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Climate Change, Green Finance & Managing Financial Risk

15th October 2018

Green Finance & Financial Risks

The topics of climate change and global warming have been hotly debated over the last few decades among environmentalists, scientific researchers, conspiracy theorists and skeptics - and now it seems that the UK Regulators are also turning increasing attention to these issues and the impact they have upon the UK financial markets.

Recent Regulatory Papers Published

The FCA have today issued a Discussion Paper targeting Climate Change & Green Finance, whilst the PRA has published a consultation paper on ‘Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change’ (PRA CP23/18).

The FCA’s DP18/8 looks to set out how matters related to climate change are relevant to the regulator’s statutory objectives, since they must consider all major risks that have an impact on the markets and firms that they regulate, which includes those risks posed by climate change. The PRA’s CP28/18, on the other hand, seeks views on a draft supervisory statement on banks’ and insurers’ approaches to managing the financial risks from climate change.

FCA Discussion: UK Financial Markets & Climate Change

The FCA informs that it has been widely recognised by the 181 parties that signed the 2015 Paris Climate Change Agreement that climate change is likely to have a significant impact on the UK’s economy and financial services markets.

It is well known that the facts about climate change are often debated, with widespread disagreement relating to its causes. However, since it is believed that climate change will have a significant impact upon the UK, as regulator, the FCA must ensure that the risks it poses to the UK are addressed as part of their strategic objective to ensure that financial markets work well.

As Andrew Bailey, Director of Enforcement at the FCA, states “Climate change presents a potentially irreversible threat to the planet… The impact of climate change on financial markets is uncertain; it is just one of many factors that will influence how these markets will look in the future. However, climate change differs from other issues in that legal frameworks – at an international, European and UK level – have already begun to change to support the transition to a low carbon economy.”

As a result of these changes, the FCA is already seeing an increase in consumer demand for ‘green’ financial services products. And, as this demand grows, the questions relating to how green products and markets are classified are increasingly being asked. In addition, the issues of green disclosure, green performance measures and ultimately both fairness and the protection of consumers become more and more important.

The FCA will have a role in ensuring this new market develops in a fair, orderly way to meet the needs of its users as well as in providing greater structure and protection for consumers of ‘green’ products. This will be a fine balancing act, no doubt, as the FCA will need to ensure that “regulation does not stifle positive innovation” as the demand for green finance grows and new products develop.

In the FCA’s Discussion Paper, the FCA inform that they must consider all major risks related to climate change including:

• The physical risks of climate change;
• International and domestic political commitments on climate change; and
• Subsequent response of corporations, capital markets and investor demand.

It seems inevitable that over the next few decades, climate change is likely to “fundamentally transform our economies” and the associated change to a low carbon economy will most probably have a major impact upon financial markets and products that serve those markets.

Four areas that the FCA are seeking views and discussion upon at present that they feel warrant greater regulatory focus are:

• climate change and pensions;
• enabling competition and market growth for green finance;
• ensuring that disclosures in capital markets appropriately give adequate information to investors of the financial impacts of climate change; and
• the scope for the introduction of a new requirement for financial services firms to report publicly on how they manage climate risks.

Those wishing to contribute their thoughts to the FCA’s discussion DP18/8 should do so by 31st January 2019.

PRA: Managing Financial Risks Associated with Climate Change

With the PRA’s Consultation Paper issued today, (CP28/18), the regulator has put forth proposals about how effective governance, risk management, scenario analysis, and disclosures may be applied by firms to address the financial risks from climate change.

It is noted that the draft rules are intended to complement existing policy material and inform compliance with current requirements in legislation and the regulator’s rules.

The desired outcome, is that firms will take a strategic approach to managing the financial risks associated with climate change both now and in the future. The regulator’s proposed expectations concern how firms:

• embed within their governance arrangements the consideration of the financial risks from climate change;
• incorporate into existing risk management practice the financial risks from climate change;
• use (long-term) scenario analysis to inform strategy setting and risk assessment and identification; and
• develop an approach to disclosure on the financial risks from climate change.

Those that wish to participate in and contribute to the consultation should do so before the consultation closes on 15th January 2019.

Climate Financial Risk Forum

It is no coincidence that the regulators have published these papers today as the FCA informs that they have been working closely together with the PRA to develop a ‘joined-up approach’ to increasing the resilience of the UK’s financial system to climate change.

Furthermore, in order to co-ordinate the regulators’ actions and share best practice, the regulators are intending to set up a Climate Financial Risk Forum that will be designed to help the financial sector manage the financial risks from climate change as well as support innovation for green . The exact make-up of this Risk Forum is to be decided upon over the course of the next months with its first meeting scheduled for early 2019.

Read our latest articles, news and views affecting compliance and regulation in the UK Financial Services Industry.