A guide for the UK’s financial industry to help it address climate-related financial risks was issued Monday by the Climate Financial Risk Forum (CFRF).
The CFRF is a body established by the UK’s Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) to build capacity and share best practice on climate risk across regulators and the financial industry.
Sarah Breeden, the PRA co-chair of the CFRF and executive sponsor of climate work for the Bank of England, said in a press release: “Climate change presents significant risks and opportunities for the financial sector.” She added that the practical guide would help in “building a UK financial system resilient to the risks from climate change and supportive of the transition to a net-zero economy”.
The guide supports businesses in integrating climate-related risks and opportunities into their risk, strategy, and decision-making processes.
The CFRF guide covers four main areas:
- Risk management: By appropriately embedding climate-related financial risk into governance and risk management processes, firms can make informed business decisions and improve their resilience.
- Scenario analysis: By modelling and considering a range of possible scenarios, a business can better understand and manage future risks today, “whilst capturing opportunities to support the transition to a net-zero carbon economy”, the CFRF said.
- Disclosures: By making effective climate-related financial disclosures, a business can improve transparency and thereby help the market appropriately assess the true future value of assets.
- Innovation: By developing novel products, services, policies, and approaches, a business can adapt to respond to the potential impacts of climate change, benefit consumers, and deliver the change required to meet climate goals.
As a result of climate change, the UK’s financial industry is subject to physical risks, and transition risks in adjusting to a net-zero carbon economy.
Physical risks, the guide explained, include an “increasing frequency, severity, or volatility of extreme weather events, leading to increased business disruption and losses, as well as potentially impacting the availability and cost of property and casualty insurance”.
In turn these can lead to the value of investors’ portfolios fluctuating substantially and insurance customers paying higher premiums or choosing not to take out cover, “leaving them or their lenders more exposed to potential future losses”, the guide said.
In addition, there is the risk of physical damage to assets held as collateral by asset owners and banks, such as residential and commercial property. This may lead to increased credit risks, particularly for banks, or to underwriting risks for liability insurers if there are greater-than-anticipated insurance or legal claims to recover financial losses, the guide explained.
In moving towards the UK’s 2050 target of net-zero greenhouse gas emissions, the CFRF guide identifies potential transition risks that include:
- Tightening minimum energy efficiency standards for domestic and commercial buildings impacting the risk in banks’ mortgage, buy-to-let, and commercial real estate lending portfolios.
- Changes in relative pricing of alternatives arising from rapid technological change, such as the development of electric vehicles or renewable energy technology, which affects the value of financial assets in the automotive or energy sector.
- Decreases in the value of certain investments that result from policy changes, leading to the creation of stranded assets (ie, assets that become worthless or uninsurable due to their exposure to physical climate-change risks, such as high-carbon-intensity resources that are complex to extract).
- Companies in the wider economy that fail to mitigate, adapt, or disclose the financial risks from climate change being exposed to climate-related litigation. This could have an impact on their market value, affecting asset owners and managers and the consumers they represent or lead to higher claims for insurers that provide liability cover to those companies.
— Oliver Rowe (Oliver.Rowe@aicpa-cima.com) is an FM magazine senior editor.