FCA targets climate risk

By Richard Young

July 8, 2020

An initiative of the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), the Climate Financial Risk Forum (CFRF) comprises senior representatives from across the financial sector whose combined expertise has been brought to bear on addressing the most urgent existential risk of our time: climate change.

In June the CFRF published its first ever guide assessing the threats presented not just by climate change directly, but also the wider risks likely to be caused by a transition towards a net-zero carbon economy. Here are five of its key findings:

  1. In it together. Mitigating climate risk will require a concerted effort from across the financial sector and beyond, with the coronavirus emergency serving as a wake-up call. According to the CFRF, “Covid-19 has demonstrated more than ever the need for firms to be prepared for the rapid crystallisation of global risks. It has also demonstrated the value of working together to address fast-evolving risks that do not respect national boundaries.”

Within organisations themselves, all staff must be united in their awareness of climate risk and engaged with the process of confronting it. While the management of climate risk must take place at the board level of financial institutions, all levels of an organisation, from the mail room to the boardroom, have a part to play.

  1. Joined-up approach: Climate risk governance should be integrated into existing risk management, but the specific nuances of climate risk need to be differentiated from established financial risks. At board level, this will require the delivery of a tailored training programme and the appropriate allocation of senior management responsibility.

Those with responsibility for climate risk governance should provide periodic regular updates to the board on the firm’s progress in preparing for and implementing climate risk management, while the board should ‘provide review and challenge’ on unexpected climate risk concentrations and emerging regulatory, reputational and legal obligations.

  1. Long-term view: Although climate risk should be embedded within an organisation’s wider risk governance strategy, it requires a longer-term approach than other established financial risks: “In addition to the standard planning cycle, climate change impacts should be considered over a longer period eg 30 years, with interim milestones,” the guide recommends. While the immediate impact of climate change is already visible – in things like heatwaves, floods and wildfires – the longer-term consequences will play our over time and be seen in things like sea level rises and rising mean temperatures. An understanding of how this will affect areas like insurance and consumer behaviour will be needed to form a robust risk management approach.
  2. Green is good for business: The institutions that remain successful in the face of climate change will be those that appreciate and prepare for changing consumer attitudes towards sustainability. This shift in consumer sentiment can be categorised as a ‘transition risk’ – i.e. a factor that emerges as society shifts towards a zero-carbon economy. According to the CFRF, “Increasing awareness and understanding of the impacts of climate change is […] affecting consumers’ preferences, leading to growing demand for genuinely ‘green’ financial products and services.”
  3. Be prepared to innovate: The challenges of climate risk will require new products and new ways of thinking. For example, it will be necessary to develop new investment vehicles such as transition bonds that enable investment into emerging net-zero markets, and to encourage fresh thinking around partnerships between financial institutions and public sector bodies. According to Nigel Wilson, CFRF Innovation Working Group Chair, “This is the biggest task we face as a generation. Positive, constructive collaboration between finance, government and regulators will help us achieve this crucial shift.”

To read the guide, click here.
 

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