Why financial institutions need to ramp up their climate risk response - by Damian Hoskins

why financial institutions need to ramp up their climate risk response

by Damian Hoskins

Climate change risk is growing - and financial institutions are beginning to recognize the need to take swifter action. Some 83% of firms highlight climate risk as a major topic, with more than half (60%) putting in place plans to prepare for the impacts of climate change, according to independent research commissioned by Acin.

Global financial regulators have also been intensifying their scrutiny of climate-related risk management. Last year, the European Central Bank (ECB) asked the region’s banks to conduct self-assessments based on its supervisory expectations, and to draw up action plans to meet them. The U.S. Securities and Exchange Commission (SEC) in October 2021 signaled its intention to finalize climate change regulations this year. Meantime, the Bank of England’s Prudential Regulation Authority (PRA) also called on institutions to embed climate change-related financial risks into existing governance and risk management frameworks.

All of this heightened regulatory attention dovetailed with COP26 last November, which underscored that global financial services companies will be under just as much scrutiny as high carbon-emitting industries such as fossil fuels, mining and aviation. The wider public focus on climate change also means financial institutions will face scrutiny not just from regulators but also investors, customers and their own employees - who are all demanding that firms do more to tackle climate risk.

more work to do

Yet despite this growing awareness, financial institutions still have much more work to do, with this year set to catapult climate risk even further up the risk management agenda. For example, in January the PRA issued a Dear CEO Letter outlining its 2022 priorities, one of which was financial risks arising from climate change. While some firms have made good progress, the letter said, action has not been consistent across all firms. It observed that most firms are more focused on the business opportunities presented by climate change, such as publishing glossy reports trumpeting their ESG credentials. Instead, financial institutions need to recognize that climate change is a business risk that is rapidly closing in and requires urgent action now.

The PRA says it expects firms to take a forward-looking, strategic, and ambitious approach to managing climate-related financial risks.

From this year, the PRA will fold supervision of climate-related financial risks into its supervisory approach. In other words, this is the year when climate risks will have to be properly identified, confronted, and managed in a way we haven’t yet really seen in financial institutions. There is a journey that firms need to embark on to be ready for climate risk regulation, and a lot of firms have not boarded that particular train yet.

take action now

You do not have to look very far into the past to see why leaving it to the last minute is a bad idea. Take the European Union’s General Data Protection Regulation (GDPR). Many firms hesitated on implementation, despite having a long runway to get prepared, resulting in firms rushing to meet deadlines and, in some instances, falling short. With climate risk, the cost of inaction could be catastrophic.

So, what should firms be doing to get prepared? Here are five steps your organization should take to get started on the climate risk management journey:

1. Move beyond high-level, box-ticking exercises such as net-zero pledges and annual reports and start working on detailed implementation and framework-building, a core part of which will be getting into the weeds and identifying the relevant climate risks and controls that need to be managed.

2. Understand where your firm is relative to your peers. Because climate risk and control management are so new, not many firms will have a clear idea of what ‘good’ looks like when it comes to the details and implementation. Seeing how you shape up compared to your peer group is a useful barometer to check if your coverage is good enough - or if more work needs to be done.

3. Know how climate risk fits into your existing risk framework. Climate risk will likely span all the major risk types—from credit (because of credit exposure to fossil fuel firms) to market and liquidity risk, as well as the more obvious operational risks.

4. Get your climate-related risks and controls data in order. We have identified more than 80 climaterelated risks and controls that need to be considered for a climate risk framework to be effective, from regulation, legislation, and litigation to reporting and disclosure risk.

5. Climate change is a systemic risk that requires firms and the wider industry to work together. Just as firms do today with cyber risk, sharing data on climate risk can ensure all firms are adequately prepared. There is no point being the last person standing if all other firms around you are failing, given there is a potential domino effect to mismanaging climate change.

The time for talking about climate risk is over - firms need to take immediate action and square up to the risks that are not only going to impact their operations, but also society as a whole.

references

1. “Dear CEO.” Bank of England, January 12th, 2022, https://www.bankofengland.co.uk/-/media/boe/ files/prudential-regulation/letter/2022/january/artis-2022-priorities.pdf

author

Damian Hoskins

Damian joined Acin as Innovation Specialist in October 2020, tasked with building the world’s first climate risk inventory for financial institutions. Today, the firm has extended its network-driven, peer-to-peer operational risk platform to include climate risk. Prior to joining Acin, Damian had 15 years’ experience in operational risk and risk transformation roles at Société Générale, HSBC, RBS and Lehman Brothers. Previously, Damian served in the British Army for 19 years.