Greening Finance: embedding sustainability in financial decision making Contents

4Financial regulators and climate risk

88.Implementing recommendations on climate-related risk reporting will require the UK ‘s financial regulators to provide guidance and monitor how companies and investors disclose information on climate risks in annual financial filings and in communications to shareholders and relevant stakeholders. Our inquiry examined the role of the UK’s financial regulators in overseeing how environmental risks are managed by companies and investors. We questioned representatives from the Bank of England, FRC, FCA and tPR on 20 February.

The UK has five financial regulators answering to different departments within Government and the Bank of England:

Financial Reporting Council (FRC)—working with the Department for Business, Energy and Industrial Strategy. The FRC is an independent quasi-regulatory private body that is delegated a mandate by the Government to set and oversee the UK’s Corporate Governance and Stewardship Codes and UK standards for accounting, auditing and actuarial work

Financial Conduct Authority (FCA)—working with HM Treasury. The FCA is the is the conduct regulator for 56,000 financial services firms and financial markets in the UK and the prudential regulator for over 18,000 of those firms. In this role it regulates the providers of contract-based pensions.

The Pensions Regulator (TPR)—working with the Department for Work & Pensions. The tPR is the public body that protects workplace pensions in the UK. It is responsible for monitoring and enforcing rules on pension governance for trust- based pension schemes.

Prudential Regulation Authority (PRA)—within the Bank of England. The PRA is responsible for this prudential regulation and supervision of around 1,500 banks, building societies, credit unions, insurers and major investment firms.

Financial Policy Committee (FPC)—within the Bank of England. The (FPC) identifies, monitors and takes action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system.

89.Evidence to our inquiry suggested that there are inadequacies in how the rest of the UK’s framework of financial regulation is currently monitoring and managing climate change risk. We heard for example, that the fragmented structure of UK financial regulation meant mandates and decision-making responsibilities were unclear when it came to monitoring how strategic risks like climate change are managed.119 Several submissions also identified a lack of capacity and expertise on climate change and sustainability issues as a problem hampering effective monitoring of climate risk.

90.ClientEarth provided a list of the relevant guidance, rules and codes managed by each regulator that could be amended to embed environmental risk reporting into UK corporate Governance:

In the following sections we will consider the role that each regulator could have in monitoring how climate change risks are managed.

Prudential Regulation Authority

The Prudential Regulation Authority (PRA) is part of the Bank of England and is responsible for promoting the ‘safety and soundness’ of around 1,500 systemically important banks, building societies, credit unions, insurers and major investment firms. Prudential regulation rules require financial firms to hold sufficient capital and have adequate risk controls in place.

91.The Bank of England’s Prudential Regulation Authority is the only UK financial regulator to have reported on the impact that climate change might have on its regulatory remit. In 2015, as part of the second round of adaption reporting initiated by the Climate Change Act 2008, the Prudential Regulation Authority (PRA) prepared a report into the impact of climate change on the UK insurance sector.120 This aimed to provide a framework for considering the risks arising from climate change through the lens of the PRA’s statutory objectives in relation to insurers—i.e. the safety and soundness of firms and appropriate protection of policyholders. The PRA Report identified three primary channels through which climate-related risks to the financial sector might arise: physical risks; transition risks and liability risks—as discussed in chapter 1. The Bank of England told us that the PRA is currently undertaking a review of climate-related risks to the UK’s banking sector, which will support its involvement in the third round of adaptation reporting. The Bank says this will be published in the coming months.

Financial Reporting Council

The Financial Reporting Council (FRC) is an independent quasi-regulatory private body that is delegated a mandate by the Department for Business, Energy and Industrial Strategy to set and oversee the UK’s Corporate Governance and Stewardship Codes and UK standards for accounting, auditing and actuarial work. It is supposed to monitor the quality of corporate annual reporting and auditing. It operates independent disciplinary arrangements for accountants and actuaries, as well as overseeing the regulatory activities of the accountancy and actuarial professional bodies. Many of these responsibilities are undertaken on a voluntary basis with the agreement of the market and the FRC’s stakeholders.

