CP10/25 – Enhancing banks’ and insurers’ approaches to managing climate-related risks – Update to SS3/19

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Responses are requested by Wednesday 30 July 2025.

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CP10/25, Central Climate Team
Prudential Regulation Authority
20 Moorgate
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1: Overview

1.1 This consultation paper (CP) sets out the Prudential Regulatory Authority’s (PRA) proposals on updated supervisory expectations for banks and insurers. The proposals would help banks and insurers manage the effects of climate change on their businesses, and thereby maintain the essential services they provide to the economy.

1.2 Climate change is leading to severe weather events such as flooding and extreme heat, as well as the prospect of longer-term effects, such as sea level rises. The impacts of climate change are expected to grow over time.^{footnote [1]}

1.3 These events are affecting PRA-supervised banks and insurers (firms) through direct losses and business model changes. Domestic and international actions to reduce greenhouse gas emissions, such as transition to net zero, aim to avoid even more extreme impacts. These actions will bring further changes to the economy which firms will need to respond to. The financial and economic losses related to climate change are projected to increase over time, although the magnitude and timing of losses are uncertain.^{footnote [2]}

1.4 Firms are expected to manage the financial and operational risks to which they are exposed, including climate-related risks. Effective risk assessment and risk management capabilities will help banks and insurers build resilience against these growing risks, make informed choices about their strategy, and identify opportunities for finance provision that can increase economic growth.

1.5 Since the PRA first set expectations for firms on climate change in 2019, firms have begun to build their climate-related risk management capabilities. However, progress is uneven and more needs to be done to meet the expectations. Understanding of climate-related risks and development of leading practice in the effective risk management of these risks is challenging and continues to evolve. Firms have asked the PRA to provide greater clarity on what the PRA expects them to do to manage the effects of climate change.

1.6 The proposals in this CP reflect the building risks, the consequent need for firms to progress their risk management capabilities and the desire from industry for greater clarity and detail on the PRA’s expectations. The proposals build on lessons learnt in the UK and internationally over the last five years on firms’ management of climate-related risks. They also combine PRA guidance from various letters to firms over recent years (see paragraph 1.22) and reflect recent international standards for banks and insurers.

1.7 The proposals consist of supervisory expectations for effective risk management practices rather than rules for banks and insurers to follow. The aim is to set out clear, straightforward and concise expectations about climate-related risk identification, management and governance outcomes that the PRA would like to see from firms. At the same time, the proposals continue to provide space for firms to take action and develop innovative solutions that are most suited to their business.

1.8 In many cases the proposals are simply applying existing regulatory approaches to managing risks (for example, in relation to effective governance), but with greater clarity on how they apply to climate-related risks specifically.

1.9 The proposals are intended to be applied in a proportionate manner. The PRA would expect a firm’s actions to manage climate-related risks to scale to the risks to which that firm is exposed, and they would only apply at their fullest to those firms that are most exposed. Initially, all firms should carefully assess the potential impact of climate change on their business. A firm that is materially exposed to climate-related risks would need to take greater action to monitor and manage those risks compared to a firm that is less exposed (see paragraphs 1.28–1.32). It is in the interest of firms to ensure effective assessment and monitoring, proportionate to their risk exposure, just as it would be for any other material risk the firm faces.

1.10 The PRA recognises that this is a challenging area for firms given the evolving and uncertain nature of climate-related risks. Therefore, the PRA would plan to engage actively with industry groups to help firms collectively develop and advance best practice. The PRA invites engagement and comments from all stakeholders on the likely effectiveness of its proposals and any additional considerations to take into account.

How climate-related risks affect firms

1.11 Climate-related risks arise through two primary channels – physical risks and transition risks:

• Physical risks from climate change can be related to both specific weather events (such as heat waves, floods, wildfires and storms) and risks from longer-term shifts in climate (such as changes in precipitation, extreme weather variability, sea level rise and rising mean temperatures).
• Transition risks can arise from the adjustment towards a low-emission economy. This could prompt a reassessment of the value of a large range of assets for banks, other lenders and insurers as costs and opportunities from the transition become apparent.

1.12 See Box A for an overview of how these risks can affect banks and insurers.

1.13 There are a number of distinctive elements to climate-related risks which, together, present challenges for the financial sector and require a strategic management approach:

• The risks are systemic. To varying extents, they will affect every customer, every company, in all sectors of the economy. Their impact will likely be correlated, non-linear, irreversible and subject to tipping points. Over time they 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 and yet foreseeable. The exact combination of physical and transition risks that will emerge is uncertain, but either current emissions pathways will continue (or worsen) and result in greater physical risks, or the pathways will improve as a result of reducing emissions, likely resulting in greater transition risks.
• The size and distribution of the future risks will be determined by actions taken now. Once physical risks begin to manifest in a systemic way, it will already be too late to reverse many effects through emissions reductions. Similarly, the longer that meaningful adjustment to a lower emissions path is delayed, the more disruptive transition is likely to be. 

Background to this consultation

1.14 This CP builds on the existing supervisory expectations set out in supervisory statement 3/19 – Enhancing bank’s and insurers’ approach to managing the financial risks from climate change (SS3/19). The draft SS published alongside this CP would replace SS3/19.

1.15 The PRA’s expectations in SS3/19 set out a high-level direction on managing climate-related risk. As this was a novel area for firms, they were set at a high level to provide scope for firms to develop their approach over time as firms’ risk management capabilities improved, and as understanding of climate-related risks and the risk outlook evolved.

1.16 Since the expectations were issued, the PRA has observed that banks and insurers have taken concrete and positive steps to improve their capabilities. However, firms’ levels of readiness to manage climate-related risks and embedding vary and the overall assessment of supervisors is that firms need to make further progress. For example, the PRA has observed that despite progress in recent years, firms’ understanding of climate-related risk is still developing, with significant uncertainty about the source and magnitude of risks. In addition, tools and capabilities to manage the distinctive characteristics of climate-related risks, such as climate scenario analysis and stress testing, are still being developed (see Box B for additional detail).

1.17 These findings, as well as feedback from industry (including the PRA Practitioner Panel), suggest that more clarity is needed on the PRA’s expectations to support firms in managing climate-related risks.

1.18 The PRA considers that the proposals would facilitate better management of climate-related risk by setting out clearly how firms should assess the risk and helping ensure that these assessments are incorporated into firms’ decision-making. This in turn should help firms strengthen their resilience, as well as support effective competition within the banking and insurance sectors in the UK.

1.19 The proposed expectations also reflect recently published international minimum standards on climate-related risk management by banks and insurers. Increasing resilience to climate-related shocks benefits firms by reducing losses and may help them better identify climate finance related opportunities. It also benefits the UK economy as a whole – it makes the economy more resilient to climate-related disruptions and puts it on a more stable medium-term growth path.

Scope

1.20 This CP is relevant to all UK insurance and reinsurance firms and groups, ie those within the scope of Solvency II including the Society of Lloyd’s and managing agents (‘Solvency II firms’) and non-Solvency II firms (collectively referred to as ‘insurers’), banks, building societies, and PRA-designated investment firms (collectively referred to as ‘banks’). ‘Firms’ is used in this CP to refer to both insurers and banks. The proposed expectations set out below do not apply to branches. Accordingly, the scope remains the same for firms as under SS3/19.

Consolidating existing published material and new international standards

1.21 SS3/19 was the first PRA supervisory statement (SS) directly covering climate-related risks. It recognised the novel challenges presented by risks from climate change to the financial sector. The SS also noted that the PRA’s expectations for firms’ approaches to managing the financial risks from climate change would mature over time as expertise developed.

1.22 Since publishing SS3/19, the PRA has provided feedback on firms’ progress, including examples of effective practices, to support firms as they continue to enhance and refine their approaches. This feedback was set out in the following communications:

• 2020: ‘Dear CEO’ letter from Sam Woods ‘Managing climate-related financial risks – thematic feedback from the PRA’s review of firms’ SS3/19 plans and clarifications of expectations’. This letter set out more detailed guidance on how firms should embed their approaches to managing climate-related risks by the end of 2021.
• 2022: ‘Dear CEO’ letter from Sam Woods ‘Thematic feedback on the PRA’s supervision of climate-related financial risk and the Bank of England’s Climate Biennial Exploratory Scenario exercise’). This letter provided thematic feedback to firms on their progress on embedding SS3/19 and from undertaking the Climate Biennial Exploratory Scenario (CBES).
• 2022: ‘Dear CFO’ letter to CFO's of selected PRA-regulated deposit-takers from Victoria Saporta ‘Thematic feedback from the 2021/2022 round of written auditor reporting’.
• 2023: 'Dear CFO' letter to CFO's of selected PRA-regulated deposit-takers from Victoria Saporta ‘Thematic feedback from the 2022/2023 round of written auditor reporting’.
• 2024: ‘Dear CFO’ letter from David Bailey ‘Thematic feedback on accounting for IFRS 9 ECL and climate risk’.

The three ‘Dear CFO’ letters set out the PRA’s views on elements that would contribute to the development of firms’ capabilities to capture the impact of climate-related risks on balance sheets over time, consistent with SS3/19.

1.23 In March 2023, the PRA also published a report on climate-related risks and the regulatory capital frameworks. This report set out the Bank’s thinking on how climate-related risks might be captured by regulatory capital frameworks.

1.24 The PRA has also shared its insights on climate-related risks in the PRA Climate Change Adaptation Report 2025 (‘CCAR-25’). This report updated on the progress firms had made on managing climate-related risks, the PRA’s supervisory strategy for advancing climate-related risk capabilities in firms, and the potential role of capital requirements.

