CFRF unveils opportunity in climate risk

This week – 1 November 2021 – marks the beginning of COP26 in which a summit of world leaders will come together with a view to accelerate action towards meeting climate-related goals set out in the Paris Agreement and the UN Framework Convention on Climate Change.

It seems only fitting then that the UK’s Climate Financial Risk Forum (CFRF) has published a second set of industry guides to help the financial industry navigate climate-related financial risks.

What is the CFRF?

The CFRF had initially worked together to publish its first set of guides in June 2020. The guides are notoriously written by its industry members, for industry. The new iterations of the guides, also referred to as the “Session 2 guides” have been revised in order to continuously reflect industry best practice.

The CFRF is formed of five industry working groups, which have banded together to publish 10 new guides in total. The five working groups comprise:

Risk Management Working Group (RMWG) – designed to help financial organisations produce and implement risk appetite statements that integrate climate related financial risks. This includes providing training materials.

Scenarios Analysis Working Group (SAWG) – produces practical examples to show firms how to incorporate sector-specific points when developing an effective scenario analysis.

Disclosure Working Group (DWG) – collates case studies on climate-related disclosures to enable firms to develop their own disclosures and to understand any associated legal risks.

Innovation Working Group (IWG) – identifies opportunities to mobilise financial capital and oversee the economy-wide transition to meet climate targets. It has also produced a set of 7 short firms to highlight innovative approaches to mobilising finance in the transition to net-zero.

Climate Data and Metrics – recommends five areas where climate-related metrics could be employed:

1. Physical risk
2. Transition risk
3. Portfolio decarbonisation
4. Mobilising transition finance
5. Engagement

Scenario analysis for smaller firms

The CFRF’s Scenario Analysis Working Group is currently undertaking to develop an online climate-scenario analysis tool that could support smaller financial institutions. The tool will enable firms to input standard information regarding business activities, products, and risks in order to receive an output that defines their climate risks and opportunities.

CUBE comment

While the FCA and the PRA are at the helm of the CFRF discussions, they have made it clear that they do not accept any liability for the views expressed in the Session 2 guides. They are based on good practice and do no amount to regulatory guidance. It is interesting to note that the regulators are trying to distance themselves here and builds on a lingering question of how much teeth the regulators will be willing to use when governing and enforcing regulations for climate change and ESG.

Commenting on the new guides, the FCA’s Chief Executive, Nikhil Rathi noted that they “will help firms overcome some of the difficulties they’ve faced”. He added that, “Importantly, they also focus on innovation, so financial firms can see the opportunities, as well as challenges, from more effective climate-related financial risk management.”

This is a key point that is often overlooked. As climate risks emerge, the focus and perspective surrounding the topic is often a negative one. This is not unwarranted, of course. Firstly, the prospect of climate risks is worrying on a personal, societal, and economical scale. Those that are taking steps to tackle emerging climate risks often find themselves overwhelmed by a deluge of information, regulation, and expectation. Much like an onion, once you peel off the skin there are innumerable layers beneath. Moreover, those that are innovating or refreshing their product offering to cater for climate-risks often find themselves walking a tightrope between suitability, profitability, and possible greenwashing.

But, despite this complexity, there also lies opportunity. The renewed focus around climate and other ESG factors is inspiring a new form of business transformation, one that has longevity and that can manage emerging risk now, and in the future. For years, financial organisations have been at the whim of fractious ESG issues – failing corporate governance, unexpected devaluation of assets, unpredictable investments. If firms can harness ESG and climate change now, they lay the foundation of a financial business – and by extension a financial system – that is more robust and will stand the test of time, long into the future.

Alice Hill, a Senior Fellow for Climate Change Policy at the Council on Foreign Relations, and a speaker at our ESG Conference, once said that risk mitigation is no longer enough. We focus too much on the risks of the past as a model to manage our risks of the future. This, she suggests, is a failure of imagination. Instead, we need to focus on the things that haven’t happened yet – the unexpected risks of the future. Only then can we manage risk – especially climate risk – effectively.

CUBE solves complex regulatory compliance across all areas of business, from ESG to prudential and financial crime.