FS regulatory affairs newsletter - Q3 2022
Following on from our Q2 edition of the FS regulatory affairs newsletter, this edition covers regulatory developments in the third quarter of 2022.
Climate and Sustainability - Q3 2022
The last quarter saw significant developments in climate scenario analysis and stress testing, and more broadly in supervisory assessment of financial firms’ management of climate-related financial risks.
In the UK, the PRA released a letter from Sam Woods on the Thematic feedback on the PRA’s supervision of climate-related financial risk and the Bank of England’s Climate Biennial Exploratory Scenario exercise relevant to all UK insurance and reinsurance firms and groups, banks, building societies, and PRA designated investment firms. Internationally, the NGFS shared the third vintage of climate scenarios for forward looking climate risks assessment relevant across jurisdictions, while in the EU ECB published the results of its 2022 Climate Stress Test relevant to European financial institutions, including European banks that operate in the UK.
Insights
Although performed in two different jurisdictions (UK and EU), the PRA and ECB climate stress test results reveal similar messages, i.e., besides making significant progress, financial firms need to continue their work to understand and address climate risks.
The letter released by PRA outlines the gaps and further steps it wishes financial firms to undertake to comply with the expectations set in its Supervisory Statement 3/19 published in April 2019. Overall, the PRA observed that banks and insurers have taken concrete and positive steps to implement the expectations. However, the levels of embedding differ, and the general assessment is that further progress is needed by all financial firms. To assist financial firms, especially the mid and small size, in complying with the expectations, the PRA provides a list of resources, including principles and guidance (Annex C of the document). With regards to the four key supervisory framework areas, the PRA shares the following observations:
The PRA expects financial firms to continue developing approaches to capture climate risk in balance sheet valuations. The PRA expects firms’ financial reporting-related priorities for 2022 and beyond to include enhancing:
The updated NGFS climate scenarios provide a new benchmark for regulators running climate scenario exercises and for financial firms utilising NGFS scenarios for the development of internal climate scenarios. The key updates include incorporation of countries’ commitments to reach net-zero emissions, increased sectoral granularity and improved representation of physical risk, including acute risks.
Further remarks
Financial firms are expected to further enhance their climate risk management frameworks with specific focus on amending their climate risk methodologies, data, scenario analysis capabilities, disclosures, and validation approaches. Although not yet specified, capital regulatory requirements are being discussed by PRA at a wider financial forum, and the firms should closely watch regulatory developments in this space.
In June 2022, the FCA published a feedback statement following its consultation a year earlier which included ESG integration in UK capital markets. The feedback statement set out the FCA’s response to views received around the following areas covered in the consultation:
Issues related to ESG labelled instruments
Advertisements, Prospectus and “Use of Proceed” (UoP) bond framework
With concerns on the negative impacts of having more stringent terms in contractual agreement and enhancing information on use of proceeds disclosed in prospectus, the FCA confirmed there would be no change to the current prospectus rules framework. However, the FCA plans to reassess its position based on the outcome of Treasury’s proposals to reform the UK’s regime for public offers of securities and admissions to the trading on capital markets. In the interim, asset issuers and their advisors were encouraged to consider voluntary adoption of industry standards on the issuance of ESG-labelled UoP debt instruments such as the ICMA Principles and Guidelines for green, social and sustainability bonds as well as the CBI’s Climate Bonds Standards.
Verifiers and Second Party Opinion (SPO) providers
The FCA will consider working with the Treasury and FRC to include verifiers and SPO providers under its regulatory remit to provide additional oversight over these firms. The FCA encouraged asset issuers and their advisors to consider relevant industry standards, such as the ICMA Guidelines, when selecting verifiers and SPO providers, who in turn should consider voluntary adoption of relevant industry standards and codes of conduct.
ESG Data and Rating providers
Regulatory oversight
As ESG data and rating play a critical role in the investment process and can cause material potential harm, the FCA is considering greater oversight on providers of this information. The FCA is looking towards a regime that will adopt a proportionate, targeted, and phased approach to regulation in this area. As developing such a regime can take time, ESG data and rating providers are encouraged to consider implementing a voluntary code of conduct which will cover areas such as transparency, conflict of interest, governance/systems, and controls.
Further remarks
Overall, key messages from the FCA centre around voluntary adoption of relevant industry standards, increasing regulatory oversight, and seeking a regulatory approach that is globally consistent. This is welcome news as these will help promote quality, discipline, and further integrity of the market.
While the regulatory framework is being more defined, asset owners and managers should consider taking actions such as:
This website uses cookies.
Some of these cookies are necessary, while others help us analyse our traffic, serve advertising and deliver customised experiences for you.
For more information on the cookies we use, please refer to our Privacy Policy.
This website cannot function properly without these cookies.
Analytical cookies help us enhance our website by collecting information on its usage.
We use marketing cookies to increase the relevancy of our advertising campaigns.