The requirements of the Prudential Regulation Authority’s Supervisory Statement on “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change” came into effect on 15 October, reflecting concerns by Bank Of England Governor, Mark Carney, that the financial sector must "raise the bar" on climate risk measurement to ensure a smooth transition to a low-carbon economy and avoid a climate Minsky moment – a sudden collapse in asset prices. Under the framework[1], the PRA expects firms will have nominated Senior Manager who will be responsible for identifying and managing financial risks from climate change. That person will be tasked with taking into consideration the evolving understanding of what best practice looks like in this area.
Commenting on the regulations, Clyde & Co partner Nigel Brook said: “Since April 2019 banks and insurers have been preparing for this as the PRA expects that there will be a preliminary plan in place to address the expectations of the PRA. This means a named senior manager will now be responsible for integrating climate change into the existing risk management framework, according to insurers’ risk appetite. There are tools and metrics available, but climate risk is multifaceted and impacts a wide range of range of processes, assets and investments.
“Managers and the teams they are pulling together will have quite a task on their hands, starting with mapping out their company’s exposure to climate change risks. Exposure could affect both sides of the balance sheet: on the asset side – in terms of how those risks could impact them directly as major asset owners themselves and (in some cases) as asset managers for others – and on the risk/underwriting side.
“Each business needs to take a clear view of what this means and start thinking about how to manage the risks identified and disclose material risks. Firms may need to grapple not just with the risks to policyholders' physical operations and infrastructure, but also understand the transition risks posed to business models by the shift to a low-carbon economy, as well as increasing regulatory pressures and scrutiny. For insurers, this also means understanding what the underwriting exposures might be – either as a result of changes to climatic patterns causing acute or chronic climate effects to insureds – but importantly the liability exposures that may arise as a result of increase in third party claims. These could affect environmental policies, general liability, directors and officers, professional indemnity and E&O cover.
“The PRA is going to expect insurers' climate response to evolve and deepen over time, so we are very much at the outset. An important point about climate change is that it is about opportunities as well as risks. Those firms that are better able to understand their risks, can develop a better strategy for dealing with them and increase their climate resilience. The message from the Bank of England has been clear. This is not a regulatory exercise for the sake of regulation. As has long been known and as Mark Carney has articulated since 2015, the risks posed by a changing climate to the economy and therefore to the financial services sector are real and present now, and must be properly understood as part of the Bank of England's mandate to support the integrity of the financial system. Climate risk management is here to stay.”
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