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    PRA Letter Sets Expectations on Approach to Managing Climate Risks

    July 01, 2020

    PRA published a letter that builds on the expectations set out in the supervisory statement (SS3/19) on enhancing banks' and insurers' approaches to managing the financial risks from climate change. The letter was issued by Sam Woods of PRA to the chief executive officers of all regulated firms; it provides thematic feedback from the review of firms’ SS3/19 plans, offers clarification on expectations, presents observations on good practices, and sets out the next steps for implementation of firms' plans. In addition, BoE published a speech by Sarah Breeden, the BoE Executive Director for UK Deposit Takers Supervision, on how the financial sector can draw on the recent work of BoE, Climate Financial Risk Forum (CFRF), and Network for Greening the Financial System (NGFS) to move beyond rhetoric and help make climate action a reality. Additionally, in a recently published statement, the BoE Governor Andrew Bailey mentioned that the COVID-19 crisis has not changed the commitment to the goals of combating adverse effects of climate change but the crisis has required hard decisions to be taken on competing priorities.

    The letter states that, in April 2019, PRA had asked firms to have an implementation plan in place by October 2019 but did not set a date for full implementation. The letter highlights that firms should have fully embedded their approaches to managing climate-related financial risks by the end of 2021. Firms should continue to take a proportionate approach that reflects the exposure of an institution to climate-related financial risk and the complexity of its operations. After reviewing the SS3/19 implementation plans of a large number of firms, PRA has found that most firms are making good progress in developing approaches to identify, assess, manage, report, and disclose climate-related financial risks and have started to embed them in associated governance and control structures. The annex to the letter provides examples of good practices and highlights where there are gaps between firms’ intentions and expectations of PRA. The key highlighted gaps are in the following areas:

    • Governance—Firms’ strategic responses need to be clearer and firms need to continue developing tools that inform business decisions. Climate management information should be communicated more consistently and actively discussed at board level. Firms’ oversight of climate-related financial risks could better demonstrate an appreciation of the far-reaching breadth and magnitude of the risks and a clearer understanding of their relationship to financial risks. This includes a clearer understanding of the physical and transition risk transmission channels and interactions between multiple lines of business, sectors and geographies.
    • Risk Management—Metrics and quantification were identified as the most challenging aspect of assessing climate-related financial risks. PRA recognizes that there are some areas where the science, data or tools are not yet sufficient to estimate the risks accurately. In these cases firms should ensure that identified risks are recognized through the use of reasonable proxies and assumptions.
    • Scenario Analysis—Firms have significant gaps in their capabilities, data, and tools and have not yet integrated scenario analysis into their broader risk assessments. The development of a proportionate and integrated approach to scenario analysis by the end of 2021 will require many firms to increase their capabilities materially in the near-term.
    • Disclosure—Firms’ appetite for making climate disclosures is limited by capabilities and as a result some firms are yet to make any associated disclosures. Capabilities will need to be materially improved to facilitate future disclosures.

    Recently, the Climate Financial Risk Forum, which is co-chaired by PRA and FCA, produced a guide on how to approach climate disclosure, risk management, scenario analysis, and innovation. BoE will also issue additional guidance and useful material such as reference scenarios prior to the launch of the 2021 climate focused Biennial Exploratory Scenario. These steps, alongside the examples of good practices set out in this letter, will assist in meeting supervisory expectations of PRA.

     

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    Keywords: Europe, UK, Banking, Insurance, Securities, COVID-19, SS3/19, Governance, Proportionality, Disclosure, ESG, CFRF, NGFS, Climate Change Risk, BoE, PRA, FCA

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