1.25 New international guidance relevant to the supervision of climate-related risks has also been issued since the PRA published SS3/19. These have included the Basel Committee on Banking Supervision’s (‘BCBS’) Principles for the effective management and supervision of climate-related financial risks, as well as the latest developments in standards and guidance supporting the Insurance Core Principles (ICPs) published by the International Association of Insurance Supervisors (‘IAIS’) and the advice provided in its May 2021 application paper.

1.26 Reflecting that addressing climate-related risks was novel for most firms, in March 2019, the Bank and the Financial Conduct Authority (FCA) established the Climate Financial Risk Forum (CFRF) to build capacity and share best practice across industry and financial regulators to advance the financial sector’s responses to climate-related risks. The CFRF was in part intended to help advance firms’ capabilities to support implementation of the PRA’s expectations. Since its inception, the CFRF has published a range of guides and practical tools to help firms develop capabilities in various aspects of managing climate-related risks. These have included:

• CFRF Risk Management Chapter and Use Cases Guide – to provide guidance to firms on how to integrate climate-related risks into their risk management frameworks.
• CFRF Scenario Analysis Chapter, sector-specific guides, online scenario analysis narrative tool, short-term scenario analysis guide – to enable firms to enhance their capabilities in climate scenario analysis and share best practice in this area.
• CFRF Climate Disclosure Dashboard, guide on forward-looking portfolio metrics and webinars on data limitations and data coverage – to support firms in overcoming existing data challenges and developing climate disclosures.
• CFRF Adaptation report – to provide firms with guidance on how to prepare for and deal with physical risks.

1.27 The PRA’s intent is that the proposals in this CP consolidate the volume of existing published PRA guidance (see paragraphs 1.22–1.24), embed improved understanding of climate-related risks and reflect new international standards (see paragraph 1.25) that have been issued since 2019. In doing so, the consolidated proposals respond to the request for more detailed expectations for firms and it is acknowledged that this may require more action from firms to meet the updated expectations. The PRA also intends to continue its work with industry to support the implementation of its expectations, recognising the need for collaborative work across firms and with regulators.

Proportionality

1.28 The proposals are consistent with the PRA’s Supervisory Approach to Banking and Insurance.^{footnote [4]} The PRA’s approach is proportionate and risk-based, and reflects the diversity of firm structures, sizes, and business models, including the approach for lower impact firms.

1.29 The PRA recognises that firms of any size may be significantly exposed to climate-related risks. The impact of climate-related risk on a firm is driven by a range of factors, in particular the firm’s business model and the geographical concentration of its balance sheet, rather than just the size of the firm.

1.30 The PRA expects the framework to be applied proportionately. In considering the appropriate response to managing climate-related risks, all firms should adopt a two-step process, which is set out in detail in the proposed SS (see draft SS paragraphs 3.9–3.15) and summarised below:

• Step 1: Firms should carry out effective risk identification and assessment approaches to determine the material climate-related risks they are exposed to and to understand how these risks will impact the resilience of their business model over relevant time horizons and under different climate scenarios.
  
  This process should be supported by relevant scenario analysis. It may be appropriate for smaller firms to use less sophisticated approaches to scenario analysis. This includes the use of narrative scenarios quantified with expert judgement where developing sophisticated scenario analysis capabilities could cause a disproportionate increase in cost and could hence negatively impact competition.
  
  
• Step 2: Firms’ knowledge of their business, and resulting exposure to climate-related risks, will guide them towards a risk management response that is proportionate to their vulnerability to climate-related risk. Specifically, in the interests of proportionality, firms' risk management response should be scaled to the materiality of the climate-related risks they face. The need for firms to use more sophisticated risk management tools will increase as the magnitude and likelihood of material risks to which they are exposed increases.

1.31 The PRA’s intent is that all firms should have a robust understanding of the risks to which they are exposed, and scale their approach to managing those risks accordingly. Firms that are materially exposed to climate-related risk are expected to take greater action than those less exposed to climate-related risks. Firms should be able to evidence or explain how they have reached any judgements that underpin the outcomes from steps 1 and 2.

1.32 Firms that have already been taking action to improve their climate-related risk identification and assessment capabilities consistent with the objective of SS3/19 may not have to take significant further action to fully reflect these proposals. However, these firms may still benefit from the additional clarity and certainty provided. Firms that have not made as much progress consistent with SS3/19 may have to undertake a larger initial set of actions, but will be aided by the detail in these proposals.

Legal obligations

1.33 The PRA has a statutory duty to consult when introducing new rules or changing rules (FSMA s138J), or new standards instruments (FSMA s138S). This consultation is on supervisory expectations and will not lead to a change to PRA rules. When not making rules, the PRA has a public law duty to consult widely where it would be fair to do so. 

1.34 The Practitioner’s Panel was consulted on the proposals in this CP.

1.35 The PRA CBA Panel was consulted on a voluntary basis.

1.36 In carrying out its policymaking functions, the PRA is required to comply with several legal obligations. The analysis in this CP explains how in making these proposals, the PRA has had regard to the most significant matters, including an explanation of the ways in which having regard to these matters has affected the proposals.

Implementation

1.37 As the proposed SS builds on and is consistent with the existing supervisory expectations set out in SS3/19, the PRA proposes that the final SS replaces SS3/19 in its entirety at the time of publication.

1.38 Following publication of the final SS, the PRA proposes that firms conduct an internal review of their current status in meeting the updated expectations. Firms should identify the expectations that require further work and plan for how they will address any gaps (including through interim actions).

1.39 The policy, if adopted, will take effect immediately upon publication of a final SS. However, to give firms time to transition to the updated expectations, the PRA proposes that supervisors will not ask firms to evidence their internal assessments, gap analyses, action plans or other steps taken to meet the updated expectations, until a period of six months has elapsed from publication. Firms should continue to appropriately manage climate-related risks during this period.

Responses and next steps

1.40 This consultation closes on Wednesday 30 July 2025. The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to CP10_25@bankofengland.co.uk.

1.41 When providing your response, please tell us whether or not you consent to the PRA publishing your name, and/or the name of your organisation, as a respondent to this CP.

1.42 Please also indicate in your response if you believe any of the proposals in this consultation paper are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.

2: The PRA’s proposals

2.1 SS3/19 set out the PRA's expectations in four areas: governance, risk management, scenario analysis and disclosure. Reflecting the more detailed set of expectations proposed by the PRA, the draft SS has been structured into the following chapters: 

• Chapter 1: Governance – considers climate-related risks in governance arrangements. 
• Chapter 2: Risk Management – incorporating climate-related risks into existing risk management practice. 
• Chapter 3: Climate Scenario Analysis (CSA) – describes the uses of CSA to inform strategy setting and risk assessment and identification. 
• Chapter 4: Data – sourcing robust, standardised climate-related data of sufficient coverage and relevance. 
• Chapter 5: Disclosures – approach to transparency, as relevant, for climate-related information. 
• Chapter 6: Banking-specific issues – provides further detail on the specific climate-related issues banks^{footnote [5]} face (applicable only to banks). 
• Chapter 7: Insurance-specific issues – provides further detail on the specific climate-related issues insurers^{footnote [6]} face (applicable only to insurers). 

2.2 The PRA’s proposals set out in this CP reflect the revised structure of the proposed SS.

Chapter 1: Governance

2.3 Firms have made progress in establishing appropriate governance structures for climate-related risks.^{footnote [7]} The proposals add detail and clarity to the existing governance expectations in SS3/19 to enable firms to make further progress. They are in line with existing PRA policies related to governance practices^{footnote [8]} around risks to firms, but clarify the application of these policies for climate-related risks.

2.4 They emphasise the need for the board to set and own the overall business risk appetite for climate, which should be based on analysis drawn from the risk management function and cascaded across the firms’ business lines. The proposals include new expectations to ensure coherence between a firm’s strategy and meeting a firm’s own climate targets, where these have been adopted, and on setting the internal controls environment. They include more detail on corporate governance structures needed for firms to manage climate-related risks.

Provision of climate-related risk analysis to the board

2.5 In its engagement with firms, the PRA has observed that climate-related risk analysis provided to boards is often unclear and is generally insufficiently specific or targeted. This potentially limits boards’ ability to assess the risks and provide effective challenge. As a result, climate-related risk may be inappropriately assessed and managed.

2.6 To address this, the PRA proposes that management bodies should provide their board with the relevant information on climate-related risks. This will help the board to understand the impact of climate-related risks on the firm’s business over relevant time horizons and under different climate scenarios, utilising the outputs from the risk identification process outlined in Chapter 2: Risk Management.

2.7 Furthermore, to enable the board to offer effective challenge, the PRA proposes that firms provide the board with appropriate training on climate-related risk, including current methods and tools used by the firm to manage risks.

2.8 These proposals will support the board in offering informed and effective challenge as climate-related risks continue to evolve, the impacts of climate change crystallise and the economy transitions to low emissions.

Use of climate-related risk analysis for ensuring appropriate setting of business risk appetite, risk management approaches and strategy

2.9 In its engagement with firms, the PRA has observed that firms’ analysis of the impact of climate-related risk on the overall business level strategy is limited. This creates a risk that the firm will have an incomplete assessment of the risks it faces when setting its business strategy and associated risk appetite.

2.10 The PRA proposes that the board should be provided with an analysis of the performance of the firm’s business strategy under a range of climate scenarios (see Chapter 3: Climate Scenario Analysis). The firm’s management body should demonstrate to the board the resilience of the firm’s existing strategy given the climate-related risks to its business model.

2.11 The PRA proposes that the board ensure there is a periodic review^{footnote [9]} of the firms’ risk appetite, climate-related risk management practices and strategy. In doing so, the board should look to the management body, and particularly the relevant Senior Management Function holder (‘SMF’), to implement this review. The management body should demonstrate to the board how the risk appetite and business strategy are appropriate to developments in climate-related risks to the firm’s business model.

