Financial institutions should offer companies that invest in climate risk-reducing measures improved credit or insurance conditions, an advisory body convened by UK financial regulators has said.
The Climate Financial Risk Forum (CFRF), which is run by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) and brings together senior financial sector representatives, has today published updates to a set of guides for financial institutions on managing the risks and opportunities from climate change.
One of these, focused on adaptation and resilience (A&R), includes research and case studies on how financial institutions can integrate A&R information into their decision-making.
According to the report, traditional credit and insurance models can lead to underinvestment in adaptation and “inflated credit spreads for borrowers who have significantly enhanced their resilience”.
“Resilient investments reduce the likelihood and severity of climate-related losses, enhancing operational borrower stability, collateral integrity, and cash flow predictability,” said the CFRF.
“By linking physical risk to expected credit losses and probability of default, a pathway is offered for banks and insurers to more accurately price climate-related financial risks and recognise the value of adaptations.”
The report included case studies on how investments in adaptation measures could prevent sovereign credit downgrades and reduce insurance premiums, and how capital requirement rules could be leveraged so that banks would need to set aside less capital for loans that contribute towards adaptation and resilience.
The CFRF has suggested that financial institutions could offer lower interest rates, extended maturities or reduced fees for projects that meet defined environmental criteria.
The updated report builds on guidance released a year ago which focused on developing climate transition plans that incorporate A&R metrics and planning. The CFRF said it would aim to create tailored guidance on A&R planning for different financial institutions as part of future output.
The group also said there was “potential for a sevenfold increase” in KPIs for adaptation in sustainability-linked loans and bonds.
Research suggests that these instruments “overwhelmingly prioritise decarbonisation targets, leaving a critical gap in financial mobilisation for adaptation”, with only 5 percent of publicly available SLLs and SLBs including resilience-linked targets.
Existing guidance on sustainability-linked instruments from the International Capital Markets Association (ICMA) and the Loan Market Association (LMA) should be revised to explicitly include references to adaptation, said the CFRF.
While CFRF publications do not impact rule-making at the FCA or PRA, both agencies are present during group deliberations and provide feedback on their output.
Regulating physical risk data
The CFRF said regulatory bodies should consider how to address the need for standardisation and accreditation of data providers and their methodologies, using the example of flood risk in the UK.
This could be done by setting a standard, such as through the British Standards Institute (BSI) or ISO, or facilitating dialogue between data users and vendors.
The report noted that data on flood risk is particularly poor in the UK, due to the lack flood risk data sharing between and across the insurance industry and mortgage providers, and outdated flood maps.
Providers of hazard data should also consider making their data open source and provide climate scenario modelling guidance, said the CFRF.