Financial firms in the UK have been issued new risk management guidance on climate risks as regulatory pressure on the sector prepares to move up a gear. The guidance could well be used to set targets for firms next year as the Bank of England (BoE) raises its expectations on understanding and mitigating climate change risk.
The guide is the first of its kind to be published since the Climate Financial Risk Forum (CFRF) was formed by UK regulators the Financial Conduct Authority and the BoE’s Prudential Regulation Authority in March last year.
It sets out shared best practice to help financial firms understand the risks of climate change and support risk integration into existing frameworks. The CFRF says understanding climate change impacts on asset values, the cost of insurance and creditworthiness of borrowers is “relatively immature”, but the impact on these areas will be “substantial”.
It says firms should decide whether to treat climate risk as a standalone or cross-cutting risk before integrating into existing risk management frameworks. The governance approach for climate risks should be akin to that used for established financial risks, the CFRF states.
Firms should plan for the impact of climate policies over different time periods, the guide notes.
“It is important that financial institutions fully integrate climate risk into their existing risk management framework. Failure to do so means that firms will be unable to understand and respond to the true dangers it poses to their business models,” commented Daniel Klier, chair of the CFRF risk management working group.
In a chapter on scenario analysis, the CFRF guide uses case studies to inform firms’ strategy, risk management and business decisions. “The expectations and practices around climate financial risk are quickly evolving,” the CFRF states. “There are many challenges and barriers to overcome in performing scenario analysis, in particular the breadth and magnitude of the effects of climate change, the extended time horizons, uncertainty and lack of recent historic precedents.”
The guide also covers climate-related financial disclosures, which has been led by recommendations from the Taskforce for Climate-related Financial Disclosures. Another focus is innovation and looking at opportunities for the financial sector.
Consumer pressure will lead to more demand for greener financial products and services, and the guide sets out how companies can identify opportunities from climate change.
“Leadership and cultural change are critical to deliver the climate risk agenda. Every decision-maker at every level of the organisation must understand the importance of reacting to climate risks,” Mr Klier said.
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