2.12 These steps should ensure that potential climate-related risks to the firm are accurately reflected in its business strategy. This will enable firms to take appropriate steps, where necessary, to manage these risks. The periodic review will enable boards to check and reconsider relevant actions to reflect the evolving impact of climate change and/or the transition to a low emission economy.

Where relevant, coherence between plans for meeting climate-related targets and a firms’ overall strategy

2.13 The firm’s board should determine its business strategy, including how it relates to climate change and the transition. The PRA does not require firms to adopt climate goals, for example net zero emission targets or adaptation goals. However, the PRA recognises that some firms have voluntarily adopted climate goals, and others operate in jurisdictions that have set national climate targets. In some instances, jurisdictions also require firms operating in that jurisdiction to adopt specific climate goals or align their business to specific climate goals.

2.14 Meeting, or aligning to meet, climate goals may impact a firms' business model, result in significant business transformation projects, or over time change the risk profile of the firm (eg through material shifts in the sectors a firm provides services to or in the products/assets it invests in). This is especially relevant where a firm has disclosed public commitments to achieve climate goals. To address these changes, the PRA proposes that a firm should be able to demonstrate how it has integrated its plan to meet any climate goals that it has either adopted itself or is required to meet in the jurisdictions (including the UK) within the firm's overall business strategy. The firms should also demonstrate how any associated risks have been reflected in its risk management frameworks.

2.15 These proposals aim to ensure that any climate goals adopted by firms would be underpinned by coherent actions to deliver the required business transformation. This includes identifying and managing any risks related to, or arising from, business change strategies or changes to the risk profile of the firm. The risks identified should be addressed by the firms’ risk management.

Defining and cascading risk appetite from board to business line levels

2.16 The PRA has observed that firms have generally not established climate-related risk appetites that are cascaded from the board to business lines and supported by an appropriate framework of risk metrics and limits. In some firms, this may be because the potential impact on a firm’s business model or the magnitude of climate-related risks faced by firms is not well understood. As such, the controls within the risk management framework for climate-related risks may not be effective.

2.17 The PRA proposes that the board should agree climate-specific risk appetite statements for material climate-related risks identified in the firm risk register (see paragraphs 2.24–2.26). Risk appetite and supporting risk metrics and limits should be defined at both firm and business line level. Firms can categorise risk appetite statements in different ways (including designating risks according to those the firm plans to avoid, manage or accept) but the desired outcome should be structured and give a clear statement of how the firm intends to approach these risks. In determining risk appetite metrics and limits, the PRA proposes that boards should be informed by scenario analysis, including reverse stress tests (see Chapter 3: Climate Scenario Analysis).

Corporate governance structures

2.18 The PRA has observed that firms have made progress against some of the expectations in SS3/19 concerning the creation of appropriate corporate governance structures for the management of climate-related risks. To build on this progress, the updated expectations include additional measures that will help enhance firms’ approaches.

2.19 The PRA proposes that management responsibilities for identifying and managing climate-related risks are assigned at an appropriate level of seniority within the organisation such as a relevant SMF holder or board member and that clear reporting lines are established. Individuals so appointed should play a key role in implementing the firm’s strategy for addressing climate-related risks, including ensuring the board has the appropriate information to facilitate decision-making, and be held appropriately to account eg through the firm’s appraisal and reward system.

2.20 The PRA also proposes that in setting the high-level risk management and controls environment, boards should include risk appetite and tolerance levels for outsourced and third-party arrangements^{footnote [10]} that may be exposed to climate-related risks or introduce climate-related risks to the firm through their activities.

2.21 The PRA also proposes that climate-related risk should be incorporated into internal control frameworks, across the three lines of defence.

2.22 These proposals build on progress under SS3/19 by seeking to link rewards and accountability of individuals more clearly to the successful delivery of a firm’s objectives in respect of climate-related risks.

Chapter 2: Risk Management

2.23 The PRA assessment is that firms have made progress on climate-related risk management, but there is significant variance in the quality and depth of their approaches and ability to identify and, where necessary, mitigate climate-related risk. Further work is required by all firms. To enable firms to develop appropriate risk management tools that support and inform decision-making, the PRA proposals introduce clearer expectations for each element of the risk management framework and clarify how the existing PRA policies related to management of all risks to firms should be applied to climate-related risks. In particular, the proposals aim to ensure that firms identify and assess material climate-related risks using a structured approach where firms develop appropriate metrics and limits to monitor and manage these risks. Additionally, the proposals aim to ensure that the board and management body are provided with appropriate, decision-useful risk reporting.

Risk identification and assessment

2.24 The PRA has observed that firms often lack an in-depth understanding of climate-related risk transmission channels and often rely on judgement-based overlays. Therefore, a structured approach to risk identification and assessment will improve climate-related risk management within firms and help firms to ensure that no material risks go unrecognised. Furthermore, these proposals will also assist firms in determining an appropriate and proportionate climate-related risk management response as an effective risk identification and assessment process forms the basis of the two-step approach to proportionate application of the expectations in the updated SS (see draft SS paragraphs 3.9–3.15).

2.25 The PRA proposes that firms periodically carry out structured risk identification and assessment to identify the material climate-related risks they face and appropriately classify all material risks identified during the risk assessment process in the firm risk register. The PRA proposes that firms substantiate any judgements made during their risk assessment. The proposals note that firms should be transparent about the way they arrive at these judgements to allow for effective review and challenge by the board and management body.

2.26 The PRA proposes risk identification and assessment should be subject to periodic review to ensure that the materiality assessment is up to date and no material climate-related risks go unrecognised.

Client, counterparty, investee and policyholder risk identification and risk assessment

2.27 The PRA’s engagement with firms showed that the quality and coverage of client, counterparty, investee and policyholder climate-related risk assessments is variable.

2.28 As part of their overall risk identification and assessment, the PRA proposes that firms undertake a risk assessment of climate-related risks arising from their material relationships with clients, counterparties, investees and policyholders and assess how these risks interact with other climate-related risks included in the firm risk register. These proposals build on and clarify the existing SS3/19 expectation related to the impacts of climate-related risks on clients, counterparties, investees and policyholders.

Risk measurement and monitoring

2.29 The PRA has observed that firms face challenges in understanding and agreeing which climate-related metrics they should be using and the extent to which these metrics can meaningfully inform decisions on business strategy.

2.30 The PRA proposes that firms develop quantitative risk appetite metrics and limits for each material climate-related risk that they face (see paragraph 2.17). The proposals set out the factors firms should consider when developing appropriate quantitative metrics and limits, as well as other considerations to make when developing more granular metrics and limits. The PRA proposes that firms should review the metrics and limits periodically and update as necessary to reflect the evolving nature of climate-related risks and the tools to manage these risks.

2.31 The PRA is not proposing specific risk metrics. The PRA recognises that climate-related risk metrics is an area where market practice is evolving and that the appropriateness of specific risk metrics will vary across firms. Implementation of appropriate and targeted risk metrics will enable effective risk management.

Internal risk reporting

2.32 The PRA has observed that including the suggested types of information above in risk reporting has enabled boards and management to effectively discuss, challenge and make decisions relating to firms’ management of climate-related risks and climate-related risk strategy.

2.33 As such, the PRA proposes that firms develop and employ an appropriate internal risk reporting infrastructure that will allow for regular as well as ad-hoc reporting of climate-related risks to the board and its relevant sub-committees. The proposals note that the reporting frequency should be in line with that for other risks of similar materiality, noting the general approach to proportionality set out in paragraphs 1.28–1.32. The proposals also suggest the type of information to be included within risk reporting.

2.34 This proposal builds on and expands the existing SS3/19 expectation related to risk reporting and aligns with BCBS Principles that require firms to have appropriate reporting infrastructure to provide the board and management body with timely management information that may be necessary due to the fast-changing nature of climate-related risks.

Operational resilience

2.35 In line with the BCBS Principles, the PRA acknowledges that changing climate conditions can give rise to operational risks that may affect firms’ overall operational resilience, and that this is relevant to both banks and insurers.

2.36 The PRA proposes to clarify that under its operational resilience policies firms should assess the impact of climate-related risk drivers from the perspective of both their general operations and their ability to continue providing critical operations. Firms should also be aware of and have suitable measures in place to assess the extent to which their operational resilience may be negatively impacted by changes in physical climate-related risk.

Chapter 3: Climate Scenario Analysis (CSA)

2.37 CSA is a key risk assessment tool that supplements the standard scenario analysis and stress testing toolkit used by firms to account for the specific characteristics of climate-related risks. Risks associated with further global warming, and policy responses to mitigate it, have no comparable historical precedent. Given the forward-looking character of climate-related risks, including non-linearities, potential for tipping points and irreversible damage, standard stress testing and scenario analysis approaches calibrated on backward looking data are not suitable predictors of climate-related risk. CSA is a key tool to account for the uncertainty about future climate-related outcomes.

2.38 The PRA considers that CSA has evolved since the publication of SS3/19. The PRA proposes to enhance the supervisory expectations in relation to the use of CSA with an additional level of detail intended to provide firms with clearer and more useful guidance.^{footnote [11]} The proposals reflect the improvement in knowledge and modelling capabilities and international standards set out in BCBS Principles and IAIS Application Paper.^{footnote [12]} The expectations focus on the use cases and objectives of CSA, and aim to ensure firms understand the calibration of CSA. They also encourage firms to enhance CSA capabilities over time to reflect evolution of the reference scenarios, advances in climate science and the ongoing impacts of climate change. The PRA’s proposals are designed to ensure that they do not act as a limit on firms’ building their future capabilities.

