The role of the CRO in addressing financial climate risk

We discuss the impact climate change is having on risk in financial services and how the role of the chief risk officer is evolving as a result

The UK’s economy is in a transitional period to net zero carbon emissions in response to the UK’s legislated objective set last year. Despite the government’s agenda to drive climate change action on a national level, only one fifth (22%) of UK financial services firms have a well-developed strategy to manage the risks of climate change. In the past six months, we have seen this addressed by the financial regulators; both the PRA and the FCA have published reports and proposals for action, which in turn has highlighted the current underdeveloped state of financial climate risk functions across financial services firms.

In order to discuss this topic further, we spoke to Andrew Shiels, Maria Turner and Tim Davies, three of our highly experienced interim chief risk officers.

Andrew told me that, “climate change risk needs to be a present-day consideration. It is not a future concern; action must start now”. This has been one of the key messages the Bank of England has been pushing in their recent drive to make the financial services in the UK more environmentally sustainable. The PRA report published in 2018, declared that “A ‘too little too late’ scenario, where significant action is taken, but too late to achieve climate goals, could result in the most severe financial risks crystallising in the banking sector”.

But the drive to take action is not being led by a shared long-term vision for a green economy, but by the current pressure being placed directly on the financial services sector by shareholders and stakeholders. Andrew explained that, “there is no doubt that expectations are changing. Across the financial services sector, organisations are increasingly being urged to introduce specification and detail to annual reporting in order to clearly define how the organisation is helping, not hindering, climate change impact”.

Andrew went on to say, “reaction to stakeholder expectations with transparent messaging is not only a business sustainability issue but, if managed correctly, can be a potential source of strategic and competitive advantage”. Research has indicated that climate risk management is a strong advantage for organisations. Looking specifically at the recommendations the TCFD have published for organisations across the globe, the Bank of England and PwC found a positive correlation between company’s stock price and the number of TCFD disclosures that firms have made. This was also seen in research from the Commonwealth Climate and Law Initiative; it stated that companies that fail to disclose climate risk in line with the TCFD recommendations may be less attractive to investors and struggle to secure loans or insurance.

Maria Turner also made this point of competitive advantage and advocated for business transformation in order to embed climate financial risk into the organisation for long-term strategic business positioning. She commented that, “business transformation is required for this with the CRO being heavily involved”, making the point that, “climate change risk needs to be managed; it’s not just a PR exercise”. She explained that an organisation needs a clear strategy and to have a strong leader to deliver it organisation-wide. Above all, Maria emphasised the point that like any change, it has to be embraced and tackled head on to get a successful, lasting impact.

Although we are starting to see increased movement to prioritise climate financial risk, Tim Davies said, “the sticking point for financial institutions is that there is a voluntary nature to climate risk management which has placed it low on the priority list. It is hard to take action now when day to day risk is already shrouded by a number of periphery challenges that need to be addressed in the shorter-term. This year for example the impacts of Brexit, with the potential loss of London as the financial capital, financial services are having to contend with credit risk”. Maria also mentioned that climate risk is just one of a long list of areas CROs will need to face this year, saying: “we will see credit risk being especially affected by Brexit fallout, such as trade agreements made with the US or China and consequently the impact on the EU economy. On the macro level, international politics will play a role, namely the US election will impact the market climate towards the second half of the year”.

With a need to consider two channels to address financial climate risk, it’s not an easy demand for the risk function to contend with. Tim told me that, “weather related risk, part of the physical channel, has been part and parcel of the job for years, but this needs to be broadened to cover the full remit of climate risk”. Transitional risk is yet another order of business to add to the risk function that requires extensive assessment. As Sarah Breeden, executive director of the BoE has declared, “every asset will have a different value in a net zero economy” meaning that will need modelling in scenario analysis to feed into credit, market and operational risk management. The expansion of risk activity poses an onerous challenge for financial organisations.

In order to handle this heavy demand, Tim told me that, “the role of the CRO is going to evolve more so this year than ever before”. Where the environmental agenda has previously fallen in the remit of CSR, climate financial risk management will inevitably fall in the remit of the CRO. The risk expert will have to be responsible for having a strong understanding of not just the legal requirements of the organisation but also the latest developments in the climate crisis to adapt the strategy accordingly. Andrew commented that, “the CRO of a financial organisation should be a proactive, life-long learner with the capability of adapting rapidly and effectively to the changing environment. In the case of the climate emergency, they must keep themselves aware of the external environment and consider it a universal need”. Expanding on this, Andrew stated that, “climate change can only be tackled with a global understanding of the issues and a non-selfish approach to helping address them”.

The climate change agenda is beginning to move from the peripheries to centre stage as the UK’s financial regulators make plans to implement regulatory requirements to address climate financial risk. Although it is a future-facing challenge, Tim highlighted the need for firms to consider that conventional business propositions are at risk with the shift to millennial buying power: “The risk profile is changing. For the most part this is due to the younger generations demanding new standards of business practice in line with their values of sustainability and ethical conduct”. For long-term economic and business sustainability, the financial services sector must take further action in the coming year to understand and assess the financial risks arising from climate change.