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As the regulatory focus on climate change risk ramps up, many financial institutions are lagging. The Bank of England’s Prudential Regulation Authority (PRA) warned as far back as 2019 that firms need to step up their response to climate risk, but according to its Dear CEO Letter in January, many have failed to make material progress. In this first of a five-part blog series on climate risk, we examine the PRA’s key messages, and outline what accountable senior managers must do to safeguard their firms and themselves against climate change risk.
Here are five takeaways from the letter:
1. Inconsistent progress
The PRA first published its supervisory expectations for how banks should approach managing climate-related financial risks back in April 2019. While some banks have made good progress embedding those expectations into their risk management frameworks, that progress has been patchy, with many firms still having more work to do, the PRA says. Senior managers need to understand climate risk commitments, ensure the right controls are in place and goals set appropriately. Acin has identified more than 80 climate-related risks and controls mapped to relevant regulatory guidance that senior managers should be aware of, including inadequate governance of climate change risk and failure to engage with external climate bodies.
2. Business risks
Too much of the focus on climate change so far has been around the business opportunities it presents, the PRA says. Firms have been producing glossy reports about their climate change credentials, publishing impressive net-zero targets and announcing senior climate risk hires, but few firms have scratched much below the surface. The letter reminds firms that climate change presents an increasing business risk that is fast approaching and requires action now. Firms need to move beyond high-level, box-ticking exercises and start working on detailed implementation and framework-building to ensure they are making sufficient progress.
3. Strategic approach
The PRA says it expects firms to take a forward-looking, strategic and ambitious approach to managing climate-related financial risks. It also says that approach should be proportionate to the scale of the risks and the complexity of a firm’s operations. That means firms need to understand where climate-related financial risks fit into their existing risk management frameworks, be it credit risk (such as over-exposure to fossil fuel companies), market risk, liquidity risk or operational risk.
4. Collective understanding
Given that climate change risk management for financial firms is still in its relative infancy, the PRA recommends that as the market’s collective understanding of climate-related risks, data and best practice evolves, firms should refine and innovate to better integrate climate-related financial risk management across their organizations. By sharing data, firms can not only benchmark themselves against their peer group, they can also bolster their climate-risk response in much the same way as firms do now by sharing data on cyber threats.
5. Costs of inaction
From this year, the PRA will start incorporating supervision of climate-related financial risks into its core supervisory approach. In a clear warning shot to regulated firms, it says it will pay close attention to how those firms embed climate risk into their business strategies, decision-making and risk-taking, adding that it will use appropriate supervisory tools where it deems progress to be insufficient. Climate change is a systemic risk where failure to act will not only result in regulatory censure, it can also cause lasting reputational damage among customers, investors ,employees and the entire financial market infrastructure.
None of this will be easy for firms to address. In a snap Acin poll, half of respondents said firm-wide coordination of climate risk will be their biggest challenge this year, followed by 25% who said work to meet regulations will cause them the biggest headache. But there is no time for inaction. With so many firms already behind the curve, failing to move quickly will likely mean falling short of regulatory expectations. That means working collectively and using tech and data to manage climate risk will be vital for avoiding unwanted attention from regulators – and ensuring firms are well-prepared to meet the impending challenges caused by climate change.
For more information on climate-related risk management, click here. Stay tuned next month for the second part in our climate risk series looking at how ready firms are for climate change.
Acin has a comprehensive, pre-built risk and control quick start library of inventories constructed through industry consultation and mapped to regulatory guidance, to provide immediate value and accelerate impact. Easily and proactively demonstrate to the regulator, auditors, investors, shareholders, and boards that you are managing climate risk – ahead of regulatory deadlines.