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Freshfields Sustainability

| 9 minutes read

Climate change regulation for financial services firms: a global view

Central banks and financial services regulators around the globe are increasingly focussing on how financial institutions manage and disclose climate change risks.  On one level, this new type of regulation is tackling a potentially material financial risk head-on.  On another, it is increasing pressure on corporates in the real economy, through their touchpoints with financial services firms, to transition towards a low-carbon economy.  While the UK and European central banks and regulators have the most developed plans for financial services firms so far, there have been important developments in Asia and in the US in the last few months.  In this blog post we have outlined the current areas of focus in the UK, Europe, the Asia-Pacific and the US.


In the UK, and in line with the government’s 2019 Green Finance Strategy, the financial regulators have clear expectations for financial services firms’ management of climate risk, focussing on increasing firms’ capabilities for understanding the risks involved and their disclosure of those risks. This translates into specific requirements for firms’ governance arrangements, risk management procedures, development of scenario analysis and disclosures, first articulated by the Prudential Regulation Authority (PRA) last year.  The PRA wrote to firms in July this year asking them to ensure that their plans were fully embedded by the end of 2021, and harder-edged regulation seems likely after that point. 

The PRA recognises that firms’ management of climate risk should be proportionate to their business models, but it does expect to see significant improvements being made as data, tools and capabilities improve.  In some areas, such as disclosure, the PRA expects firms to be thinking ahead of what is technically required and encourages firms to make “insightful” disclosures on climate risks and to prepare for disclosure to be mandated in more jurisdictions.  It recommends that firms engage with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). 

The Financial Conduct Authority (FCA) currently has a narrower focus.  In its capacity as overseer of listed companies, it has just finished consulting on a new listing rule which would require premium-listed issuers to disclose in line with TCFD, on a comply or explain basis.  The results of the consultation are due later in 2020.  It has also indicated that it is considering whether TCFD disclosures should be mandatory for all regulated firms, beginning with asset managers and occupational pension schemes.  With its consumer-protection lens, the FCA has said that it is focused on preventing firms from greenwashing, or from making claims that products and services are green or sustainable when that is not the case.   

And then there is some lateral thinking to really accelerate developments in this area.  First, the PRA and FCA have overseen the production of an industry-developed guide to managing climate risk, which does not have the status of regulatory guidance, but is intended to be of real practical help to firms.  Second, the Bank of England has devised a pioneering stress-testing exercise, now planned for 2021, to test the resilience of firms’ business models to climate change in three different scenarios.  Although it is an objective exercise, it will highlight firms’ exposures to climate risk in a tangible way and ultimately increase pressure on firms to reduce those exposures.


In recent years, the European Union (EU) has made sustainability a cornerstone of its policy. In its pioneering Sustainable Finance Action Plan, the European Commission (EC) identified “sustainability risk management” and “transparency” as two of the three key aims of its strategy. The EC also made it clear that financial services firms, and their management of climate risk, would play an important role in the transition to an economy built on sustainable growth.

The EU – further invigorated by the takeover of the “Van der Leyen”-Commission in late 2019 – and its institutions have since adopted or proposed several legislative and non-legislative measures in this area:

  • the Disclosure Regulation, which lays down transparency requirements for manufacturers of financial products and financial advisers towards end-investors;
  • ESMA guidelines on disclosure requirements applicable to credit ratings where these are influenced by ESG factors;
  • the EBA Action Plan, outlining the authority’s path for reviewing a potential inclusion of ESG risks in the supervisory review, technical standards for ESG risk disclosure and an assessment whether a dedicated prudential treatment of ESG-related exposures would be justified (all including climate change risks).

While the rules on disclosure have already been cast into law and will (partially) apply from 10 March 2021, it will probably take some time until we can expect, if at all, a regulation or directive on a so-called green supporting factor (with EBA’s final report on this matter currently not expected prior to 2025).

In the meantime, both the European Central Bank (ECB) and various national banking supervisors (NCAs) have clarified their expectations on ESG-risk assessment and disclosure for financial services firms.

The German BaFin took an early lead with its cross-sectoral Guidance Notice on Dealing with Sustainability Risks published in December 2019 and reminding supervised entities to ensure that sustainability risks, including climate change, are also considered and that this process is documented. For these purposes, supervised entities must develop an appropriate approach for their business model and risk profile which should be adjusted over time for any change in circumstances. While simpler structures may be sufficient for a more limited business scope, more extensive structures, processes and methods are required for entities with more significant sustainability risks. The long time-horizon associated with ESG risks may make it necessary to adapt existing processes and develop new and innovative measurement, management and risk reduction tools.

In September this year the ECB finished consulting on its own expectations related to climate-related risk management and disclosure which was developed together with the NCAs and has thus a wider impact for financial services firms in Europe. Similar to BaFin, the ECB distinguishes between physical risks (e.g. extreme weather events, resource scarcity) and transitional risks (e.g. policy and regulation change, technology, market sentiment) which may be interdependent and have wide ranging consequences for credit exposures, market risks, operational risks and other risks (e.g. the business model). Institutions are expected to understand the impact of these risks in the short, medium and long term. They must, among other things, integrate the risks in their business strategy, include them in their risk management and appetite framework and reflect these factors in their organisational structure.  The ECB also expects firms to disclose meaningful information and key metrics on financially material climate-related and environmental risks.  The ECB will ask firms to explain any divergence from these requirements from the end of 2020.

Finally, some central banks in Europe (including in France and in the Netherlands) are also conducting climate-related stress tests to understand the impact of climate change on firms’ business models.


