International arbitration report
In this issue, we cover a broad spectrum of ‘hot button issues’ for boards and companies operating internationally.
On June 29, the Climate Financial Risk Forum (CFRF) published its guide to climate-related financial risk management. The CFRF, which is co-chaired by the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), aims to build capacity and share best practice across financial regulators and the industry to advance the sector’s approach to understanding and mitigating the financial risks, and the opportunities, posed by climate change.
The guide helps financial firms to understand the risks and opportunities that arise from climate change, and provides support for how to integrate them into their risk, strategy and decision-making processes. The guide therefore considers how firms can plan for the impact of climate policies over different time horizons and assess their exposure to climate-related financial risks so that they can adapt their businesses in response.
The guide contains four industry-produced chapters – covering (1) risk management, (2) scenario analysis (3) disclosures, and (4) innovation – as well as a summary co-produced by the FCA and PRA. Below we summarise the guidance in each of these four chapters.
Although the PRA and FCA have convened and facilitated CFRF discussions, the views expressed in the guide do not necessarily represent the view of the regulators and does not constitute regulatory guidance.
The chapter on risk management aims to help firms make informed business decisions and improve their resilience by appropriately embedding climate-related financial risks into their governance and risk management processes.
The chapter deals with risk governance, risk management, frameworks, risk appetite, risk assessment, data and tools, training and culture, as well as key challenges. It sets out how firms can approach designing and implementing a governance approach for climate risks akin to that used for established financial risks, while addressing climate risk-specific nuances. It discusses how firms can decide whether to treat climate risk as a standalone or as a cross-cutting risk and then integrate climate risk into existing risk management frameworks, recognising how the links between climate risk and established risk types may be identified and understood.
In addition to the standard planning cycle, the chapter recommends climate change impacts to be considered over a longer period, for example 30 years, with interim milestones. The guide provides detail on the most material and applicable risk types relating to climate across the financial sector, which include insurance underwriting, credit, operational and financial market risks.
The chapter should be read alongside the PRA’s supervisory statement on enhancing banks’ and insurers’ approaches to managing the financial risks from climate change (Supervisory Statement 3/19 (SS3/19)) and the FCA’s requirements for solo regulated firms (including consideration of how external factors can impact on strategy and viability), as discussed in a consultation paper on financial resources (Consultation Paper 19/20 (CP19/20)).
The chapter on scenario analysis aims to assist firms to better understand and manage future risks today, whilst capturing opportunities to support the transition to a net-zero carbon economy, by appropriately modelling and considering a range of potential futures.
The chapter sets out leading practice and case studies on how to use scenario analysis to assess climate-related financial risks to inform firms’ strategy, risk management and business decisions. The results from identifying potential exposures should inform the scenario development process, which in turn should determine the key assumptions used in the assessment of the financial impact of that scenario. Information obtained from that financial impact analysis should in turn feed back into the refinement and identification of new risks and potential exposures and inform the ongoing development of existing scenarios, as well as leading to the identification of potential new scenarios. This cycle is illustrated by a diagram in the chapter.
The chapter should be read alongside SS3/19, and outputs of the PRA’s 2021 Biennial Exploratory Scenario (BES), the FCA’s requirements for solo-regulated firms including CP19/20 and requirements around scenario analysis in the Prudential sourcebook for investment firms (IFPRU), as well as the Network for Greening the Financial System (NGFS)’s publication on scenario analysis and reference scenarios.
The chapter on disclosures aims to help firms to improve transparency regarding the impact of material financial risks from climate change on their businesses, thereby helping the market appropriately assess the true future value of assets, by making effective climate-related financial disclosures.
The chapter sets out key messages for approaching good practice climate-related financial disclosures, disclosures on governance and strategy, specific disclosures for banks, insurers and asset managers, as well as a suggested timeline for phased implementation. Phase 1 focuses on high level, mainly qualitative, disclosures (to be completed by mid-2021), while Phase 2 focuses on adding quantitative disclosures and complete roll out (to be completed by mid-2021 to end of 2022).
The recommendations are based on the seven principles for effective climate-related financial disclosures set out in the recommendations of the Financial Stability Board’s Task Force for Climate-related Financial Disclosures (TCFD). The TCFD recommendations state that disclosure should represent relevant information; be specific and complete; be clear, balanced, and understandable; be consistent over time; be comparable among companies within a sector, industry, or portfolio; be reliable, verifiable and objective; and be provided on a timely basis.
The chapter on innovation aims to assist firms in adapting their businesses to the potential impacts of climate change, benefit consumers and deliver the change required to meet climate goals, by developing novel products, services, policies and approaches.
The chapter explains that there are growing opportunities for pools of private capital to align with climate solutions and help to tackle some of the key issues facing the global economy in transitioning to a net-zero carbon economy. Some opportunities support global action, while other opportunities may be domestic, such as improving the energy efficiency of the housing stock.
The chapter recommends developing new investment vehicles and products (for example, transition bonds and emerging market green infrastructure funds) to enable deployment of assets into developing and emerging transition and net-zero markets. In addition, the chapter suggests building local partnerships between finance institutions, local authorities and other public sector bodies to support development of investable, net-zero carbon projects, building on clear national policy frameworks for net-zero ambitions. It is also recommended to improve the quality and consistency of climate-related data to enable markets to better quantify the risks and opportunities, and then act on them; for example, by developing common principles and good practice for sector-wide data sharing, building on those for open banking and open finance.
The CFRF explains that the chapters represent the output of its first year, and recognises that thinking continues to evolve around these topics and capability and capacity will develop rapidly in the coming years. The CFRF intends to maintain relevance and leverage industry learnings by continuing to deliver new material on topics that progress the management of climate-related financial risks and opportunities. An update on the CFRF’s forward-looking work and future outputs will be provided later in 2020.
It is impossible to ignore that climate change and sustainability issues are scorching hot topics (pardon the pun).
© Norton Rose Fulbright LLP 2021