The UK’s financial regulators are finally taking action to address the profound risks that climate change poses to the firms they supervise, and the system they oversee. But in our response to the Financial Conduct Authority’s recent climate change discussion paper, we argue they must rapidly accelerate their efforts before it’s too late.
As a major report from senior central bankers last year made clear, “climate change will affect the global economy and so the financial system that supports it. The financial risks it presents are in consequence system-wide and potentially irreversible if not addressed.” Both the physical damage from weather and shifts in technology and policy have the potential to reverberate through the global economy, with destructive results.
The UK’s place as a financial centre makes it particularly vulnerable, with finance firms’ lending and investments exposing them to a potentially dramatic loss in the value of high carbon companies.
Some combination of extreme weather or a policy shift away from fossil fuels is inevitable, and this means a transformation of the financial system, whether firms like it or not. Regulators must act quickly to ensure it’s as smooth and painless as possible. It’s therefore welcome that the Financial Conduct Authority and Prudential Regulation Authority are setting up a joint Climate Risk Forum to coordinate action and share best practice. They’ve each also laid out new expectations of how the firms they supervise should manage climate risk.
These announcements come not a moment too soon, and it’s good to see regulators taking action. But their initial plans don’t suggest they’re treating the issue with the urgency that’s required.
In order to properly scrutinise and regulate financial firms, we need comparable and consistent information about their activities. The Taskforce on Climate Related Financial Disclosures offers an internationally-recognised framework for firms to report on their management of climate risk through governance, strategy, metrics and targets. The FCA and PRA have both given it their backing, but have fallen short of indicating that comprehensive disclosure will become a mandatory requirement.
In the absence of a robust regulatory regime, disclosures are currently patchy and limited. For example only 10% of banks take a long-term strategic approach towards managing climate risk, while 30% consider it merely as a corporate social responsibility issue. Many organisations incorrectly perceive the implications of climate change to be long-term and not necessarily relevant to decisions made today.
The logic of disclosure is that improved information will make the market better at allocating resources. If only some firms disclose, the framework breaks down. We’re therefore calling on the FCA and PRA to lay out a timetable for comprehensive climate reporting to become a mandatory requirement.
A further problem is that even among firms that do disclose their management of climate risk, there’s a lack of common understanding of what climate change might actually entail, and the nature of the risks it represents. Regulators can help here too by communicating at least one central scenario for the effects of climate change, to which firms must refer to in their disclosures. The Government needs to show leadership, and inform regulators as to the path of policy and investment it expects to see over the coming years. Otherwise, firms’ efforts to manage risk will amount to shooting in the dark.
You can read our full response to the FCA’s discussion paper here. If regulators’ response is to be effective, they need to act fast. The longer the transition takes, the more disorderly it will be, with a diminishing chance of success.