PRA outlines strategic approach to climate financial risks

Financial risks from climate change manifest through two primary channels: physical and transition risks.

Physical risks stem from specific weather events like heatwaves, floods, and storms, as well as longer-term climate shifts such as sea level rise, impacting property values and insurance claims.

Transition risks arise from the adjustment process towards a low-carbon economy, influenced by policy, technology, shifting sentiment, and legal interpretations, affecting asset values in sectors like energy and automotive.

A third factor, liability risks, arises from parties seeking to recover losses from those held responsible, particularly relevant for insurers.

These risks are far-reaching, uncertain in their time horizons, yet foreseeable, and their future magnitude depends on actions taken today.

An orderly market transition is crucial to minimise severe financial risks.

The PRA expects firms' responses to climate financial risks to be proportionate to their business nature, scale, and complexity, maturing over time.

Boards must understand and assess these risks within their overall business strategy and risk appetite, taking a sufficiently long-term view beyond standard planning horizons.

Firms should monitor and manage these risks in line with their risk appetite statements, which must include exposure limits and thresholds.

These statements should consider long-term financial interests, stress and scenario testing results, uncertainty in risk materialisation, and balance sheet sensitivity to key drivers and external conditions.