Bank of England to mainstream climate risk management, encourage disclosure

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The Bank of England has committed to action in support of an orderly transition to a carbon neutral economy for the United Kingdom, seeking to “mainstream climate risk management” in the financial sector and encourage broad disclosure of climate-related risks.

The Bank wants the UK’s financial sector to “support the transition by managing the risks and seizing the opportunities” related to this carbon neutral economy goal and has committed to encouraging it to happen earlier, which it believes will be more orderly.

“We will lead by example to help mainstream a culture of climate risk management throughout the economy,” the Bank said.

This is important, as while the financial sector in terms of risk, insurance and reinsurance is clearly up to speed and addressing its climate risks, other areas of the financial sector, from banking to investing, is further behind and in some cases leaving all of its climate risk on its balance-sheets.

Regular readers will know that we’ve followed numerous initiatives that encourage taking greater responsibility for the climate, severe weather and catastrophe risks on the balance-sheets of institutions, corporations, municipalities, cities and governments.

It is our view that a responsible approach would involve these entities taking responsibility for the exposure they hold and managing it with the help of risk finance, insurance and reinsurance capital, to the benefit of stakeholders, shareholders, investors, citizens, employees and the communities they serve.

Not taking responsibility for climate, weather and catastrophe risk means a financial burden or impact that has to hit someone, hence a responsible approach to business and commerce should mean taking responsibility for your risks as well.

The Bank of England echoes this in some of its proposals for a smoother transition to carbon neutral, saying that it will conduct a climate stress test for financial institutions in 2021, which it hopes will “help mainstream climate risk management.”

Of course, the insurance and reinsurance sector in the UK is already undergoing stress tests for catastrophe risk and other exposures, but it’s doubtful all participants have undergone one that is linked to pure climate exposure before.

By taking part in stress tests such as this, the climate exposure within other banks and financial entities will become clearer, which could in turn result in a greater desire to offset or hedge those climate risks, with insurance and other forms of risk transfer including weather risk management contracts clearly among the solutions most applicable.

Another initiative that could drive financial institutions and entities to take greater responsibility for managing their climate related exposures is the Bank’s continued push to get all companies to disclose their exposure on their balance-sheets.

It was way back in 2010 when we first wrote about the need for climate, weather and catastrophe risk disclosure, to provide stakeholders a view of the risks being carried by corporations, which should encourage better protection to be acquired.

The same applies to financial institutions, as well as entities like municipalities and cities, which would all benefit from understanding their exposure better and being able to hedge or insure it more effectively.

Since then initiatives such as the “1-in-100” initiative which aimed to integrate climate and natural disaster risk into the financial system, through a process of stress-testing and disclosure, and was driven by insurance and reinsurance broker Willis Towers Watson (just Willis at the time) has successfully raised this important discussion into the highest circles.

That initiative was then taken forwards by the Financial Stability Board (FSB) which created the Task Force on Climate-related Financial Disclosures (TCFD), which aims to encourage companies to be more transparent on physical, liability and transition risks of climate change through adoption of robust disclosure standards.

The Bank of England said yesterday that it will continue to encourage adoption of these TCFD disclosures by UK financial institutions and companies, so they can “provide better information on climate-related risks and opportunities.”

Importantly the Bank said, “We expect by 2022 that all listed companies and large asset owners will be disclosing this information.”

That’s potentially huge for the development of demand for climate related hedging tools, which will include weather risk transfer, insurance and reinsurance.

It also bodes well for parametric risk transfer products, which fit the use-case of climate, weather and natural disaster hedging.

The Bank of England aims to lead by example as well, saying it will, “Lead by example by increasing transparency over the Bank’s exposures to climate risks and approach to managing them, and adopt best practice to reduce its own carbon footprint.”

These are all extremely encouraging steps, not just for the UK economy in its mission to reach carbon-neutral, but for the companies and entities disclosing their climate exposure and their stakeholders, employees and communities, all of which should as a result get better protected.

It’s hard to imagine that if disclosure of climate risk is adopted that greater uptake of protection won’t occur.

Climate risk management, as well as weather and natural disaster risk management, does need to be mainstreamed in society, business and at sovereign levels as well.

It’s the natural response to having a negative figure representing climate or related risks on a balance-sheet of any kind, using whatever tools are available to minimise that figure’s impact.

That will naturally include insurance and risk transfer products.

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