Perspectives | 9 October 2019
In 2018, the Bank of England (the “BoE”) set up a project called “Future of Finance” aimed at anticipating the upcoming changes in financial services for the next decade, and the impact of these changes for market participants, customers and regulators.
This research was led by Huw van Steenis, Senior Adviser to the Governor, and his recommendations to the BoE were published on 20 June 2019. The decarbonation of our economy is identified as a predominant factor among the main forces that will shape the economy in the coming decade.
In this article, our experts examine Mr van Steenis’ recommendations in relation to climate change, the commitments made by the BoE, and the implications for the financial services industry.
GOING CARBON NEUTRAL: A PRIORITY FOR THE UK FINANCIAL SYSTEM
The BoE’s report “New Economy, New Finance, New Bank” responds to Mr van Steenis’ recommendations, identifying support of an orderly transition to a carbon-neutral economy as one of its top-five priorities. The BoE is committed to lead by example and help mainstream a culture of climate risk management throughout the economy.
Climate change represents a threat to financial stability and the safety and soundness of financial firms particularly through two channels: physical risks and transition risks. Since April 2019, UK banks and insurers are required by the Prudential Regulation Authority (“PRA”) to take a strategic, Board-led approach to tackle this new financial risk factor, and to incorporate it in their governance, risk management, scenario analysis and disclosure arrangements. The first key milestone for banks and insurance companies will be the submission of an action plan to the PRA by 15 October 2019. Eventually financial firms’ capital requirements will reflect their exposure levels to climate financial risks.
Mr van Steenis reports some significant barriers to the emergence of an appropriate response to climate change-related risks as well as the occurrence of a smooth transition. These include:
- Lack of understanding and awareness: for many institutions, climate change-related risks still remain seen through the exclusive lens of CSR instead of an integral part of financial risk management;
- Information shortages: recipients of finance do not disclose enough information for an appraisal of climate risks, which is compounded by the absence of standardised measuring of carbon intensity for specific assets;
- Limited consideration for the long-term impact: financial markets tend to be too focused on short-run profit maximisation to consider the long-term impact, and the negative effects of climate change are only perceived as relevant well beyond normal business planning horizons.
Despite these barriers, the BoE observes that progress has been made in a number of areas in recent years:
- The Task Force on Climate-related Financial Disclosures’ (TCFD) voluntary disclosures are creating a virtuous circle by encouraging “learning by doing” – the proportion of companies disclosing information has increased up to nearly 15% over a two-year period; and
- The Network for Greening the Financial System (NGFS) is leading the way in encouraging greater recognition of the risks of climate change to the financial system and to individual firms – recommending discussion of climate-related risks at Board level and consideration in risk management, investment and strategic decisions.
THE BOE: COMMITTED TO SUPPORT CHANGE
The BoE has committed to a number of actions aiming to promote the adoption of climate change disclosures and the embedment of climate risk management. The two actions highlighted below will expectedly have a significant impact in shaping the financial industry approach toward climate change risk management:
- The design of climate change scenarios: a discussion paper will be published in the autumn of 2019, leveraging input from the industry and other stakeholders through the Climate Financial Risk Forum (CFRF) and the Network for Greening the Financial System (NGFS).
- The inclusion of a new climate-risk scenario for the Biennial Exploratory Scenario (BES): the BoE Governor Mark Carney announced in his Mansion House speech on 20 June 2019 [1] that a climate stress test will be performed for financial institutions in 2021.
ACTIONS TO BE TAKEN BY FINANCIAL SERVICES
The BoE is calling for the financial services sector to act now and ensure it is resilient to the risks arising from climate change. “The window for an orderly transition that minimises those risks is finite and closing.” [2] It is about time to take actions for the economy to adapt.
[1] https://www.bankofengland.co.uk/speech/2019/mark-carney-speech-at-the-mansion-house-bankers-and-merchants-dinner
[2] Bank of England, New economy, new finance, new Bank, The bank of England’s response to the van Steenis review on the Future of Finance, June 2019
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