Role of CSA

2.39 In its engagement with firms, the PRA has observed that a common challenge among firms is the complexity involved in constructing and implementing CSA, understanding the scenarios to use and using the outputs from CSA to assess their overall exposures to climate-related risks. As a result, many firms lack adequate understanding of the climate-related risks they face, with little evidence that they appropriately account for those risks in their decision-making and risk management.

2.40 The PRA proposes that firms’ CSA should seek to capture all material climate-related risks. The PRA proposes that firms should appropriately document how their CSA fulfils their objectives and informs their decision-making. The PRA expects firms to be able to justify the selection and conceptual soundness of scenarios they rely on. The PRA proposes that firms should be aware of the limitations and uncertainties associated with the CSA models and toolkits they use and account for those when using the results.

2.41 The PRA’s proposals emphasise the importance of clear objectives for CSA to inform firms’ decision-making and align the PRA’s expectations to the BCBS Principles and IAIS Application Paper.^{footnote [13]} They further clarify the role of CSA to supplement standard stress testing and scenario analysis approaches outlined in SS31/15^{footnote [14]} (for banks) and SS19/16^{footnote [15]} (for insurers), to account for the distinctive characteristics of climate-related risks. The proposed clarifications will support firms in implementing robustly designed CSA that strengthens risk management and informs decision-making.

2.42 Current CSA models and toolkits used by the industry do not capture the full range and scale of climate-related risks. As such, the proposals seek to ensure firms interpret and use the results in full knowledge that they may be exposed to greater risks than the estimates quantified by current models. Firms should then seek to evolve their capabilities to address these limitations as CSA practice develops.

2.43 The proposals would lead to improvements in firms’ calibration and design of CSA. They would also help firms to better tailor the CSA for specific use cases, and enable firms to better understand the limitations to help inform how the outputs can be used for more accurate pricing of risk, leading to conditions for better decision-making.

Selecting scenarios and use cases

2.44 The PRA assesses that firms need to make further progress to embed CSA in their business planning and decision-making, to support their safety and soundness.

2.45 The PRA proposes that firms select, match and tailor scenarios as relevant for their objectives and specific use cases. Firms would be expected to explore a range of plausible future outcomes covering both physical and transition risks, including adjusting the intensity of scenarios for the assessment of climate tail risks. Firms would be expected to include relevant jurisdictional climate targets, appropriate for their exposures, within a scenario.

2.46 The PRA also proposes that firms use CSA in a proportionate manner for a range of purposes. These include setting and reviewing business strategy, setting and reviewing risk appetite and risk management approaches, in valuations and internal capital setting, and to assess the impacts of climate-related risks on liquidity, solvency and, for insurers’, the ability to pay policyholders. Firms would be expected to match scenario time horizons, frequency, balance sheet assumptions and calibration to their objectives and use cases.

2.47 With respect to capital, the PRA proposes that firms include CSA as part of their Internal Capital Adequacy Assessment Process (ICAAP) or own risk and solvency assessment (ORSA). Within their ICAAP or the ORSA, firms would be expected to document and be able to demonstrate how they applied CSA to achieve their exercise’s objectives and to inform their decision-making. This proposal is included to support embedding CSA in the existing frameworks for conducting and communicating the firms’ approaches to internal capital adequacy, own resources and solvency.

2.48 The PRA also proposes that firms include reverse stress tests as part of their CSA. Reverse stress testing is already a PRA expectation for insurers in scope of the ORSA^{footnote [16]} and for banks in scope of ICAAP.^{footnote [17]} This proposal will facilitate greater awareness of business model vulnerabilities to the impacts of climate change specifically by asking firms to consider what type of climate scenario would result in the firm no longer being able to carry out its business activities. Depending on the potential impact of climate change on firms’ PRA-regulated activities, their business model and their CSA capabilities, firms can choose between simpler narrative based scenarios and more mathematical approaches to conduct reverse stress testing.

2.49 The PRA further proposes that where firms are unable to conduct an appropriate CSA exercise, or where a decision has been made not to develop sophisticated CSA capabilities in line with the approach to proportionality set out in paragraphs 1.28–1.32, they should demonstrate that they have an alternative approach to understand future risks in the absence of this framework.

2.50 Overall, the proposals would help firms conduct CSA that is embedded in their risk management and inform more effective decision-making processes, and as a result mitigate the risks of firms remaining exposed to climate-related risks not captured or adequately assessed.

Scenario analysis and calibration

2.51 The PRA has observed that some firms lack adequate understanding of the scenarios they use, including the assumptions and limitations of toolkits provided by external suppliers. The PRA has seen examples of firms relying on inadequate scenarios and reaching conclusions without considering the limitations of their CSA models and toolkits. As a result, CSA does not currently play an effective role in supporting firms’ decision-making. Further, inadequate application of CSA results leads in some cases to poorly supported conclusions that climate-related risks are immaterial for the firm. The resulting poor risk identification and assessment poses risks to firms due to the underestimation of climate-related impacts they are exposed to.

2.52 The PRA proposes that firms develop appropriate understanding of the CSA models and toolkits they use to inform their effective application. Firms using quantitative scenarios would be expected to evaluate the assumptions and calibration of scenario components and their coherence with the scenario narrative and to understand the level of severity of a given scenario among the range of plausible outcomes. Firms would be expected to calibrate and tailor scenarios according to their objectives and specific use-cases, and as proportionate, seek to explore novel and complex climate-related threats.

2.53 This proposal sets out more detail to provide firms with clearer expectations for conducting well-designed CSA and interpreting the results with adequate understanding of associated caveats and uncertainty. The proposed updated expectations would mitigate the risks from firms incorrectly assessing their level of exposure to climate-related risks due to conducting inadequate CSA.

Scenario governance, controls and review

2.54 CSA approaches continue to develop and mature over time. However, in the PRA’s engagement with firms, it is evident that firms vary in their practices, and some continue to rely on scenarios provided by external suppliers without appropriate adaptations and updates.

2.55 The PRA proposes that firms regularly review and update their scenarios in line with modelling and scientific advancements and the changing nature of risks to the firm, and that the board ensures adequate resources are allocated to that end. In line with the proposals on governance (see paragraphs 2.9–2.12), the board and management body would be expected to have an adequate understanding of the CSA, including of the limitations of the models and toolkits used and the main sources of uncertainty, to inform their interpretation and use of the results. Where appropriate, firms would be expected to conduct sensitivity analysis of their model choice and calibration. The PRA proposes that firms using management actions to mitigate their climate-related risks would be expected to consider whether these are realistic.

2.56 This proposal is in line with the existing PRA expectations on model risk management for banks^{footnote [18]} and insurers.^{footnote [19]} It provides clarity on how these expectations should be applied to CSA, reflecting the distinctive characteristics of climate-related risks, and on the specific relevance of updating CSA models and toolkit in line with continuously evolving scientific understanding and modelling capabilities.

2.57 Overall, the proposed expectations would mitigate the risk of firms and boards relying on inadequate assessments of their climate-related risks due to them failing to implement the necessary steps to ensure their CSA models and toolkits are regularly reviewed and updated as appropriate.

Chapter 4: Data 

2.58 The PRA has observed that data gaps remain a significant challenge in firms’ management of climate-related risks. Adequate climate-related data and associated data architecture are essential foundations for all the core areas identified in the proposed SS. This includes data gaps where firms have not sufficiently invested in the necessary data tools and frameworks. It also reflects that in some cases appropriate and reliable forward-looking data and disclosures for climate-related risk management are not yet readily available. These proposals are in line with guidance related to data outlined for firms in the PRA’s Dear CEO and Dear CFO letters as well as the BCBS Principles.

2.59 The proposals should enable firms to explain how they identify and assess any data gaps and quantify the consequent uncertainty in their assessments and reflect this when setting risk appetite and developing risk management tools. A helpful CFRF guide on climate-related data and metrics is available to support this work.^{footnote [20]} 

Contingency solutions for data gaps 

2.60 The PRA has observed that firms continue to flag data availability and quality as obstacles to the determination of their view on climate-related risks. Such data gaps should not prohibit a firm from developing interim and end-state climate-related risk management capabilities. 

2.61 The PRA proposes that where data gaps have been identified and can be remedied by further investment in data tools, frameworks and capabilities, firms should have in place strategic plans to manage and close those gaps. Where reliable or comparable climate-related data are still not available, firms should have in place contingency solutions that use appropriately conservative assumptions and proxies as alternatives as an intermediate step to ensure they meet end-state expectations. This can help ensure that firms have solutions in place to support effective risk management in the interim, as firms continue to work on end-state solutions.

Governance of data provided by external suppliers

2.62 In the PRA’s engagement with firms, it has observed that most firms are reliant on externally supplied data, with different practices across firms in overseeing use of such data, and varied progress across firms in developing their own internal models and systems.

2.63 The PRA proposes that where firms rely on external data providers, they should have an effective system of governance to oversee and integrate the data provided. In addition, it is proposed that firms should plan their strategic development of in-house capabilities over both the short and long-term. 

2.64 The proposals should improve oversight and controls on the use of external data, aligning this with existing PRA policies on third-party risk management, and improving the reliability of CSA and risk management for decision-making.

Data aggregation

2.65 The PRA proposes that firms should have systems in place to collect and aggregate climate-related risk data as part of their overall data governance and IT infrastructure with processes to ensure that the aggregated data are accurate and reliable, in line with the approach to proportionality set out in paragraphs 1.28–1.32.

