Climate risk in financial services

In 2021 we predict

First climate risk regulatory investigations covering governance and greenwashing.

The picture in 2020

For PRA-regulated entities climate change is now a controlled function under SM&CR, and this is likely to be extended to FCA-regulated entities.

New laws, regulation, guidance and codes are being developed to improve transparency around green products, including:

• The EU’s Sustainable Finance Action Plan, which aims to create a unified EU 'green classification system’.
• In its 2019 Green Finance Strategy, the UK Government set an expectation that all listed issuers and large asset owners would be disclosing in line with the Taskforce on Climate-related Financial Disclosures’ (TCFD) recommendations by 2022. However, given the urgency of the climate threat, in November 2020 it was determined that a voluntary approach to climate-related financial disclosure may not be enough. Therefore, the UK Government intends to introduce fully mandatory TCFD-aligned climate-related financial disclosure requirements by 2025, with a significant portion of mandatory requirements in place by 2023.
• However, as climate-related standards solidify, the market’s focus is shifting to wider sustainability issues, with a call from market participants for a global standard to be agreed (like TCFD), though a clear winner is yet to emerge.

Looking ahead to 2021

• Climate change will feature more prominently than ever on the FCA/PRA’s agenda.
• Climate-related financial disclosure rules for premium listed companies to take effect from 1 January 2021, on a comply or explain basis, with a view to introducing mandatory disclosures later in 2021.
• For other market participants (other listed issuers, asset managers, insurers, pension providers, banks and building societies), the FCA, PRA and BEIS will consult on similar rules in 2021, with a view to introducing such rules as early as 2021 for certain categories of organisation.
• The FCA will challenge firms where it sees potential greenwashing of financial products.
• The market’s focus will shift from climate change to wider sustainability issues.
• The FCA will look closely at governance arrangements to ensure understanding, oversight and accountability for climate risk.
• There will be increased pressure and exposure to short selling attacks for firms that are perceived to be failing to address climate risk.

What does this mean?

• Pressure to disclose more than climate-related information and to make sustainable choices in their operations will require market participants to investigate and audit climate risk and exposures.
• The increasing responsiveness of the market to climate and wider sustainability issues, combined with these new disclosure obligations, will increase the risk of both regulatory and litigation risk, including exposure to short selling attacks.
• Firms will be required to ensure quality climate risk controls and governance (top down).
• Firms will need to consider what reputational risks they are willing to accept and not accept in the transition to a low carbon economy.