFD) has led the way on this. What we cannot measure we cannot manage, so it is important that financial firms and their clients use the TCFD framework and the latest tools available to measure, model and disclose the climate risks and opportunities they are exposed to today and in different future climate scenarios. We at the Bank started to do this ourselves when we published our own climate disclosure this summer. We have worked closely with industry through the Climate Financial Risk Forum (CFRF) to publish a practical guide for firms so that they can implement changes.”
Takeaway 3: The TCFD guidance remains the standard bearer. Given the recent Progress Report last week, firms should give serious consideration to the contents of the guidance and key learnings from the annual progress reports. The CFRF publications also include extensive guidance that firms would merit performing gap analysis exercises against.
- Disclosure is ramping up - “We are now working with the Treasury and other regulators to consider the UK’s approach to climate disclosure. Disclosure metrics force us to confront the question of where we are and where we want to be, and thereby drive different decisions today. Knowing that we will be publishing our next TCFD disclosure in less than 12 months creates discipline and urgency.”
Takeaway 4: Given poor voluntary rates of disclosure in the TCFD’s Annual Progress reports, the direction of travel does suggest mandatory disclosure. What climate risk-related disclosures are you currently producing, and have you assessed these against TCFD / CFRF base requirements and examples of good practice?
- Stress testing is back after a hiatus – “When the pandemic hit, we decided to postpone the exercise in light of strain on firms’ resources and to ensure the ambitious scope of the exercise could be maintained. We have used the extra time to continue our work on the design of the exercise, and firms have been busy preparing for it. And today I am pleased to announce a launch date, June 2021. The exercise will explore three different climate scenarios, testing different combinations of physical and transition risks over a 30-year period. We expect to use the exercise as a tool to size the risks faced in these scenarios, to understand how different bank and insurance business models will be affected and how they might respond, and finally as a way of improving firms’ risk management practices through the process of carrying out the exercise. We will share with participants more detail on some key aspects of the exercise – for example around data requirements and scenario variables.”
Takeaway 5: How does the June 2021 timing align with your own firm’s ability to recruit and ring-fence resources and prepare the granularity of data required to deliver the BoE’s requirements?
- ICAAPs and ORSAs – “As we have set out in our supervisory expectations, firms must assess how climate risks could impact their business and review whether additional capital needs to be held against this. Investments that look safe on a backward look may be existentially risky given climate risks. And investments that might have looked speculative in the past could look much safer in the context of a transition to net zero. Uncertainty and lack of data is not an excuse. We expect firms to make reasonable judgements rather than default to “zero”. UK banks and insurers must work to develop these capital assessments over the coming year and the Bank will be working in tandem to develop its approach to reviewing them.”
Takeaway 6: How has climate risk featured in your capital planning (ICAAP or ORSA) exercises and, if not to date, how will you seek expert guidance in assessing and challenging the scale of potential capital impact?
For further insights on getting started on implementing your climate risk framework, please download our insights deck HERE.