[co-author: Anna Lewis-Martinez]

The PRA expands its supervisory expectations for firms on managing climate-related financial risk — publishing a Dear CEO guidance letter.

On 1 July 2020, the PRA published guidance in the form of a Dear CEO letter to banks, insurers, and other PRA-regulated firms on managing climate-related financial risk. The letter builds on the expectations set out in the PRA’s supervisory statement on enhancing banks’ and insurers’ approaches to managing financial risks from climate change (SS3/19).

The PRA’s letter informs firms that they should fully embed their approaches to managing climate-related financial risks by the end of 2021. This means PRA-regulated firms should be able to demonstrate that the expectations set out in SS3/19, covering governance, risk management, scenario analysis, and disclosure, have been implemented and embedded throughout their organisations as fully as possible. The letter confirms the PRA’s stance that firms should continue to take a proportionate approach that reflects their institution’s exposure to climate-related financial risk and the complexity of their operations.

On 29 June 2020, the Climate Financial Risk Forum (CFRF), co-chaired by the PRA and FCA, published a guide on how to approach climate disclosure, risk management, scenario analysis, and innovation, which firms can use to help develop their own approaches to managing these challenges. The Bank of England will also be issuing additional guidance and useful material, such as reference scenarios, prior to the launch of the 2021 climate-focused Biennial Exploratory Scenario (BES). These steps, together with the examples of good practice set out in the Dear CEO letter, will assist banks, insurers, and other PRA-regulated firms in meeting their supervisory expectations.

The letter also sets out the PRA’s observations from its thematic review of firms’ SS3/19 implementation plans. The PRA confirms that since SS3/19 was published in April 2019, it has found that most firms are making good progress in developing approaches to identify, assess, manage, report, and disclose climate-related financial risks, and firms have started to embed these approaches in associated governance and control structures. Annex 1 to the letter provides examples of good practice. However, gaps still remain:

Governance

• Firms’ strategic responses should be clearer and firms should continue developing tools that inform business decisions.
• Firms’ oversight of climate-related financial risks could better demonstrate an appreciation of the far-reaching breadth and magnitude of the risks, as well as a clearer understanding of their relationship to financial risks.

Risk Management

• In some areas the science, data, or tools are not yet sufficient to estimate climate-related financial risks accurately.
• Few banks, building societies, and insurers have implemented integrated risk management policies, thresholds, mitigation strategies, monitoring capabilities, and risk appetites, and are still at the early stages of development.

Scenario Analysis

• Many firms must increase their capabilities, data, and tools materially in the near term to develop a proportionate and integrated approach to scenario analysis into their broader risk assessment by the end of 2021.

Disclosure

• Firms’ appetite for making climate disclosures is limited by capabilities and, as a result, some firms are yet to make any associated disclosures.

On the same day the Dear CEO letter was published, Sarah Breeden, the Bank of England’s executive director for UK deposit takers supervision and executive sponsor for climate change, gave a speech stating that climate change “needs to happen in the real economy,” and that consumers, governments, and corporates must all act. She went on to say that, “if the real economy does not make that change and we head down a path of increasing climate instability or disorderly transition, the financial sector will bear that risk.”

Breeden also highlighted that, “[a]s the pandemic has revealed, the interconnections between the real economy and the financial system run deep. And just like Covid-19, climate change is a far-reaching, system-wide risk that affects the whole economy, from which the financial system is not immune.”

Breeden spoke of the “economy-wide orderly transition to net-zero emissions,” and that the financial sector should be instrumental in driving this change. She also stated firms must “make financial decisions that take the risks and opportunities from climate change into account,” both through “consistent, comparable, and comprehensive climate disclosures” and by using this information to understand and actively manage climate-related risks in their business.

Next steps

The PRA will continue to embed climate-related financial risk into its supervisory approach. The PRA will also continue its ongoing engagement on climate risks to discuss the implementation and progress of firms’ plans with key individuals, particularly the assigned senior management function holders. Firms should also expect climate-related financial risk to be integrated within the PRA’s full range of regular supervisory activities, including the 2021 BES exercise.

Firms should look now to act on climate risks, collect data and build tools and frameworks to enable changes in their strategy and risk management.