2.66 This proposal builds on the expectations in Chapter 2 related to risk reporting (see paragraphs 2.32–2.34). It aligns with BCBS Principles to ensure that risk data aggregation capabilities and internal risk reporting practices account for climate-related risks. 

Chapter 5: Disclosures

2.67 The PRA is not proposing substantive changes to the expectations on disclosures in SS3/19.

2.68 There have been significant developments in other bodies’ climate disclosure frameworks since the PRA published SS3/19. The International Sustainability Standards Board (ISSB) was established to develop standards for a global baseline for sustainability reporting, and has issued its first two standards – including a standard on climate. The Task Force on Climate-related Financial Disclosure (TCFD) was disbanded, and its recommendations were incorporated into the new ISSB standards. The UK Government has established a framework to create UK Sustainability Reporting Standards (SRS), based upon ISSB standards. Once the process for UK endorsement of the ISSB standards is sufficiently advanced in 2025, the Financial Conduct Authority (FCA) intends to consult on amending its disclosure rules to move from TCFD recommendations to UK SRS for UK-listed companies. The Government will consult and decide on disclosure requirements against UK SRS for UK companies that do not fall within the FCA’s regulatory perimeter.

2.69 To bring the PRA’s expectation in line with these developments, the PRA is proposing to remove a reference to TCFD recommendations and to add a reference to UK SRS (subject to the finalisation of the UK endorsement process).

2.70 The Bank has been a strong supporter of the development and adoption of ISSB standards and supports the UK framework for the development of UK SRS. High-quality, comprehensive and consistent climate disclosures should support transparency and market discipline over firms’ exposure to and management of climate-related risks. Climate disclosures that are integrated with firms’ financial reporting should allow users to understand how climate-related risks have been factored into, and may affect, firms’ balance sheets, earnings and, particularly for banks, regulatory capital.

2.71 The broader proposals in this consultation should strengthen firms’ ability to produce high-quality decision-useful disclosures based on ISSB standards:

• Chapter 1 (Governance) and Chapter 2 (Risk Management) align with the core pillars of the ISSB standards.
• Chapter 3 (Climate Scenario Analysis) aligns with the ISSB principle of disclosing information that enables users to understand the resilience of a firm’s strategy and business model, by providing firms with clearer expectations for conducting well-designed CSA.
• Chapter 4 (Data) aligns with the ISSB principle of using reasonable and supportable information and, together with enhances in disclosures across the economy, should help firms access the data needed for effective disclosure.
• Chapter 6 (Banking-specific issues) aligns with the ISSB principle of connectivity, by encouraging integration of climate-related risks within financial reporting.

2.72 Other than the change of reference from TFCD to UK SRS, the PRA is not proposing any other changes to disclosure expectations in this consultation. The PRA is aware of concerns that a proliferation of new disclosure requirements by multiple regulators is likely to place operational strain on banks, which could undermine the quality of disclosure and result in user overload and so does not intend to add this. Firms need sufficient time to implement existing and new disclosure requirements introduced through corporate reporting.

Chapter 6: Banking-specific issues

2.73 The proposals in this chapter contain expectations concerning aspects of managing climate-related risk that are specific to banks. While there is considerable overlap between banks and insurers in terms of the management of climate-related risks, specific differences in their business models and regulatory requirements should be considered independently.

2.74 The proposals provide clarity on how to apply existing PRA policies and expectations related to financial reporting, ICAAP,^{footnote [21]} Internal Liquidity Adequacy Assessment Process (ILAAP),^{footnote [22]} and credit risk, market risk^{footnote [23]} and reputational risk for climate-related risks.

Climate-related considerations for financial reporting

2.75 Accounting values are foundational to the banking capital framework. SS3/19 did not provide expectations on how banks should include climate-related considerations in their financial reporting. The proposed SS is intended to address this gap to reflect the importance of high quality and consistent accounting of climate-related risk by banks for effective supervision.

2.76 The Bank of England’s 2023 report on climate-related risks and the regulatory capital framework explained that the development of capabilities to support high quality and consistent accounting practices for climate-related risks will help mitigate the risk of gaps in the capital framework, and the PRA will play an active role in promoting high quality and consistent accounting for climate change. The PRA’s Dear CEO letters and Dear CFO letters^{footnote [24]} set out the importance of firms enhancing their climate-related data and modelling capabilities, governance, and controls for financial reporting.

2.77 The proposals have been informed by the PRA’s findings from reviews of written auditor reports, discussion with auditors and firms, and thematic projects. The PRA’s thematic findings for selected UK banks have been set out in previous Dear CFO letters. The proposals have been adapted to reflect both the range of firms in scope of this CP and accounting frameworks in use in the UK.

2.78 The PRA proposes that banks should have appropriate processes in place to ensure timely capture of climate-related risks for financial reporting purposes, subject to effective governance. This includes proposing that firms consider the way responsibilities are allocated in the financial reporting function and ensure that appropriate personnel and processes are in place to oversee the capture of climate-related risk for financial reporting.

2.79 The PRA proposes that firms include processes and controls to source, manage and enhance the data needed to factor climate-related risk into balance sheet valuations, and to introduce suitable controls for data quality (see paragraphs 2.60–2.64).

2.80 The PRA proposes that firms should have sound practices and policies for assessing and measuring the impact of climate-related risk in their financial statements in accordance with accounting standards, including ensuring that relevant climate-related risk drivers are identified and assessed. In addition, the PRA proposes that firms should ensure climate-related risk is sufficiently considered in accounting policies for new and existing products, including tracking exposure to instruments with climate-linked terms.

2.81 The PRA proposes that banks consider the practices and policies necessary to be able to identify climate-related risk drivers of expected credit losses (ECL) so they can recognise climate-related risk within ECL in accordance with applicable accounting standards (including as they inform economic scenarios and weightings). Firms should also consider processes needed to enable the challenge of the ECL calculation and inform use of post-model adjustments, and controls needed to enable review and monitoring of how climate-related risk drivers have been incorporated into ECL calculations. The PRA also proposes that firms engage in a periodic review of these processes, identifying any data requirements needed to effectively factor climate-related risk drivers into loan-level ECL estimates.

2.82 The proposals are expected to enhance the way that banks consider climate-related risks in their financial statements in accordance with relevant accounting standards. They do this by setting expectations for how firms should have appropriate: governance, controls over data, and processes and practices for considering climate in balance sheet valuations and, where relevant, ECL.

Assessment of capital for climate-related risks in the context of ICAAPs

2.83 The PRA has observed that many firms do not provide sufficient contextual information for supervisors to understand how they have arrived at their estimates of the scale of the risks they face arising from physical and transition risks. This could lead to a risk that firms may not be adequately capitalised.

2.84 The PRA proposes that banks should provide information about how they have determined the materiality of climate-related risks in their ICAAPs, as well as methodologies, assumptions, judgements, proxies and subsequent uncertainties used in assessing climate-related risk for the purposes of ICAAPs.

2.85 The proposals will lead to ICAAPs capturing a more complete consideration of climate-related risks, with clearer expectations for a firm’s assessment of material climate-related risks or the basis for judging that no material risks exist (reflecting climate-related risk remains a known unknown for many firms). Where firms have made an assessment of material climate-related risks, the proposals will also ensure that the firm is appropriately capitalised for this. These proposals align with the BCBS Principles.

Liquidity and funding risk

2.86 The PRA has observed that some banks are already assessing the impact of climate-related risks on liquidity adequacy as part of the ILAAP set out in SS24/15.^{footnote [25]} Banks should continue to use the ILAAP as the key framework within which to consider the liquidity risks from climate change.

2.87 The PRA proposes that where material and appropriate, banks should incorporate the impact of climate-related risks into their calibration of liquidity buffers and into their liquidity risk management frameworks. Where not considered material, firms should be able to evidence the reasons for this judgement.

2.88 The PRA also proposes that assessments of the impact of any material climate-related risks on net cash outflows or the value of assets comprising their liquidity buffers inform the level of liquidity that banks should hold in order to meet the PRA’s Overall Liquidity Adequacy Requirement.^{footnote [26]}

2.89 The PRA’s proposals should lead to banks assessing and reflecting climate-related risks into their funding and liquidity adequacy assessments. These proposals align with the BCBS Principles.

Management of climate-related credit risk

2.90 The PRA has observed a high degree of variability in the quality of firms’ credit risk management capabilities for climate-related risks. In addition, the PRA has noted that corporate client risk assessments are a key tool that many firms still do not employ appropriately for measuring and evaluating climate-related credit risks.

2.91 The PRA proposes that banks should have clear processes and policies to identify, measure, monitor and mitigate climate-related credit risks, including integrating climate considerations into credit risk assessments, evaluating climate-related risks across the credit life cycle and evaluating how these risks may impact their ability to recover loans. The PRA also proposes that firms consider how to approach climate-related concentration risk and proposes a non-exhaustive list of mitigants.

2.92 The PRA proposals should lead to effective integration of climate into credit risk frameworks, leading to more effective credit risk management overall. These proposals also align with the BCBS Principles.

Management of climate-related market risk

2.93 The PRA has observed a large variability in the quality of firms’ climate-related market risk management capabilities, often with considerable differences not only between firms, but also between business lines within firms.

2.94 The PRA proposes that firms should understand how climate-related risks translate into market risks through, for example, price volatility related either to physical events or changes in expectations around transition pathways. The proposals also raise the issue of historical correlations changing under climate-related risk, which can affect firms’ ability to hedge their positions efficiently. The PRA proposes the use of scenario analysis as an important tool for measuring and managing the market risk arising from climate change.

2.95 The proposals should lead to effective integration of climate into market risk frameworks, leading to more effective market risk management overall. These proposals are also in line with the BCBS Principles.

