PRA Business Plan reaffirms focus on climate-related risks
The PRA's 2024/25 Business Plan reaffirmed its commitment to managing the financial risks of climate change as part of its strategic priority to `be at the forefront of identifying new and emerging risks and developing international policy'. In 2024, the PRA will publish thematic findings on banks' processes to quantify the impact of climate risks on expected credit losses, and will commence work on updating SS3/19 for banks and insurers.
EIOPA consults on recalibrated natural catastrophe parameters in the standard formula
EIOPA is consulting until 20 June on proposed changes to the natural catastrophe (nat cat) parameters of the standard formula (SF). Having last assessed the parameters in 2018, EIOPA is proposing amendments to multiple perils: flood, hail, earthquake, windstorm and subsidence. It will monitor the impact of other perils such as wildfire, coastal flood and drought to make a future assessment on their potential inclusion in the nat cat SF parameters.
EIOPA is also adding countries previously excluded from the parameters as a result of the increased severity and frequency of nat cat events in Europe.
EIOPA has affirmed its commitment to ensuring the continued protection of policyholders and the stability of the EU's insurance market, noting that it is important for insurers' capital requirements to reflect the expected impact of climate change.
IAIS consultation on climate risk supervisory guidance
The International Association of Insurance Supervisors (IAIS) has launched its third consultation on proposed changes to guidance in its Insurance Core Principles (ICPs) to better incorporate climate risk. The first and second consultations were conducted in 2023 and were covered in previous editions of ESG Regulatory Essentials. The fourth and final will take place later in 2024 covering issues including supervisory reporting and public disclosures. The IAIS will respond to each consultation at the end of the project.
The current consultation closes on 19 June and proposes the following changes to ICP guidance:
- ICP 15 (regulatory investment requirements): additions are made to ensure that insurers consider climate risk holistically in investment risk assessments — e.g. how climate change has been factored into ratings and over what time horizon, considering climate change risk in traditional risk categories such as credit, market, reputational and strategic risk, considering how climate change may impact asset-liability matching especially for liabilities with a long duration etc.
- ICP 16 (enterprise risk management [ERM] requirements): ERM frameworks must consider climate risk and other emerging risks, incorporating elements such as varying time horizons and scenario analysis. Analysis on an insurer's exposure to climate-related risks over the short, medium, and long term should be included in the ORSA.
BCBS discussion paper on climate scenario analysis
The Basel Committee on Banking Supervision (BCBS) has published a discussion paper on the role of climate scenario analysis in strengthening the management and supervision of climate-related financial risks. It is seeking stakeholder feedback until 15 July, before issuing additional materials that complement the work of the Financial Stability Board (FSB) and the Network for Greening the Financial System (NGFS). The key areas of focus are:
- Risk identification
- Risk management processes
- Internal and supervisory capital and liquidity assessments
- Assessment of business model resilience and business strategy building
- Constraints for the application of scenario analysis and stress testing
- The key features and usage-specific considerations of climate scenario analysis
BoE bulletin on measuring climate-related financial risks using scenario analysis
The BoE has published a bulletin focusing on how firms can use scenario analysis to quantify physical and transition risks. The bulletin considers the extension of macro-climate scenarios to undertake granular asset-level analysis of financial risks, using sovereign and corporate bonds as well as residential mortgages as examples. It also explores how scenario analysis outputs can be applied to firms’ existing financial modelling toolkits.
ECB updates modelling guidance for climate and environment-related risks
In February, the ECB published its final revised guide to internal models together with a feedback statement. The guide clarifies the rules for banks' internal models and covers topics including credit risk, market risk and counterparty credit risk — the ECB notes that, where relevant and material, institutions should include climate-related and environmental risk drivers in the internal models approved for use for the calculation of credit and market risk own funds requirements.
ECB working paper on bank climate commitments and lending and engagement activities
The ECB has published a working paper that evaluates the impact of banks' voluntary climate commitments on their lending behaviour. The ECB used data on bank lending from 19 European countries and found that:
1) Many banks have signed up to green initiatives, particularly larger banks. However, at a global level, larger banks tend to lend more to “brown” sectors (e.g. mining) than banks which do not sign up.
2) There was no evidence of divestment by climate-aligned banks from targeted sectors.
3) Climate-aligned lenders have a slightly higher rate of entry into new relationships with firms in high-emissions targeted sectors.
4) Companies borrowing from Net-Zero Banking Alliance (NZBA) banks are not more likely to themselves set a decarbonisation target.
Overall, the results cast doubt on the efficacy of voluntary climate commitments for reducing financed emissions, whether through divestment or engagement. This aligns with recent efforts by governments to improve the credibility of net zero commitments.
GARP survey on nature risk management at financial firms
The Global Association of Risk Professionals (GARP) has published its first global survey of nature-related financial risk management across financial services firms. The survey of 48 firms (37 banks, seven asset managers and four insurers) found that:
- There is a growing regulatory focus on nature risks.
- Boards at nearly half of the firms had oversight of nature-related risks and opportunities.
- C-suite executives at around two thirds of the firms were accountable for nature-related risk assessments and management efforts.
- However, nature risk is relatively new for many firms and maturity levels on strategic engagement are relatively low.
- Only 17 per cent of the firms were using metrics, targets or limits to address drivers of nature-related risks.
- Availability of data and models were firms’ greatest short-term concerns, and nature scenario analysis was not widely used.
- Staff training on nature-related risk is increasing.
GFI report on nature degradation
The Green Finance Institute (GFI), with input from other scientific and financial experts, has published a report quantifying the impact of nature degradation on the UK’s economy and financial sector: an estimated 12% loss to GDP and up to 4–5% loss in the value of banks’ domestic portfolios ‘in the years ahead’. The GFI notes that these estimates are likely to be conservative, indicating that nature-related risk will impact not just the economy but potentially also financial stability.
For FS firms, the GFI recommends integrating nature within transition plans and working with clients to support their transition. For central banks and regulators, it recommends:
- Advancing disclosures of nature-related risks and impacts in the UK; and
- Broadening supervisory statements on climate to explicitly include environmental risks and incorporating aspects of environmental degradation into exploratory scenario exercises.