Guidance on PRA’s expectations on approach to managing climate related financial risks - UK

Central banks across the globe, including the Bank of England, believe that climate-related financial risks present an unprecedented challenge for regulated firms and the financial sector.

In April 2019, the Prudential Regulation Authority (PRA) published Supervisory Statement 3/19, in which it set out its expectation of firms’ approach to managing the financial risks from climate change covering:

• governance;
• risk management;
• scenario analysis; and
• disclosure.

On 1 July 2020, the PRA published guidance to industry in respect of its Supervisory Statement, in the form of a “Dear CEO” letter. This letter makes it clear that the PRA expects firms to fully implement the supervisory expectations by the end of 2021.

This means that firms are expected to have fully embedded their approaches to managing climate-related financial risks by the end of 2021 and should be able to show that the expectations in the Supervisory Statement have not only been implemented, but also embedded throughout the organisation as fully as possible. The PRA has said it will be paying particular attention to the metrics and targets that firms are using, their comparability and how they are incorporated into risk and governance frameworks.

Whilst the PRA acknowledges that there will undoubtedly be challenges to certain aspects of the implementation that it expects to see, the letter unambiguously states that firms should be able to explain what steps have been taken to attempt to meet these expectations. For example, the PRA recognises that data limitations mean that firms will not be able to embed an end-state analysis of climate-related financial risks within their capital frameworks by the end of 2021. However, organisations should be able to explain what steps they have taken to ensure that, where appropriate, capital levels adequately cover the risks to which the firm is, or might be, exposed.

The letter also provides a gap analysis following review of various firms’ Supervisory Statement implementation plans. The PRA 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 PRA also provided commentary on the gaps and what needs to improve. See summary below.

The PRA expects firms to provide continuous periodic updates to their boards throughout the process of embedding the expectations of the Supervisory Statement.

The letter also states that the Bank of England is expected to publish further guidance for firms and useful material such as reference scenarios prior to the launch of the 2021 climate-focused Biennial Exploratory Scenario (i.e. the climate change stress test), which will assist firms in meeting the PRA supervisory expectations. We expect that such further guidance is likely to be published later in 2020.

Firms covered by the Supervisory Statement may also find useful the guide to climate-related financial risk management, published in June 2020 by the Climate Financial Risk Forum (CFRF), which is co-chaired by the PRA and the Financial Conduct Authority. The CFRF guide, which was developed with industry input, is designed to help firms understand the risks and opportunities that arise from climate change (both the physical and transition risks), and provides practical guidance on four key areas: risk management; scenario analysis; disclosures; and innovation.