Clifford Chance

The FCA and PRA have given some clues about their views as to how firms should approach climate change-related risks. The reports create no additional regulatory obligations but are likely to be followed by more concrete guidance.

In their Climate Adaptation Reports (the "Reports"), published at the end of January, the FCA and PRA have identified the key climate adaptation challenges faced by regulated firms. The Reports are based on informal engagement with regulated firms (by the FCA) and analysis of the UK Government's most recent climate change assessments. The Reports do not themselves set regulatory expectations, but rather highlight the potential barriers firms may face in adapting to climate change and actions which they could take to better enable climate adaptation.

Why are the regulators concerned about climate adaptation?

The Reports both anticipate that climate change adaptation may pose risks to financial markets, either through failures by firms to adapt to climate change or through the consequences of adaptation measures themselves.

The FCA highlights market-wide risks, especially those relating to climate impacts on firms' critical infrastructure, for example, IT systems, which may be impacted by physical climate events.

Additionally, the FCA's report expresses concerns around the impact of the increasing occurrence of extreme climate events on the affordability and availability of insurance.

The FCA further flags the potential impact on banks and investment firms where lending is secured on, or investments are made in, physical assets or commodities which could be damaged by climate events.

The PRA's report focuses on the potential operational resilience challenges and financial losses which may flow from physical and transition risks. It emphasises the "unique challenges" posed by climate change, identifying them as systemic risks which will occur "on a much greater scale than the other risks that firms are used to modelling and managing" and which are "simultaneously uncertain and yet foreseeable". It clearly outlines the PRA's view that "once physical risks begin to manifest in a systemic way it will already be too late to reverse many effects through emissions reductions".

What adaptation challenges are identified?

The FCA's report identifies three primary challenges impacting climate change adaptation in the financial services industry:

• Data and modelling: issues with the availability and quality of local hazard data and models to help financial services quantify and manage climate risks.
• Insurance underwriting barriers: changing market dynamics as extreme climate events become more prevalent.
• Barriers to capital allocation for adaptation: structural and market inefficiencies in adaptation financing.

What can firms do to mitigate adaptation challenges?

The FCA's report outlines various actions firms can take to facilitate their adaptation to climate change risks:

• Integrate climate risks into governance and decision-making processes, including using scenario analysis (for example, the FCA highlights the Climate Financial Risk Forum's "Aim-Build-Contingency" framework).
• Develop financial products which assist with adaptation to climate risks.
• Protect critical firm infrastructure against physical climate risks.
• Incorporate adaptation measures into net-zero transition plans.
• Enhance the quality and availability of climate data and metrics within firms and through industry body collaboration.

Do firms have climate adaptation obligations?

Neither of the Reports creates new obligations for firms and there are no indications that regulators are yet contemplating enforcement action based on firms' approaches to climate change. However, they are illustrative of the regulators' views of how firms should address new or developing climate change risks under existing requirements. These include the requirements on businesses to manage their affairs responsibly and to have adequate risk management systems under Principle 3 of the FCA's Principles for Businesses and the corresponding obligations to have effective risk strategies and risk management systems and to organise their controls responsibly and effectively under Fundamental Rules 5 and 6 in the PRA's Rulebook. The PRA has previously set out some further detail on the steps firms should be taking to manage risk associated with climate change in Supervisory Statement 3/19 (which was originally published in 2019 and updated in 2024) and has since monitored the approaches firms have been taking and fed back concerns through 'Dear CEO' letters.

What will happen next?

Both regulators are clear that climate change risks for firms are evolving. The Reports are a further invitation for firms to review how they are evaluating and addressing these risks and a reminder to give them appropriate prominence in their planning and risk management processes.

Going forward, the PRA is working to update the supervisory expectations set out in Supervisory Statement 3/19. The updated supervisory expectations will build upon and clarify the existing expectations and will seek to consolidate existing published PRA climate-related guidance.