92.The Financial Reporting Council will have a key role to play in implementing TCFD and potentially monitoring the disclosure of climate-related risks and opportunities in strategic reports. There are concerns however about its robustness as a regulator. The FRC has faced mounting criticism in recent months after UK corporate governance has come under scrutiny in the wake of the Tesco accounting scandal, and the collapse of BHS and Carillion. Critics have alleged that the FRC’s:

‘ … ability to scrutinise auditors has been impaired by its heavy dependence on the very profession that it is tasked with overseeing. This has resulted from an opaque and piecemeal statutory basis; weak governance structures; funding that depends on the audit profession’s discretion; and poor public transparency.’121

93.During our inquiry we heard criticism of how the FRC has monitored company reporting on climate risk. The Climate Disclosure Standards Board raised concerns that the Financial Reporting Council is not taking a proactive role in enforcing existing financial disclosure rules. It said that reform and capacity building at the FRC is required so that existing rules are enforced where material climate-related risks should already be disclosed.122 ClientEarth criticised the FRC for providing minimal guidance on how companies should be reporting on environmental risks and for being ‘slow to respond to complaints where companies have failed to disclose these risks.’123 It highlighted a case from August 2016, where it had filed a complaint with the FRC against two oil and gas exploration companies—Cairn Energy (Cairn) and SOCO International—for making inadequate mention of climate change in their Strategic Reports. In response to the complaints, Cairn and SOCO included sections on climate change risks in their strategic reports the following year. The FRC closed the complaint without ruling on whether their original reports were compliant. ClientEarth says that in the complaints it submitted, it asked the FRC to make a public statement to clarify ‘how climate risk must be material or, more likely than not, is material to oil and gas companies and they did not’.124

Section 456 of the Companies Act 2006 gives the Financial Reporting Council the power to apply for a court order if a company’s accounts or reports are found to be defective, to force the company to prepare revised accounts or a revised report. ClientEarth has said that it believes this power has never been used by the FRC.

94.We asked the FRC CEO, Stephen Haddrill, about the complaint that ClientEarth had lodged and whether this was evidence that the FRC was not policing company reporting adequately:

‘I don’t think so. We review about 10% of the listed company reports every year. That is what we have the resources for and that is a reasonable proportion. If something comes up in the other 90%, then we are indebted to the people who bring those things to our attention. If we felt that the company had really abused the rules, we could take enforcement action against any directors who were accountants. If we feel that the matter can be most readily addressed by correcting the information in the annual report or adding additional information to the annual report, and that can be done within a matter of months, from the investors’ point of view, that seems to me to be the most satisfactory outcome, because the actual heavy-duty enforcement cases could take a considerable period of time.’125

Corporate Governance Code

95.Several submissions to the inquiry identified the FRC’s current review of the Corporate Governance Code and its forthcoming review of the Stewardship Code as opportunities to mainstream climate-related financial disclosures into UK regulation.126 In December 2017, the Financial Reporting Council announced a review of the UK Corporate Governance Code and issued a draft revised Code for listed companies. The consultation closed on 28 February 2018. The revised Corporate Governance Code proposed by the FRC during its consultation does not explicitly mention environmental risks like climate change. However, it does suggest requiring boards to assess how the company preserves value over the long term and maintain the sustainability of the company’s business model:

‘Provision 1. The board should assess the basis on which the company generates and preserves value over the long-term. It should describe in the annual report how opportunities and risks to the future success of the business have been considered and addressed, the sustainability of the company’s business model and how its governance contributes to the delivery of its strategy.’127

The FRC’s proposed new guidance (to accompany the revised Code) encourages company boards to consider their duty under Section 172 of the Companies Act 2006, which includes having regard to the impact of the company’s business on the community and the environment (all UK incorporated companies whether listed or not are bound by Section 172). The Committee on Climate Change (CCC) has recommended to Government that the FRC’s Stewardship Code should ask investors to consider company performance and reporting on adapting to climate change.128

96.On 17 April 2018, the Government launched an independent review of the Financial Reporting Council (FRC) led by Sir John Kingman. The Government says this will ‘assess the FRC’s governance, impact and powers, to help ensure it is fit for the future’ and ‘aims to make the FRC the best in class for corporate governance and transparency.’129 The review is due for completion by the end of 2018.

