The Prudential Authority (PA) is working on a new system which would see banks and insurers incorporate climate-related risks into their operations,
The PA has released four proposed guidance notes for comment by banks and insurers on climate-related disclosures and risk practices.
The guidance notes supply substantial recommendations for the governance, strategy, risk management, metrics, and targets related to climate-related risk.
Garyn Rapson, Kent Davis, Paula-Ann Novotny, and Dalit Anstey from Webber Wentzel said that the new guidance notes must be understood in terms of the global push to integrate Environmental, Social and Governance (ESG).
“Historically, climate-related and other ESG risks were not adequately factored into capital allocation decisions or pricing. This has resulted in a financial system that fails to appreciate and cost environmental and social externalities,” the experts said.
“Sustainable finance efforts by various financial market participants on a voluntary basis, and now by regulators, aim to integrate these externalities, which are viewed as critical to resilience and financial stability.”
Crucially, banks and insurers will be expected to see climate risk as a financial risk rather than simply a reputational risk. The experts said that this will change how climate-related risks are integrated into business models.
The PA said that insurers will also play a crucial role in the management of climate-related risks in their capacity as an assessor, managers and carriers of risk. They are also uniquely qualified in their ability to understand the pricing of insurance risks.
“Climate-related risks have the potential to impact the solvency position of an insurer, as well as its ability to raise capital, and they could affect the valuation of assets and liabilities in both life and non-life insurers from the perspective of both physical and transition risks,” the experts said.
Financial markets have a vital role in pricing risk to promote well-informed and efficient allocation of capital, according to the PA.
Disclosures are also key to understanding how climate-related risks can be assessed, priced and managed in South Africa and abroad.
The guidance notes have thus adopted recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and the International Sustainability Standards Board (ISSB), which have published standards on how to promote consistency in sustainability reporting and disclosure,
Climate-related disclosures will have to be contained in the bank or insurer’s annual report – or more frequently if the information is available.
Boards of directors and senior management will also have to ensure appropriate oversight and management of climate-related risks.
Although certain aspects can be delegated, the board will have the responsibility to monitor the exercise of the delegated functions.
The board and senior management will also have to develop comprehensive policies to identify climate-related risks and their potential impact – the board will also have to be cognisant of any potential legal consequences for failing to deal with the climate-related risks.
Moreover, it is envisioned that climate-related risks are accounted for in compliance risk management frameworks – climate-related risks will thus be seen as liability risks.
The experts also highlighted the following important aspects of the guidance notes:
- The need for appropriate resourcing and capacity to grasp the specialist nature of climate-related risk from the Control Functions;
- The multiple references to appropriate international frameworks;
- The need for metrics and targets that are sufficiently detailed to manage climate-related risks and opportunities and disclosure of performance against these targets;
- Reference to the South African green finance taxonomy;
- The need to undertake transition planning and compile transition plans in proportion to their size, business model and complexity; and
- Currently, the disclosures are not expected to be subject to independent external assurance, but in the future external assurance is expected.
“The draft guidance notes focus on climate-related risks. However, climate change and the just transition to a low-carbon economy also bring opportunities. The PA’s stated approach to climate-related risks is one of proactivity.
It specifically encourages financial institutions not to wait for regulation or to be compliance driven. Developments and improvements in approach are not considered sufficient justifications for delaying implementation when it comes to climate risk management.
The experts said that climate-related disclosures will become mandatory over time.
The deadline for comments from banks and insurers on the guidance notes is Wednesday, 13 September 2023.
The guidance notes for banks and insurers