UK regulator sets clear climate risk management expectations for UK financial institutions in 2024

UK financial institutions need to keep up the momentum

In all three letters, the PRA recognised the progress made by financial institutions in managing financial risks arising from climate change and reinforced the need for these institutions to make further progress in below areas:

• Insurance companies need to strengthen their scenario analysis capabilities and embed climate risk within their risk appetite statements, at both qualitative and quantitative levels. In 2024, the PRA will monitor the progress made against its expectations.
• International banks and domestic deposit takers should further develop climate risk management capabilities and link them to decision-making. In 2024, the PRA expects to see further progress in the development and integration of climate-related financial risk identification, quantification and mitigation.
• Domestic deposit takers should also consider relevant and ambitious stress scenarios in a manner proportionate to their business, size, scale of risks and complexity.

The PRA also committed to update supervisory statement 3/19.

There are similarities to previous regulatory expectations

The PRA continues making steady progress on its plan for ensuring banks and insurers are resilient to climate-related risks*. Currently, the PRA is in Phase 3 of its climate-related risk timeline, and it focuses on active supervision and reflection on the policy framework.

In April 2019, the PRA set out its expectations concerning the management of climate-related financial risks in its supervisory statement 3/19. Firms** were asked to:

(a) Embed the consideration of climate-related financial risks in their governance arrangements

(b) Incorporate climate-related financial risks into existing financial risk management practice

(c) Use (long-term) scenario analysis to inform strategy setting and risk assessment and identification

(d) Develop an approach to disclosure of climate-related financial risks.

Climate change was also the subject of the 2021 Biennial Exploratory Scenario, the first exercise of its kind for the largest UK banks and insurers. In 2023, the PRA shared its thinking on climate-related risks and regulatory capital frameworks. The report included updates on capability and regime gaps, capitalisation timelines, and areas for future research and analysis. In the same year, the Bank of England published its Climate-related financial disclosure 2023 and Climate transition plan, alongside its 2023 Annual Report. The PRA remains clearly committed to its climate risk agenda.

What financial institutions need to do now

Firms should be proactive in addressing the PRA’s expectations concerning the management of climate-related financial risks. The announced update to the supervisory statement 3/19 will provide further detail on what the PRA considers important in the management of climate-related financial risks.

Firms are advised to perform a gap analysis of their risk management frameworks towards current regulatory expectations, but also industry best practices. Updates to stress testing frameworks should not only address the PRA’s lessons from the 2021 Climate Biennial Exploratory Scenario but also respond to the latest international developments in climate scenario analysis.

These PRA’s recommendations complement other climate risk management priorities for UK financial institutions. The Transitional Plan Taskforce recently published its final Disclosure Framework***, providing financial institutions with clear guidance to build and develop their climate transition plans, noting the rollout of mandatory Task Force on Climate-related Financial Disclosures-aligned climate disclosure requirements by January 2025 for all listed companies.

* Source: Bank of England report on climate-related risks and the regulatory capital frameworks | Bank of England

** This supervisory statement (SS) is relevant to all UK insurance and reinsurance firms and groups, i.e. those within the scope of Solvency II including the Society of Lloyd’s and managing agents (‘Solvency II firms’) and non-Solvency II firms (collectively referred to as ‘insurers’), banks, building societies, and PRA designated investment firms (collectively referred to as ‘banks’). ‘Firms’ will be used to refer to both insurers and banks (PRA SS3/19).

*** See TPT’s final Disclosure Framework sets clear guidance for UK financial institutions