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In the introduction to the Financial Conduct Authority (FCA)’s ‘Climate Change and Green Finance’ discussion paper (DP18/08), it states that ‘climate change is likely to have a significant impact on the UK’s economy and financial services markets’. This view is widely accepted and, as such, is – or certainly should be - a priority area for financial institutions.
FCA’s priorities
The FCA has identified a number of areas where climate change will affect their strategic objective of ensuring that financial markets work well. These include:
- Disclosure obligations about climate change risks
- Ensuring firms have adequate controls in place for considering climate change risks
- Ensuring that consumers, including those seeking green finance products, are appropriately protected
- As demand for green finance grows, ensuring that regulation does not stifle positive innovation.
Key considerations for financial institutions
Financial institutions need to be proactive and innovative in respect of external developments and the internal changes they can make to their services and products to lead the way to a greener future.
Investors are becoming increasingly conscious of ‘green investments’ whether for ethical or financial reasons. In time, investors will not want to be seen to be - or will be prevented from - investing in non-environmentally friendly or unsustainable products. Therefore, more green investment opportunities will not only be in investors’ interests, but also in the interests of financial firms themselves, as they will benefit both commercially (by adapting to consumer demand) and reputationally for being at the forefront of creating green investment opportunities and outcomes.
As identified by the FCA, transparency is key. It allows regulators to keep track of progress in the market, but more importantly it allows businesses to keep track of their own progress and development. Transparency also enables customers to be informed about the firms they rely on for products and services.
To enable successful growth and innovation, investment products need to have adequate controls in place. Previous schemes, such as carbon credit schemes, were seen as positive by introducing green investments into the market but they turned quickly into a scam. The investments became illiquid investments sold to retail clients with little to no experience or sophistication who have subsequently been unable to trade them and suffered loss as a result. An element of regulation and control is required so that similar, positive initiatives are not exploited by other market users at the expense of consumers’ best interests, thereby deterring future green investment schemes. Consumers need to know that investments have longevity and insurers need to know their liability risks for clients providing advice about or selling such investments.
Insurance implications
Insurers need to understand climate change related risks and the potential exposures in order to write policy wordings and know how policies will respond to the materialisation of such risks. If insurers and insureds fail to mitigate climate change risks, some risks may become uninsurable, which is not beneficial for consumers or the market.
The traditional nature of investment products such as pension schemes and private portfolios that may be impacted by climate change - for example, property and overseas investments in areas at risk from flooding and earthquakes - need flexibility to adapt to and develop long-term sustainable investments.
Insurers should also be aware of the potential exposure to firms and their boards of climate change-related claims that could arise from, for example, overstating the value of assets in financial statements (where insufficient consideration has been given to the potential future trading environment and/or sustainability of assets) or a failure to prevent a firm causing climate-change related damage. Firms need to be alive to such exposure and create strategies to mitigate such risks.
As risks materialise, there is potential for more litigation and disputes as to who should have foreseen such risks and advised upon it. This may be exacerbated where financial service providers are international and there is not a consolidated, global approach in place.
Insurers and insureds need to recognise the importance of averting, minimising and addressing loss and damage associated with the adverse effects of climate change and adequately managing risks. Risks should be insured where possible, whilst at the same time protecting the integrity of the insurance market and insurance firms. Where financial markets become uninsurable, this will inevitably lead to the reduction in value of products and services, and eventually make them worthless as funders pull out of those markets, which will result in losses to a significant number of funds and investors.
Comment
The EU has pledged up to €180 billion of its 2014-2020 budget to protecting the climate (on top of funding from individual EU countries). However, ahead of its planned departure from the EU, the UK has experienced a slowdown in clean energy investment. In order to attract investors, the UK has to demonstrate the attractiveness of its clean energy market. The government has stressed its commitment to the UK’s clean growth and decarbonisation goals, and that it will maintain EU environmental protections post-Brexit. However, political factors have caused uncertainties that only time will tell what the impact will be.
Read other items in Professions and Financial Lines Brief - March 2019
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