Financial Conduct Authority

97.The Financial Conduct Authority will play a key role in monitoring climate risk disclosures as it oversees the information that is made available when companies wish to sell shares or debt through an Initial Public Offering (IPO) on the London Stock Exchange and in subsequent capital raisings and/or major transactions. Alongside the FRC, the FCA also oversees listed companies’ ongoing provision of information to the share and debt markets. The FCA’s role in regulating the financial firms that provide contract-based pensions, discussed in Chapter Three, also means that understanding climate change risk is important for it to fulfil its remit.

98.There is evidence that the Financial Conduct Authority needs to improve its approach to climate change risks. ShareAction pointed out that the FCA has not carried out an assessment of the impact of climate change on the firms and markets it oversees or issued guidance on the management of climate risk in the market sectors it regulates.130 The FCA takes a risk-based approach to fulfilling its objectives and the physical impacts of extreme weather and flooding linked to climate change was identified as a risk in the FCA’s latest Risk Outlook in its Business Plan 2017/18. However, its risk outlook made no mention of the liability and transition risks identified by the Bank of England and others, as a potential threat to financial stability. The language used in the FCA risk outlook would suggest the FCA perceives the risk as being confined to the insurance sector in any impact it may have on financial services (and risks to FCA objectives). Following the Financial Conduct Authority’s appearance before us on the 20th February we are not convinced that the regulator understands the material risks that climate change poses. The witness gave the impression that the FCA considers climate change as an ethical issue, rather than a material risk for pension schemes and businesses.131

Share Listing Rules

99.Share listing rules will also need to be updated if climate risk reporting is to be fully embedded in the UK’s corporate governance framework. The Financial Conduct Authority (FCA) will also need to update its guidance and listing rules regulating how information is made available to market participants when companies offer stock on the London Stock Exchange through Initial Public Offerings (IPO).

100.When shares are offered for public sale on a stock exchange it is known as an Initial Public Offering (IPO). The IPO process regulated by the FCA plays a central role in helping companies raise capital in UK markets. The IPO process is complex and technical but broadly consists of the FCA:

The directors of an applicant/listed company are responsible for the contents of a prospectus, but the FCA must approve it. The FCA can challenge a risk factor within a prospectus: ‘where disclosures conflict with an issuer’s eligibility or continuing obligations … ’.132

101.Carbon Tracker and WWF both argued that there is an opportunity for the FCA to use its position on the International Organization of Securities Commissions to push for coordinated international securities regulation of climate-related financial disclosure based on the TCFD recommendations.133

The Pensions Regulator

102.Considering climate change risk from the perspective of pension regulation is especially important given the long time-scales involved in pension saving. The Pensions Regulator has a role to play in encouraging and overseeing how pension schemes manage climate change risks because it provides guidance for trustees on how schemes should be governed, what information they must make available in annual reports and on the information that pension funds make available to members and prospective members. While we heard positive feedback that the Pensions Regulator had updated its guidance for pension trustees on considering environmental risks,134 we were also told that tPR could be doing more to ensure that boards are starting to factor sustainability into investment decisions.135

103.The UK could help to galvanise global momentum on climate-related risk disclosures by announcing at the G20’s leader summit in November that it will implement climate-related financial disclosures fully and that disclosures will be mandatory for large companies by 2022. During this timeframe the FRC’s Corporate Governance Code and UK Stewardship Code and the FCA’s listing rules should all be amended to require climate-related financial disclosures on a comply or explain basis.

104.Embedding climate risk reporting in all relevant UK corporate governance and reporting frameworks could negate the need for new legislation. However, if UK regulators do not improve how they monitor the management of climate risk then the Government should pass new sustainability reporting legislation similar to France’s Article 173.

Adaptation Reporting

105.ClientEarth argues that because climate change is acknowledged by the Bank of England and Committee on Climate Change as posing potentially systemic risks to the finance sector, the UK’s other financial regulators the FCA, FRC and tPR should join the PRA in considering the implications of climate risk for their operations, including their regulatory functions.136 ClientEarth and Share Action suggested that the third round of Adaptation Reporting under the Climate Change Act, due to start in 2018, provides a timely opportunity for the rest of the financial regulators to fully assess the impact of climate change on both their own organisations and the firms they regulate.137