Reputational risks

2.96 The PRA also proposes that banks should understand the impact of climate-related risk drivers that may increase strategic, reputational and regulatory compliance risk, as well as liability costs associated with climate-sensitive investments and businesses. These risks can have a significant impact on business strategy setting and testing. The proposals also highlight links between these risks and the proposals in Chapter 1: Governance.

Chapter 7: Insurance-specific issues

2.97 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 scenario analysis by many insurers.

2.98 The proposals in this chapter set out in more detail the PRA’s expectations of how insurers should include climate-related risks in their risk management frameworks, and for those insurers subject to the relevant obligations, in their ORSA in the calculation of their solvency capital requirement (SCR) and in preparing their Solvency II balance sheet. The proposals clarify existing expectations connected with climate-related risks. They also build on the proposals on risk management and use of scenario analysis applicable to all firms set out in Chapters 2 and 3 that apply to all firms. These proposals align with the latest developments in standards and guidance supporting the ICPs made by the IAIS and the advice provided in its Application Paper.

Integrating climate-related risks in insurers’ risk management frameworks

2.99 In its engagement with insurers, the PRA has observed that insurers can sometimes underestimate the impact of climate change. Some insurers are still in the process of embedding climate-related risk within their risk appetite statements including both qualitative and quantitative measures.

2.100 The PRA proposes to clarify its expectations for the risk management framework for insurers to reflect climate-related risks (eg impact on technical provisions and assets). This is to ensure that the existing risk appetites that insurers have set to manage their current natural catastrophe, non-natural catastrophe and asset risks do not underestimate the impact of climate change. The expectations would also facilitate the process of embedding climate-related risk within insurers’ risk appetite statements, including both qualitative and quantitative measures.

Integrating climate scenarios in insurers’ ORSAs

2.101 In its engagement with insurers, the PRA has observed that insurers’ ORSAs do not always assess the potential impact of climate change with sufficient depth or granularity.

2.102 The PRA proposes to clarify that ORSAs should include climate scenarios when climate-related risks are material. The PRA proposals clarify its expectations of the different time horizons of the risks to be captured in an insurer’s risk management framework, ORSA and SCR for climate-related risks.

2.103 The PRA proposes to clarify that it expects insurers to detail the investment and underwriting changes they would make in response to climate-related risks and what metrics and indicators they would monitor to inform those decisions and their timing. Regarding underwriting, this proposal is particularly relevant for non-life insurers who can quickly reduce coverage or reprice given the annual nature of their policies.

2.104 The PRA’s proposals seek to strengthen the robustness of the management actions insurers may need to take to manage risks to their business model, in addition to ensuring the PRA is sighted on those risks and management actions.

Integrating climate-related risks in insurers’ SCR

2.105 In its engagement with insurers, the PRA has observed that insurers’ SCRs do not consistently reflect the impact of climate-related risk in all relevant risk categories. Moreover, not all insurers are able to explain how the material climate-related risks are appropriately capitalised following guidance in the 2022 Dear CEO letter.

2.106 The PRA proposes to clarify that SCRs should reflect the impact of climate-related risks on underwriting, reserving, market, credit and operational risks, where relevant. While the existing regulatory framework is already comprehensive enough to cover climate-related risks implicitly, this proposal seeks to clarify this expectation and reaffirm how climate should be considered through the relevant risk components.

2.107 The proposal aims to ensure that capital requirements do not underestimate the impact of climate-related risks on those risk categories over the time horizon of the risks captured in the SCR. No new additional capital requirements – ie beyond those required by the PRA’s Solvency II SCR Rules – are being imposed on insurers from these proposed clarifications.

Reflecting climate-related risks on insurers’ regulatory balance sheet

2.108 In its engagement with insurers, the PRA has observed that insurers’ valuations of assets and liabilities are not always consistent regarding the inclusion of climate-related risk.

2.109 With Own Funds, SCR and supervisory actions being based in part on the Solvency II balance sheet, the PRA proposes to clarify its expectations of assets and liabilities to include climate-related considerations. Where Eligible Own Funds benefit from Matching Adjustment (MA), the PRA proposes to clarify its expectations regarding credit assessments and MA attestations.

2.110 This proposal aims to ensure that insurers’ solvency ratios appropriately reflect climate-related risks, and therefore do not overstate the capital position of insurers.

3: PRA objectives analysis

3.1 This chapter sets out the PRA’s assessment of its statutory obligations in relation to the proposals in this CP.

Primary objectives

3.2 Improving firms’ identification, assessment and management of climate-related risks would advance the PRA’s primary objective to promote the safety and soundness of the firms that it regulates and contribute to securing an appropriate degree of protection for policyholders. The physical effects of climate change and the transition to a net zero emissions economy could have a material impact on firms’ solvency. This may also affect both the safety and soundness of individual firms as well as the robustness of the financial system as a whole. In the absence of the updated expectations in this CP, it is possible that firms would not identify or appropriately manage climate-related risks in a timely manner as the risks grow.

3.3 As supervisory reviews have evidenced, even the largest and most advanced firms still have further to go with building capabilities to effectively identify and quantify climate-related risk. The PRA has communicated to firms that while they have made progress in relation to most of the expectations outlined in SS3/19, there is still a substantial gap between firms’ current capabilities and the standard required to identify and manage climate-related risks effectively. Therefore, all firms need to make progress to integrate climate-related risks into effective risk management.

3.4 The proposals are designed to provide greater clarity to firms about how they are expected to improve their capabilities to manage climate-related risks, building on the expectations outlined in SS3/19 and supporting firms’ steady but slow development of climate-related risk identification and management abilities. The proposals add detail compared to the expectations in SS3/19 and combine the PRA’s various public statements on climate-related risk in a single set of proposals. The PRA expects that these proposals would improve the resilience of firms to climate-related risks by providing a more rigorous and coherent approach to risk identification and management.

3.5 The proposals further align the PRA’s expectations with international standards, and to evolving science and understanding around climate change and climate-related risks to PRA-regulated firms that the PRA has observed since the publication of SS3/19.

3.6 In addition to the expectations for all firms, the proposals contain specific expectations for insurers on the management of climate-related risks, which contribute to securing an appropriate degree of protection for insurance policyholders. This includes, among others, the expectations regarding underwriting and reserving risk, and considerations around potential accumulations of claims.

Secondary objectives

Competition (SCO)

3.7 The secondary competition objective (SCO) requires the PRA to facilitate effective competition in the markets for services provided by PRA-authorised persons in carrying on regulated activities.

3.8 Importantly, the proposed SS embeds proportionate prudential standards for climate-related risks. As set out in paragraphs 1.28–1.32, the application of the expectations focuses on effective and proportionate risk identification, assessment, and management processes to determine the risks firms are exposed to. This should help facilitate effective competition in the financial markets for services provided by firms by ensuring prices of financial products more appropriately reflect the underlying risk.

Competitiveness and growth (SCGO)

3.9 The SCGO requires the PRA to act, so far as reasonably possible, in a way that facilitates, subject to aligning with relevant international standards, the international competitiveness of the UK economy and its growth over the medium to long term.

3.10 The PRA considers that there is a clear link between alignment with international standards and the relative standing of the UK, and that adherence to international standards underpins the UK’s position as one of the largest global financial centres.

3.11 The proposals bring the PRA’s expectations to manage climate-related risks into closer alignment with the BCBS Principles for the effective management and supervision of climate-related financial risks, and the latest developments in standards and guidance supporting the ICPs made by the IAIS and the advice provided in its Application Paper. The proposals are also in line with many other jurisdictions’ approaches. However, in some areas, the PRA’s proposals provide greater detail to give firms clarity and support in building out capabilities, eg outsourcing, the use of CSA and data by external providers. Financial services firms and other stakeholders rely on internationally aligned standards, and the resulting stability and predictability, when they choose to conduct their business in the UK. The PRA considers that updating SS3/19 to achieve a closer degree of alignment with relevant international standards should have a positive impact on the SCGO.

3.12 Incorporating more complete assessment and management of the impacts from climate change into business strategy may support competitiveness by helping firms to be better positioned to identify sustainably profitable opportunities in climate-transition financing and insurance and avoid losses as climate impacts grow and the economy transitions.

3.13 Enhancing individual firms’ safety and soundness could reduce the impact of climate driven shocks on the UK financial system and resulting knock-on impacts to the real economy. Since it is well documented that large one-time negative macroeconomic shocks – such as those that could arise from the crystallisation of transition or physical risks – can reduce growth in the medium term, the proposed SS could also lead to a more stable medium-term growth path for the UK economy.

3.14 Due to the proportionate approach embedded in the proposals, firms without material climate-related risk would incur the one-off cost of determining that risk to be immaterial, but they would not incur any ongoing cost. These firms would therefore not be affected in the medium term, and their growth path would remain unchanged. Firms that find that they face material risk will incur ongoing costs, but only insofar as prudently managing that risk requires incurring that cost. This risk management cost can be seen as an investment in medium-term firm growth, since as risks crystallise, firms might be able to better anticipate or manage related losses and opportunities.

4: Cost benefit analysis (CBA)

4.1 This section lays out the CBA that the PRA conducted for these proposals. Reflecting the novel and complex nature of these risks, the PRA has undertaken extensive analysis of the benefits and costs of its proposals. Where it is reasonable to do so, the PRA has produced quantitative cost estimates. Where the PRA considers it would not be practicable or possible to quantify costs and benefits, those costs and benefits are described qualitatively.

