The FCA has published a report requested by DEFRA, looking at the major issues that affect climate change adaptation in the financial services industry. Its research and its discussions with firms highlighted 3 major issues:
- data and modelling to help firms to quantify and manage risks: all firms will need to consider whether their operational resilience planning (including of course their supply chain and third party relationships) is adequate to assess climate-related risks and review and update their disaster recovery plans;
- barriers and enablers to insurance underwriting that in turn affect lending and investment: the international nature of UK markets means that insurers are exposed to risks not currently common in the UK, and the affordability and availability of reinsurance may be affected by overseas losses. New risks are emerging such as those of extreme heat events. Increasing climate-related risks concern lenders where lending is underpinned by a charge on physical property, particularly where that property is expected to produce a long-term income stream – and this risk becomes even higher if insurance cover is restricted or unavailable. At the moment, cover is generally available, but some lenders are no longer lending on vulnerable properties; and
- barriers and enablers to the ability to allocate capital to adaptation. The FCA says firms do not have available quality data to enable them confidently to assess and price climate related risk. And a significant problem is how adaptation is to be funded – with smaller businesses not having the relationship with insurers and lenders that will give some protection while encouraging investment in adaptation measures. But requiring adaptation measures as a condition of loans or insurance risks reducing take up of key financial products. The FCA suggests that lenders could include adaptation measures within the “eligible assets” for green loans.
The FCA is clear as to the risks that climate change adaptation may pose to financial markets, consumers and competition – either because of a firms’ failure to adapt or because of the consequences of adaptation measures. It also notes that mispricing of climate risk may lead to losses and capital erosion.
The report notes that regulated firms must already consider novel or changing risks and have robust risk management systems, allied to the more granular disclosure requirements.