Climate Risk - Are you on track?
In April 20019, the issued Supervisory Statement SS3/19 titled “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change”. The PRA followed this with feedback on the industry’s ongoing response to SS3/19 in July 2020 in the form of a “Dear CEO” letter which provided observations on good practice, set out next steps for implementation. It also clarified their expectations on timing, mandating that firms should have fully embedded their approaches to managing climate-related financial risks by the end of 2021.
Whilst progress had been made in 2020, most firms started their climate risk management programs in earnest in 2021. Our research, completed during July and August this year, sought to understand how firms are progressing with their key deliverables for the end of the year. The results demonstrated that, for a significant number of firms, a large amount of work is still required to meet the 2022 deadline. Below are some key themes from the research.
Despite the complex nature of climate risk, the data limitations and the distant modelling horizon, most firms thought they were on track.
Most respondents believed they were on schedule for the December 31st 2021 deadline with just over a quarter experiencing a small delay. Half of respondents indicated that they are clear about what needs to be achieved whereas a third suggest there are a few areas that need further exploration.
Given responses on progress with data and scenario analysis (see below), the fact these are quoted as some of the biggest challenges, and the time-consuming nature of those challenges, we wonder if firms were over-optimistic in their assessment.
The most quoted challenges were Data, Scenario Analysis and Climate Risk Methodology, which is consistent with our informal conversations across the industry.
The most cited reason for delays to progress was availability of internal or external data to support scenario analysis and metrics. The longer timeframes of the scenarios are challenging as is finding the relevant expertise to complete the activities that are necessary in managing climate risk. Firms are also confronted with the volume of activity for key staff given the impact of the global pandemic and BAU priorities. Some are grappling with what proportionality means given the size or nature of their business whilst others are uncertain on regulatory expectation citing a lack of clear direction from the regulator.
Most firms have updated their existing governance and control frameworks rather than developed anew for climate risk.
A majority of firms have integrated climate risk into the existing risk governance frameworks. For some, they felt their existing structure was adequate to manage climate risk, whilst others felt that climate was not a key risk for them and so didn’t warrant more than adding to the existing risk taxonomy.
Where firms have decided to alter, or plan to alter, their governance then changes have been made throughout all governance structures including the board, executive and risk committees. Most, if not, all of these are creating new or modifying existing risk management frameworks and corresponding policies, procedures and controls in addition to creating new climate change-oriented forums.
Most firms risk management capabilities require significant enhancement for compliance.
Most firms have included some level of climate risk information in their most recent ICAAP in line with the PRA’s expectation that the ICAAP should at the very least include all material exposures resulting from climate change and an assessment of how they have determined the material exposure(s) in the context of their business. For most, this has been qualitative in nature whilst they acquire and understand data and develop climate scenario modelling capability.
Nearly 56% of respondents hadn’t begun to collect suitable climate data to support their metrics and of the 44% who had, half were looking for external data vendors for support and half had decided to source using internal and free data.
Through its August questionnaire the PRA is beginning to demonstrate a greater expectation on modelling capability. This contrasts considerably with the lack of model development found by our survey (82% nit started) and reflects the lack of progress with data development and challenges over methodology already stated.
Most are yet to being scenario analysis but have considered their approach and expect it to develop over the coming years.
Whilst nearly 50% of firms are planning a mix of qualitative and quantitative approaches to scenario analysis, a majority of those (56%) have yet to identify the data to do so. Most (74%) are looking to perform a qualitative approach supplemented with the Bank of England’s (BoE) Climate Biennial Exploratory Scenarios (CBES) scenario data.
All firms questioned are seeking to be compliant with the Taskforce on Climate-related Financial Disclosures (TCFD) disclosures.
A majority of firms will locate their climate risk disclosures in their annual reports agreeing that doing so will drive the transparency, rigor and accountability necessary to ensure firms do implement and maintain a strategic approach to managing climate risk that shapes how their actions positively affect future financial risks.
At point of closure of the survey, there was 5 months left before the PRA’s deadline. Firms have made good progress on their governance and risk management structures and have in plan actions to quantify their potential losses and identify the strengths and weaknesses in their business models. More anecdotally, many have also begun looking for the opportunities that climate risk has to offer.
However, many respondents have made little progress on data, metric and scenario analysis. These are more challenging capabilities to develop and more time consuming to deploy. Even then, once these challenges have been met, there are still the cycles of governance required before a risk appetite can be signed off. Given that most firms believe they are on track, we are concerned that some firms may be overconfident in their ability to meet the deadlines.
For a copy of the full report, please contact Michael Price (firstname.lastname@example.org).