Bank of England governor indicates new climate risk rules are imminent

Source(s): Acclimatise

By Robin Hamaker-Taylor

On 21st March, 2019, Bank of England Governor Mark Carney gave a speech at the European Commission High-Level Conference in Brussels, where he indicated that new rules from the UK’s financial regulators on climate risk are imminent.

Carney’s speech gives several indications as to the content of the upcoming PRA supervisory statement (SS) on banks’ and insurers’ approaches to managing the financial risks from climate change. The PRA’s SS will apply to banks, insurers and investment firms and will set out the PRA’s expectations regarding firms’ approaches to managing the financial risks from climate change, including with respect to: 

  • Governance, where firms will be expected to embed fully the consideration of climate risks into governance frameworks, including at board level, and assign responsibility for oversight of these risks to specific senior role holders;
  • Risk management, where firms will need to consider climate change in line with their board-approved risk appetites;
  • The regular use of scenario analysis to test strategic resilience; and
  • Developing and maintaining an appropriate disclosure of climate risks.

There have been important advances in both the supply and demand for climate reporting following the release of the final TCFD recommendations in 2017; support from both finance actors and companies has been resounding. Yet actual action on disclosure is lacking. According to Carney, financial implications are often not yet disclosed, and where they are, they are made in multiple reports making comparisons harder. Disclosures also vary considerably by industry and region.

Carney set out a vision for climate disclosure and made the case for regulatory action relating to it, stating that “in the future, disclosure will move into the mainstream, and it is reasonable to expect that more authorities will mandate it.” The role of financial regulators was delineated as well, suggesting that it is not their role to drive the transition to a low-carbon and resilient economy. Instead, financial regulators such as the PRA need to smooth the flow of investment into green technologies and encourage firms to plan over longer time horizons than normal; they ultimately operate within the climate policy frameworks that governments set.

A call was made for financial institutions to take a more strategic approach to climate, which Carney suggested requires scenario analysis; firms will need to consider scenario analysis as part of their assessments of the impact of climate risks on their balance sheet and broader business strategy. Specifically, Carney suggested scenarios should be:

  • Comprehensive, rigorous and challenging;
  • Transparent: the assumptions and methodologies in the models – such as the assumed global temperature rise, the energy mix, or whether the transition happens smoothly or abruptly – should allow for comparisons and external challenge; and  
  • Scenarios should be implemented consistently across the business, linking identification of risks and opportunities to both strategy and disclosure.

Scenario developments will be assisted by the PRA and FCA joint Climate Financial Risk Forum, which will work with industry to review tools and metrics, for the publication of reference scenarios and standard assumptions.

Finally, Carney explains that supervisors will require climate-related stress testing that links ‘high-level data-driven narratives on the evolution of physical and transition risks to quantitative metrics to measure the impact on the financial system.’ In conducting these stress tests, financial institutions would aim to:

  • Consider whether, across the financial system, financing flows are consistent with an orderly transition to the climate outcome set out in the Paris agreement. These long-term scenarios can facilitate discussions between firms and their clients about possible risks across different sectors and geographies; and
  • Consider whether the financial system would be resilient to shorter-term shocks – including a climate “Minsky moment” when climate risks materialise suddenly. 

The Bank of England will also work closely with colleagues in the Network for Greening the Financial System (NGFS) to develop a small number of high-level scenarios. Following the issuance of the draft supervisory statement and subsequent consultation in October 2018-January 2019, the final supervisory statement will be released in mid-April 2019.

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