CBA panel

4.2 The PRA consulted the PRA’s CBA Panel on its CBA. The Panel challenged the PRA’s analysis, provided valuable feedback and suggested several additions and changes, which are reflected in this CP. The PRA appreciates the Panel’s contribution to this publication. Three core challenges identified by the panel were:

• Market failures and case for regulatory action – the Panel noted that, absent market frictions, profit maximising firms would be expected to have an incentive to incorporate climate-related risk into their business strategy. The Panel recommended that the PRA expand and clarify its analysis of market failures that could explain why firms have not gone further in identifying and managing climate-related risk without regulatory intervention.
  
  In response, the PRA has highlighted below the information gaps around climate change, noting that where market participants lack market-relevant information, markets are not guaranteed to function efficiently. This is especially relevant in the context of identifying and managing climate-related risk, where firms do not yet have established risk management systems in place and past data are less useful as a guide to future risk exposure.
  
  In addition to this, the PRA expanded its discussion of a key coordination failure present in the context of climate-related risks – while firms bear the cost of improving risk identification and management today, the benefits only materialise in the future, as climate-related risk crystalises. This can make firms unwilling to invest now, particularly if their competitors are not incurring similar expenses at the same time.
  
  
• Supervisory evidence – the Panel asked for more information regarding the supervisory evidence underpinning the PRA’s assessment that firms need to improve their climate-related risk identification and management capabilities. The PRA incorporated this feedback by including additional supervisory observations on climate-related risk identification and management (see Box B).
• Transmission channels – the Panel suggested the PRA expand its discussion of the distinction between different kinds of climate-related risk (eg physical and transition) and how these impact different types of firms (eg banks as compared to insurers, and life insurers as compared to general insurers (GIs)), as well as highlighting the most relevant transmission channels across these different types of firms.
  
  In response, the PRA has added more detail on physical and transition risks and how these translate into risk categories that are relevant to banks and insurers (see Box A).

The case for action: Firm capabilities and market failures

4.3 The PRA observes that firms’ ability to identify and manage climate-related risks is still relatively under-developed. See Box B for additional detail on these observations.

There are three core climate-related market failures, some associated with negative externalities, which might explain firms’ not fully embedding PRA expectations, and which regulatory intervention can help address.

• The PRA considers that firms may not have taken climate-related risk sufficiently into account due to information gaps. When market participants lack information – in the case of climate-related risk, information on the risk exposure of certain assets or investments – markets are not guaranteed to deliver an efficient outcome due to these information frictions.^{footnote [27]} Information gaps can arise in the climate context because climate-related risk is a fairly novel and complex risk. Firms do not (yet) have sufficiently robust systems in place to identify and quantify it, and relying purely on past data to project future risk is unlikely to work well because climate change makes past data less informative about future risks. Climate-related risks thus contrast with other, more familiar sources of risk for which firms have established assessment and management tools.^{footnote [28]} This lack of information about climate-related risks can lead to an inefficient allocation of capital, since firms might make investments under the assumptions that certain assets carry less risk than they actually do, thus investing more capital into these assets than firms would if they were fully aware of the associated risk. Likewise, firms might miss the opportunities of investing in some assets with a higher demand under the net zero transition, thus potentially investing less capital into those assets than they otherwise would.^{footnote [29]}
• In addition, given that the most significant impacts of climate-related risk are likely to occur in the future, this risk is less immediate for firms than other risks, diminishing the perceived urgency to act in day-to-day firm operations – the ‘tragedy of the horizon’.^{footnote [30]}
• Relatedly, firms face short-term competitive pressures, which disincentivise them from incurring the costs of improving their climate capabilities and systems when competitors are not making similar efforts, even if in the medium term, this investment might pay off, especially if undertaken by all firms in the market – a coordination failure.

4.4 Taken together, these three market failures can lead to inadequate identification and management of climate-related risk, as the PRA observes in practice and as is supported by academic research.

4.5 Research has found that rather than taking a strategic view of climate-related risks, firms can be affected by the salience of specific natural disasters and can react in haphazard ways to these events rather than making long-term adjustments to their business strategy. For example, a natural disaster in one market can lead to temporary hikes in loan spreads for borrowers in other markets not directly affected by the disaster, but potentially at risk of future similar disasters. This suggests that firms had not already priced in the likelihood of such an event, eg, using climate projections. Additionally, the temporary nature of the hikes suggests that these pricing decisions are not a result of the risk of future similar disasters. Instead, they are a short-term reaction to one specific event, potentially without the benefit of longer-term learning and pricing adjustments. Furthermore, loan spread hikes are amplified by media attention to such disasters, again suggesting that firms may overreact to some climate-related shocks and miss others.^{footnote [31]}

4.6 Taken together, this suggests firms are not yet proactively incorporating the future likelihood of climate driven shocks in prices – otherwise, loan spreads would not react to such shocks in this way. Firms appear to be reacting to events in real time, potentially leading to sudden price adjustments in the wake of future events.

4.7 Gaps in firms’ climate-related risk identification and management expose firms to the risk of future losses, which could undermine their safety and soundness, and, in the case of insurers, protection for policyholders. The PRA’s proposals address these gaps.

The counterfactual and assumptions

4.8 The baseline of the CBA is what might happen if the PRA were not to introduce the policy proposals in this CP. Under this baseline, the existing expectations set out in SS3/19 would continue to apply, and the current situation – with notable shortcomings in firms’ climate-related risk identification and management practices – would persist, at least in the short to medium term. The consequences for firms and the financial system would become magnified as the impacts of a changing climate continue to materialise and the net zero transition advances.

4.9 This CBA lays out the PRA’s assessment of the incremental costs and benefits that the proposals generate compared to this baseline. The CBA aims to capture changes in firm behaviour that would not take place without the updated proposals.^{footnote [32]}

4.10 Under the proportionate approach to implementation of the PRA’s proposed expectations, described above, firms for which climate-related risk is immaterial would not incur the ongoing costs of managing those risks. For the purposes of the estimation of the total direct compliance cost of these proposals, however, the PRA has conservatively assumed that all firms would assess climate-related risk to be material, and hence that all firms would incur both one-off and ongoing costs. In reality, it is of course likely that some fraction of firms assess climate-related risk to be immaterial to their business case – this assumption should therefore not be seen as the PRA’s assessment of the materiality of climate-related risks across PRA-regulated firms. Rather, this assumption serves to make the estimate of total direct compliance cost in this CBA a very conservative estimate – an estimate of the upper bound of total direct compliance cost.

4.11 The CBA assesses the firm-level costs and benefits of implementing the proposals based on the PRA’s assessment of firms’ observed baseline practices, and under the assumption that firms face climate-related risks (that is, assuming firms have to incur both one-off and ongoing costs). The CBA calculates different costs for firms of different sizes, as well as for banks and insurers. The CBA does not, however, include detailed, firm-by-firm variation in costs and benefits arising from the precise differences in each PRA-regulated firm’s progress to meet existing expectations. As a result, the firm-level cost calculations (as opposed to the total cost estimate, which as discussed above, is very conservatively estimated) and benefit assessment for a bank or insurer of a given firm size should be seen as an estimate of the average firm-level cost and benefit for banks or insurers of that size, if they are materially exposed to climate-related risk (eg, an estimate of the average costs for medium-sized banks with material climate-related risk exposure).

4.12 The realised costs for some firms may, in practice, be somewhat larger or smaller depending on their exact set of current practices. Importantly, costs and benefits are correlated at the firm level – firms that are currently somewhat further along in identifying and managing climate-related risks stand to benefit less from the proposals, but also face lower compliance cost. Therefore, this variation does not affect the overall assessment of whether the benefits outweigh the costs of the proposals.

4.13 The estimates in this CBA are uncertain due to the PRA’s imperfect information about the full state of firms’ climate-related risk assessment and management capabilities. Firms are encouraged to provide information that would enable the PRA to refine its estimates as part of the consultation. The estimates are based on the following key assumptions:

• The proposals will lead to firms better identifying and managing climate-related risks.
• Climate scenarios will be more appropriately designed, targeted and understood by firms.
• The material risks identified in risk assessment activity, including use of scenario analysis, will be used to inform firms’ decision-making.
• Firms will comply with the proposals by:
  • Largely using existing risk management technology and tools, and building in-house capacity on climate-related risks, especially around climate scenario analysis (CSA). There may be some support from external information providers and specialist industry groups to develop understanding of climate-related risks (eg, the Climate Financial Risk Forum (CFRF)).
  • Accessing relevant data both internally (eg, to be able to capture specifics of their portfolio and its exposure, such as locations of counterparties to assess physical risk) and via external data providers (eg, to collect data on physical risk exposures across relevant areas).
  • Drawing on internal and external research to understand climate-related risks and their evolution.

4.14 The compliance cost estimates assume that larger and more exposed firms are more likely to develop climate-related risk identification and management solutions in-house, while firms with less material or less imminent risks would be able to draw on more widely available and cost-effective off-the-shelf solutions.

Changes to firm behaviours and engagement with supervision

4.15 To comply with the proposed expectations, firms are expected to adopt more robust CSA and improved climate-related risk management, and incorporate material climate-related risk into firm strategy via governance structures, as applicable. Given the need for all three changes in behaviour in coordination with each other, the PRA considers the benefits of the combined proposals in full, rather than considering the benefits of specific provisions.

4.16 Implementation of the proposals would mean firms’ investment strategies more clearly incorporate climate-related risk. Where firms were previously unaware of being exposed to material climate-related risk, a better understanding of that risk should lead to exposures more accurately reflecting firms’ risk appetite. This could happen through firms managing down assets previously thought to be safe but now found to be riskier due to improved climate-related risk assessment (eg, assets in sectors that might shrink due to the net zero transition, or assets located in regions heavily exposed to physical risk). Alternatively, it may occur through firms investing more in assets that provide climate-related opportunities, eg, assets required for the UK’s and global net zero transition (such as renewables or green innovation financing).

