The issue of climate change is one that could impact companies across all industries – and the financial sector is no different.
Climate-related shareholder resolutions are increasing and litigation risks (including from activist shareholders) are also on the rise. Central banks are assessing whether the increased frequency and impact of climate events like flooding, droughts, and storms will affect monetary policy in the medium or long term – and whether this in turn will lead to a need for an adaptation of policy strategy.
Risks
The potential impact of climate change has been identified by a Bank of England report on insurance, which flagged three key risks:
- Physical – more frequent and more severe weather events.
- Transition – large economic shifts in asset values or higher costs of doing business.
- Liability risks – claims from people or businesses seeking compensation for losses suffered by a physical or transition risk.
The Bank of England’s 2018 review of the effects on the banking sector observes that banks are moving from treating climate change as a corporate social responsibility issue to treating it like any other financial risk – with board level involvement in the setting of the strategy, targets, and risk appetite. As well as the reputational risk, there are concerns about longer term exposures to members of the Board, such as:
- Failure to grapple with climate change within their organisation generally.
- Failure to manage and monitor it within their investment or loan portfolio.
- Insufficient processes to ensure adequate due diligence on funding decisions (e.g. if construction projects turn out not to be compliant with local building codes).
Directors are exposed to both the Regulators and the Courts undertaking a hindsight examination of corporate acts and an examination of directors’ duties relating to climate change – for example under s172 of the Companies Act, which imposes a requirement on the director to have regard to the “impact of the company’s operations on the community and environment”. It is likely that a regulatory action will be linked to simultaneous activist investor or customer claims.
Regulatory Response
Clearly, there has been a lot of activity in the regulatory arena around this potential threat – indeed, the Prudential Regulation Authority (PRA) has been developing its thinking on the subject for some time now. In 2015, it examined the impact of climate change on the UK insurance industry and in January 2019 it completed consultation on “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change”. The results of that consultation are eagerly awaited.
The PRA is also establishing a Climate Financial Risk Forum, to be chaired jointly with the Financial Conduct Authority, while the Bank of England is one of the founding members of the “Network for Greening the Financial System”.
And the Financial Stability Board has established the private sector Task Force on Climate-related Financial Disclosure which among other things has recommended that companies that raise capital provide a voluntary disclosure of governance, strategy and risk management relating to climate change risks. Capital providers are increasingly receiving, and relying on, this information.
Insurance
The Insurance market has a wealth of data that captures claims trends and national catastrophe (NatCat) events (an event caused by natural forces that generally results in a large number of individual losses). Whilst this insurance data isn’t specifically mapped to climate change, it could prove extremely useful, for example mapping a financial institutions global loan book to a NatCat event map.
In such a rapidly developing area of risk, you need to ensure that your business is keeping pace and responding effectively. Speak to your Marsh Adviser to address the evolving nature of your risk profile.
To read more on the subject of climate change, from Oliver Wyman, click here
