The Prudential Regulation Authority, the arm of the Bank of England that supervises the activity of regulated companies in the U.K., has published a consultation paper urging banks, insurers and asset managers to take a "strategic approach" to gauging their financial exposure to climate change.
The PRA warned that the "window for action" to deal with potential losses from assets exposed to climate risks "is finite and closing." The time has come for companies to designate a board-level senior manager to take responsibility for assessing climate-related risks, envisioning a broad variety of scenarios, said the regulator.
It urged companies, including Lloyd's syndicates and the U.K. subsidiaries of foreign banks, to develop risk models to be shared with the regulator in order to create new industry standards over the coming 18 months. The PRA is considering the introduction of mandatory disclosure of climate change exposures, potentially two to three years after the final version of the paper is published, subject to the consent of other regulators such as the Treasury and the Financial Conduct Authority.
"We will look to issue further guidance on best practice 12 to 18 months after the supervisory statement has been finalized," a spokeswoman for the PRA said. "On disclosure, this is part of a broader authorities' response and we seek to determine our approach in the context of that wider debate."
Risks 'becoming apparent'
The PRA's consultation paper, published Oct. 15, said: "Climate change, and society's response to it, presents financial risks which are relevant to the PRA's objectives. And while financial risks from climate change may crystallize in full over longer time horizons, they are also becoming apparent now."
The regulator has requested comments from affected companies. The consultation ends Jan. 15, 2019.
The two main areas of risk, the PRA said, could be divided into physical risks — such as extreme weather destroying assets that serve as collateral for bank loans or are subject to insurance policies, and transition risks — the risk of assets, such as buildings that have low energy efficiency, losing their value due to increasingly stringent norms imposed by the state as society becomes less reliant on carbon-generating industries.
In the U.K., 90% of banks agreed that the PRA should play a role in the industry's assessment of climate-related risks, according to a survey carried out by the regulator, while 70% recognized that such exposures carried the risk of financial loss to the company.
The PRA said climate change affects all the financial risks that banks, insurers and asset managers are typically exposed to, including underwriting, reserving, credit and market risks.
"The PRA proposes that firms fully embed the consideration of the financial risks from climate change into their governance framework," it said, emphasizing the need for high-level executives to be involved designing firms' strategies to tackle climate change risks.