On 30 April, the PRA published consultation paper CP10/25 on proposed updates to its Supervisory Statement on Climate Risk (SS3/19). The proposals are relevant to insurers, banks, building societies, and PRA-designated investment firms.
The PRA notes that progress since SS3/19, published in 2019, has been uneven and it believes that more needs to be done to meet the expectations. Conversely, firms have asked the PRA to provide greater clarity on what the PRA expects them to do to manage the effects of climate change.
The PRA also emphasises the features of climate-related risks that require a strategic management approach, including that:
- the risks are systemic and over time are likely to occur on a greater scale than other risks that firms are used to modelling and managing;
- the risks are simultaneously uncertain in scale and timing yet foreseeable; and
- the size and distribution of future risks will be determined by actions taken now.
The updated draft of SS3/19 is therefore much more extensive, at nearly four times the length of the original SS3/19. Whilst, as before, it sets out the PRA’s expectations of firms (rather than binding rules), it is nonetheless significantly more detailed.
The consultation paper was published alongside a speech from David Bailey, Executive Directive, Prudential Policy at the PRA. The speech emphasised that the updated expectations did not represent a change in direction but were intended to clarify and enhance the prior PRA guidance.
It is clear from both the consultation and the speech that whilst the PRA recognises the progress firms have made in improving their management of climate risk – it expects firms to go much further in integrating climate risk management into their organisations. Despite recent pressure on related areas, it seems clear the PRA remains focussed on the financial risks of climate change, and expects firms to continue to progress in this area.
Governance
The PRA emphasises that the Board must set the business’s climate risk appetite, which should cascade down to the firm’s business lines. To enable this, the PRA proposes management bodies will need to provide climate-related risk analysis and training to the Board, to enable the Board to offer effective challenge on climate issues. The PRA notes that climate-related risk analysis is often unclear and insufficiently targeted.
The PRA notes that firms must assign responsibilities for climate risks at an appropriate level of seniority, such as SMF or board member, and these individuals will play a key role in keeping the Board informed. The PRA emphasises its focus on linking the rewards and accountability of individuals more clearly to the delivery of a firm’s objectives around climate-related risks.
The Board will then be responsible for periodic review of the firm’s risk appetite, climate-related management practices, and strategy, ensuring these are appropriate. The Board must agree climate risk appetite statements for material climate-related risks identified in the firm’s risk register. Risk appetite and supporting metrics and limits should be included at both firm and business line level.
Where firms have a public commitment to meet a climate goal, they must be able to demonstrate how that is integrated into their overall business strategy.
Risk management
The PRA notes that there is significant variance in the quality and depth of firms’ approaches to climate risk management. The focus in terms of risk is on clarifying how existing PRA risk management policies are intended to be applied to climate risks. It proposes that firms will need to:
- Operate a periodic structured risk identification and assessments of material climate-related risks, by a transparent process (rather than relying on judgement-based overlays).
- Conduct climate risk assessment in relation to all material relationships with clients, counterparties, investees and policyholders.
- Set quantitative risk appetite metrics and limits for each material climate risk and keep these under review.
- Implement an appropriate internal system for regular and ad hoc reporting of climate risks to the Board and sub-committees.
- Include climate risk in firms’ operational resilience assessments.
Climate scenario analysis (CSA)
Observing that CSA has evolved since SS3/19, the PRA intends to hold firms to a higher standard. Firms will need to ensure that they capture all material risks in their scenario testing, be able to justify the selection and conceptual soundness of scenarios used and be aware of the limitations associated with their models. The Board should understand a firm’s CSA as well as its limitations and sources of uncertainty, and firms will need to regularly review and update their CSA in line with modelling and scientific advances and changing risks for the firm.
Where firms are unable to do appropriate CSA, they must be able to show that an alternative approach is in place to understand future climate risks.
Data
This new section addresses how firms are expected to handle data gaps given the PRA observes they remain a significant challenge for firms in managing climate-related risks. Firms will be expected to have strategic plans to close existing data gaps. Where data is unavailable, they should use appropriately conservative assumptions and proxies. Firms must also ensure effective governance of external data suppliers, plan to develop in-house capabilities, and operate systems to collect and aggregate their climate-related risk data.
Disclosure
No substantive changes are proposed in this area. The PRA will amend references to TCFD to refer to the new UK Sustainability Reporting Standards, subject to final approval.
Banking-specific issues
The PRA outlines that banks must consider climate risks in their financial reporting, Internal Capital Adequacy Assessment Process (ICAAP), Internal Liquidity Adequacy Assessment Process (ILAAP), and assessing credit, market, and reputational risks.
Regarding financial reporting, firms must have processes and controls for data needed to factor climate risk into balance sheet valuations and sound practice and policy to assess and measure the impact of climate risk in their financial reports, in line with accounting standards.
On capital adequacy, firms’ ICAAPs must set out how they calculate the materiality of climate risk, noting their methodology, assumptions, judgements, proxies, and uncertainties.
As to liquidity risk, where material and appropriate, firms’ ILAAPs must incorporate climate risks in the calibration of liquidity buffers and in liquidity risk management frameworks. Where climate risk is not material, firms must evidence the reasons why.
Insurance-specific issues
The PRA notes that while some insurers have made good progress in meeting the PRA’s expectations on governance, significant progress remains to be made on risk management and CSA.
Insurers must address climate risks in their risk management frameworks, Own Risk & Solvency Assessments (ORSAs), Solvency Capital Requirements (SCRs), and Solvency II balance sheets.
ORSAs must include climate risks where material Insurers should set out investment and underwriting changes to be made in relation to climate risks, and by what metrics and indicators these will be informed.
SCRs should reflect the impact of climate risks on underwriting, reserving, market, credit and operational risks, where relevant.
Solvency II balance sheet assets and liabilities are expected to include climate considerations. Solvency ratios must take in climate-related risks to ensure they do not overstate insurers’ capital position.
Next steps
The consultation is open until 30 July 2025.
The PRA proposes that, if the new supervisory statement is adopted, it will take effect immediately upon the publication of the finalised version. The PRA proposes that firms conduct an internal review in meeting the updated expectations and identify the expectations that require further work. The PRA will give firms time to transition to the updated expectations, with supervisors not asking firms to evidence their steps to meet the expectations until six months after publication of the updated supervisory statement. Whilst this offers a transition period, the PRA clearly expects firms to start acting to meet its new expectations relatively quickly.
Co-authored by Sam Sykes, Trainee Solicitor
This article was first published by Reuters Regulatory Intelligence.