4.17 The PRA recognises the considerable uncertainty in firms’ behavioural response to the policy. Different firms may choose to take different courses of action in their pricing, lending, product design, and other market engagement following better identification of climate-related risk.

4.18 Further, in line with the PRA’s approach to supervision,^{footnote [33]} the proposed expectations add detail, which could provide the basis for more productive supervisory engagement.^{footnote [34]} Without the added clarity, firms and supervisors could disagree on the correct interpretation of high-level expectations, which could lead to exchanges that are not productive for either supervisors or firms.

Benefits of the proposals

4.19 The PRA has analysed the benefits qualitatively. It has not been possible to assess the benefits quantitatively because the magnitude of the benefits depends on uncertain future physical and transition climate risks. In addition to this, quantifying the benefits would also require detailed information about firms’ exposures to climate-related risk factors, which will vary significantly by business model. Such data are not available to the PRA. Due to the uncertainty inherent in climate-related risk, it is uncertain which of these benefits would materialise when, and what the relative likelihood and magnitude would be for different firms. This is an important caveat and this uncertainty is recognised throughout the CBA.

4.20 Incorporating better climate-related risk assessment and management into business strategy should help firms to manage at least part of the anticipated climate-related risk losses to the UK financial system (estimated at £6.7 billion/year).^{footnote [35]} Firms should also be better positioned to identify opportunities around climate-transition financing and insurance,^{footnote [36]} and to more accurately price in climate-related risk.^{footnote [37]}

4.21 By including climate-related risk in pricing and transaction decisions, and by being able to capitalise adequately for climate-related risk losses, firms’ individual safety and soundness should improve as a result of increases in their resilience to climate-related risk and associated shocks.

4.22 Specifically for insurers, the proposals set out clear expectations on appropriately assessing and adequately capitalising for climate-related risks in ORSA and SCR calculations. The proposals thus aim to advance policyholder protection, for example, by ensuring that insurers’ liabilities to policyholders can be met both now and in future.

4.23 Improved firm capabilities around climate-related risk may increase consumers’ and counterparties’ confidence in PRA-regulated firms, although this depends on the public’s perception of current climate-related risk management.

4.24 Firms adjusting their portfolios as a result of implementing the policy expectations could affect asset prices. Transition-related assets (eg, innovation-related financing or renewables) could increase in value and/or volume traded, eg, due to an increase in demand. This would confer a benefit on the current holders of those assets and improve access to finance for some borrowers. For example, mortgage holders who climate-proof their houses (eg, by providing good insulation or installing more efficient heating or cooling systems) might face lower mortgage rates (eg, due to an expectation that such households’ income is less vulnerable to changes in energy prices). Moreover, companies engaged in research and development around climate mitigation or adaptation, or some especially low carbon emitters (eg, renewable energy producers) might face lower costs of funding.

4.25 Enhancing individual firms’ safety and soundness, ie, firms’ resilience to physical and transition risks, could reduce the impact of climate driven shocks on the UK financial system and resulting knock-on impacts to the real economy. The proposals could thus help to mitigate a negative externality to the financial system and the wider economy. Since it is well documented that large one-time negative macroeconomic shocks – such as those which could arise from the crystallisation of transition or physical risks – can reduce growth in the medium term, the proposals could also lead to a more stable medium-term growth path for the UK economy.^{footnote [38]}

4.26 It is possible that through firms proactively engaging with climate-related risk, the UK’s net zero transition becomes more orderly. That is because risks might then be priced in with somewhat improved foresight, rather than being priced in abruptly and in a disorderly fashion as a response to shocks as risks crystallise. This would provide a benefit in the short term to the holders of related assets, as assets that stand to see price increases as risks crystallise (eg, adaptation measures to cope with more frequent extreme weather events) would see price increases today. It would also confer a benefit over the medium term, as climate-related risks crystallise, and sudden price changes and associated disruptions are avoided.

4.27 Integrating climate factors into day-to-day decision-making and pricing should enable firms to navigate evolving market dynamics as climate change increasingly impacts the economy and consumer behaviour. This could promote effective competition by ensuring prices of financial products more appropriately reflect the underlying risk and thereby facilitating more effective price competition among firms.

Costs of the proposals

4.28 The PRA has derived quantitative estimates for the direct compliance costs. These costs are assessed across the 407 PRA-authorised firms potentially within the scope of the proposals. This compromises 176 banks, building societies and PRA designated investment firms and 231 UK insurance and reinsurance firms and groups.

4.29 Incremental direct compliance costs arise primarily from the need for firms to make changes to meet expectations around CSA, risk management and governance. Note that these changes are the incremental costs of the proposals – for example, the additional person-hour requirements of incorporating climate-related risks in existing risk assessment frameworks, rather than the cost of redeveloping firms’ entire risk assessment and management system.

4.30 The PRA has estimated these compliance costs based on discussions with industry participants, supervisory insights, and use of the PRA’s standard cost model (SCM). The SCM helps quantify direct costs to firms using assumptions, including on average salaries, the person days required to implement a policy change, and technology or other costs on firms.

4.31 The PRA estimates the total annualised compliance costs in total across all firms at £45 million over 10 years, with £13 million accruing to insurers and the remaining £32 million to banks. Table 1 shows a breakdown of cost estimates across firm sizes, separately for banks and insurers.

4.32 Firms are likely to incur one-off costs to understand the proposals and conduct a gap analysis. The gap analysis will compare the PRA’s proposals against the firm’s current practices to understand the changes needed to implement the proposals. The one-off costs also cover the initial changes to firms’ systems and approaches to meet the expectations.

4.33 The estimated resources required will be driven by the nature, scale and complexity of the firm. For small firms, the key drivers of the one-off costs are the work required to integrate scenarios into risk management processes (including potential consultancy charges), and technology costs to cover importing climate data and developing risk registers, which would enable firms to make initial adjustments to their risk management systems. For larger firms, an important component of the one-off cost would be outside expertise to help with internal capacity building around climate-related risks, including data access and processing pipelines and scenario design. The estimate thus covers the incremental additional cost of the proposals – the cost of integrating climate-related risk identification and assessment into firms’ existing risk assessment frameworks, rather than the cost of developing risk assessment frameworks from scratch.

4.34 As noted in the discussion of the proportionality approach above, work on risk identification and management approaches will tend to scale with the complexity of a firm’s business, and costs incurred in responding to risk assessment will scale with the materiality of risks.

4.35 The incremental ongoing direct costs to affected firms arise from the estimated consultancy, technology and staffing costs needed to develop and maintain systems, access data, build and run models and integrate the outputs into their business decisions.

4.36 In addition to the compliance costs, some firms may face higher costs associated with additional capital being held for identified climate-related risk. Complying with the proposals may initially reveal that firms’ existing portfolios are misaligned with their risk appetite. Firms may choose to manage these newly identified risks either by holding appropriate capital against the risk or they may choose to reduce their exposure.

4.37 The majority of large insurance firms in the UK are already required to capture all material, quantifiable risk (rule 11.6 in the Solvency Capital Requirement – Internal Models Part of the PRA Rulebook). For the remaining insurers that use standard formula (SF), firms may be required to build an internal model if climate-related risk is material and is not sufficiently reflected in the capital requirements.

4.38 The PRA does not assess that it will incur any new costs from these proposals. As a result of firms implementing these proposals, the PRA anticipates increased supervisory effectiveness with supervisory resources being applied more efficiently.

4.39 There may be some indirect costs of the proposals. For example, firms adjusting their portfolios in response to improved assessment and management of climate-related risk could affect lending volumes and asset prices in the markets in which they operate. This might mirror some impacts of climate-related risk already observed in practice. For example, there is evidence that banks charge higher interest rates to companies more exposed to climate transition and physical risks and reduce their climate transition risk by shortening maturities and limiting access to financing for high emission firms impacted by cap-and-trade schemes.^{footnote [39]}

4.40 To the extent that the proposals lead to banks and insurers becoming more aware of their exposures to assets facing significant climate-related risk (eg, sectors that might shrink due to the net zero transition or assets located in areas heavily exposed to physical risk), there could be reductions in their holdings of these assets or how they price them. This would confer a cost on the current holders of those assets. For example, mortgage holders in areas especially prone to flood risk could face higher mortgage rates. Likewise, firms that are heavy carbon emitters, eg, firms in the fossil fuel sector, could face a higher cost of funding. This could in turn deter economic activities in those sectors.

4.41 Insurers taking climate-related risk into account appropriately could increase the premiums for some counterparties, eg, homeowner’s insurance in especially flood prone areas or liability insurance for companies at high risk of climate-related litigation, or even result in a complete loss of insurance availability. In the extreme, complete loss of insurance coverage and rising mortgage rates could lead to loss of mortgage availability in some localities of the UK. Currently, the Flood Re scheme acts as a counterbalance to upward pressure on homeowner’s insurance specifically.^{footnote [40]} If this or similar schemes continue to be in place, that would act to limit the upward pressure on premiums.

4.42 Firms pricing in climate-related risk could bring some of the eventual societal costs of transition and physical risk forwards in time, as asset prices would reflect the expectation of risk crystallisation in the future today. This would create costs in the short term, especially for holders of those assets, or banks holding such assets as collateral, and could create knock-on costs for the rest of the UK economy.

4.43 If this pricing adjustment happened over a short period of time, it could additionally create shocks to the UK financial system and potentially to the UK economy. However, the PRA expects that firms will require time to implement the proposals, and that this will vary across firms. This makes it less likely that all firms suddenly price in climate-related risk, and more likely that climate-related risk becomes priced in somewhat gradually. This reduces the likelihood of disruptions to the financial system.