For the world’s largest and most populous continent, the work required to establish a shared language around climate and other environmental, social and governance risks should not be underestimated. Many of the climate risks associated with change in weather patterns can have a profound effect on those economies more heavily dependent on agriculture (through food and water scarcity, deforestation and other natural disasters). However, despite its vast cultural, economic and geographic diversity, Asia’s market participants and regulators are also increasingly turning their focus to climate change and related risks.

As the metrics, frameworks and regulatory requirements start to proliferate across the region, initiatives such as the establishment of a cross-agency steering group on sustainable finance by seven Hong Kong regulators and government agencies could represent a significant forward step in developing a common language for sustainability standards.

At a time when the resurgent Asian IPO market is making global headlines, a key regulatory focus in the region has been on developing listed companies’ ESG disclosures. Australia, China, Hong Kong, India and Malaysia have all recently created or amended their ESG disclosure rules and expectations of locally listed companies, while Singapore and New Zealand continue to operate strict ‘comply or explain’ requirements for listed companies on sustainability issues in accordance with a framework of choice. Such disclosure together with close scrutiny from investors and market observers and participants will help identify and ensure risks are clearly understood. Earlier this year, the Hong Kong Stock Exchange imposed bold mandatory ESG disclosure requirements on boards of listed companies, elevating ESG risk management to a board topic (rather than merely a corporate social responsibility or a reputational issue).

A number of Asian regulators have also kicked off initiatives to build climate resilience within the financial system, and to raise financial services firms’ awareness of climate and ESG risks. Perhaps most notably, the Hong Kong Monetary Authority has established a common assessment framework to measure the “greenness baseline” of individual banks, set out its initial supervisory expectations published in June 2020, and completed the first round of bank self-assessments against the baseline. Similarly, in June 2020 the Monetary Authority of Singapore proposed new guidelines designed to enhance the ability of firms to address environmental risks and transition to an environmentally sustainable economy, and in February 2020 the Australian Prudential Regulation Authority outlined procedures for understanding and managing financial risks of climate change and has embedded a review of these risks into its supervisory framework for all regulated entities. These supervisory expectations broadly align with those in Europe and the UK, all placing an emphasis on board responsibility, the structure and operations of banks, and climate risk assessment and management.


The US has a much less developed regulatory scheme when it comes to regulating climate risk and related disclosures. Indeed, the US has not yet enacted any regulation governing climate change issues in the financial services sector.

That said, it is clear that various US regulators are contemplating how climate-change related issues should be addressed. Ten years ago, the Securities and Exchange Commission (SEC) issued Guidance to publicly trading companies requiring them to disclose climate-related risks where those risks are material. Specifically, under the Guidance issued by the SEC, US issuers are required to disclose all risks, including climate change risks, that are “reasonably likely to have a material effect” on the company’s financial condition and operating performance. Of course, one can argue that the SEC’s Guidance did little more than expressly state what was always required as disclosure rules generally require a publicly listed company to disclose such risks.

In addition, last month, the US Commodity Futures Trading Commission (CFTC) became the first US financial regulator to address climate change, concluding in its report “Managing Climate Risk in the US Financial System” that “[c]limate change poses a major risk to the stability of the US financial system”. The key finding of the report is that the climate change is impacting and will continue to impact “every facet of the economy” and poses systemic risks that include “disorderly price adjustment in various asset classes, with possible spillover into different parts of the financial system”.

The report lists 53 recommendations to US regulators urging them to address the risks climate change poses to the US financial system. Among other things, the report acknowledges continuous investor demand for disclosure of climate change-related risks and concludes that such disclosures remain inadequate. The CFTC report adopts critical stance toward the SEC materiality standard stating that this standard is partially responsible for the insufficiency of climate change disclosure. Because materiality is often interpreted as mandating disclosure of short- and medium-term risks, “firms may have assumed that climate risks are relevant only over longer time horizons”.

The CFTC report encourages regulators to consider, among other things, “[a] mandatory, standardized disclosure framework for material climate risks, including guidance about what should be disclosed that is closely aligned with developing international consensus,” and recommends that the Guidance be revised “in light of global advancements in the past 10 years”.

The report recommendations are not binding. However, being a first of its kind report from a US financial regulator, it will likely become a foundation for further discussions and regulatory initiatives in the US.  In the meantime, and despite the lack of regulation, there is certainly pressure from many US-based shareholders and investors for better management and disclosure of climate risk.

Where to from here?

With increased expectations from central banks and regulators that financial services firms will disclose climate change risks, and many broader initiatives aimed at enhancing and standardising corporates’ disclosures too (such as the new Sustainability Standards Board proposed by the IFRS Foundation this month) the need for international cooperation is becoming more apparent - particularly for firms operating across different markets and regions faced with varying requirements. 

There is certainly a degree of cooperation in the world of financial regulation already, in part driven by the central banks belonging to the Network for Greening the Financial System (NGFS).  And although the US central banks and regulators are not part of the NGFS and there is no specific regulation of firms’ management of climate risk yet, the appetite from US-based shareholders and investors for better management and disclosure of climate risk is driving and will continue to drive action to some extent until regulation catches up.   

However, the challenge for all will be to maintain consistency in approach as technology and capabilities for management of climate risk increase exponentially over the next few years, and regulators’ expectations increase in parallel. 

"[T]he need for international cooperation is becoming more apparent - particularly for firms operating across different markets and regions faced with varying requirements"


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