‘Just as we are asking companies and investors to conduct scenario analysis on the way climate risk affects their particular business models, I see the adaptation reporting power as a kind of scenario analysis for financial regulators. It requires them to think in the long term about how this issue will affect those that they oversee, again, because the tragedy of horizon—as Mark Carney coined—applies equally to regulators as it does to those that they oversee. The adaptation reporting power is a way that they can properly and thoroughly assess the implications to various sectors, and then determine which laws already apply and how they can be used more effectively.’138

The Adaptation Reporting Power was established by the Climate Change Act 2008 giving the Secretary of State for Environment, Food and Rural Affairs (Defra) the power to direct bodies with public functions to prepare a report containing:

An assessment of the current and predicted impact of climate change in relation to the organisation’s functions;

A statement of the organisation’s proposals and policies for adapting to climate change in the exercise of its functions and the time-scales for introducing those proposals and policies; and/or

An assessment of the progress made by the body towards implementing the proposals and policies set out in its previous reports.139

106.The Adaptation Reporting Power (ARP) aims to ensure that climate change risk management is systematically undertaken by reporting authorities. This helps ensure that public services and infrastructure are resilient to climate change, and to monitor the level of preparedness of key sectors to climate change.140 The third five-year round of reporting under the ARP will take place from 2018. In March 2017, the Committee on Climate Change recommended that the third round of reporting (ARP3) be extended to cover all areas of the finance sector and be made mandatory.141 On 12 February 2018, the Government opened a consultation on which bodies should be required under the Climate Change Act to prepare an Adaptation Report in the next round of ARP reporting and has ‘approached financial regulators to ask them to consider participation in future’142 We wrote to Defra before the consultation closed on 26 March to recommend that the Government uses its Adaptation Reporting powers under the Climate Change Act to make the Financial Conduct Authority, Financial Reporting Council and the Pensions Regulator produce Adaptation Reports.143

107.Financial regulators have a responsibility to understand risks to financial stability and the financial institutions which they supervise. Evidence to our inquiry suggests that there are inadequacies in how the UK’s framework of financial regulation is currently monitoring climate change risk management. Among financial regulators in the UK, only the Bank of England and its Prudential Regulation Authority have given the issue the serious attention it requires. The FCA, FRC and the Pensions Regulator must get up to speed.

108.There is a compelling case for other regulators to use the current round of adaptation reporting required by the Climate Change Act to integrate climate change risk management into their work. If financial regulators are to play a part in implementing the recommendations of the Task Force on Climate-related Financial Disclosures, it is important that they have gone through their own process of analysing the risks of climate change for their area of work and the firms they regulate. The Secretary of State for Environment, Food and Rural Affairs should use his Adaptation Reporting powers under the Climate Change Act to require the Financial Conduct Authority, Financial Reporting Council and the Pensions Regulator to produce Adaptation Reports.


119 Carbon Tracker Initiative (GFI0005)

120 Bank of England Prudential Regulation Authority, The impact of climate change on the UK insurance sector: A Climate Change Adaptation Report by the Prudential Regulation Authority (September 2015)

121 Sarasin & Partners LLP, Local Authority Pension Fund Forum, UK Shareholders Association, Investors require a robustly independent audit regulator (October 2017)

122 Climate Disclosures Standards Board (GFI0008)

123 ClientEarth, Financial Regulators and Climate Risk (April 2017)

124 Q229

125 Q360

126 Aviva (GFI0024) Committee on Climate Change (GFI0004), E3G (GFI0016), Principle for Responsible Investment (GFI0029)

127 Financial Reporting Council, Proposed Revisions to the UK Corporate Governance Code (December 2017)

128 Committee on Climate Change (GFI0004)

130 ShareAction (GFI0013),

131 Q381

132 Financial Conduct Authority, UKLA Technical Note: Risk Factors (March 2015)

133 Carbon Tracker Initiative (GFI0005),WWF (GFI0022)

134 UKSIF (GFI0002)

135 Q232

136 ClientEarth, Financial Regulators and Climate Risk (April 2017)

137 ClientEarth (GFI0012), Share Action (GFI0013)

138 Q230

139 Department for the Environment, Food and Rural Affairs, Adapting to climate change: 2013 strategy for exercising the adaptation reporting power (July 2013)

140 Department for the Environment, Food and Rural Affairs, Adapting to climate change: 2013 strategy for exercising the adaptation reporting power (July 2013)

141 Committee on Climate Change, Adaptation Reporting Power second round review (March 2017)




Published: 6 June 2018