Climate change is a hot topic. Press reports carry sensationalist headlines and doomsday predictions. Companies are the subject of environmental campaigns, condemning them for their emissions, carbon output and other climate change-related issues. Most recently we have seen companies and senior management targeted in shareholder, consumer and regulatory claims, alleging insufficient disclosure of those risks.
UK regulators have now entered the fray too, looking to make their mark. They have set out expectations they have of firms and, importantly, their senior management on financial risks around climate change. Companies and directors need to ensure that they are prepared. To assist we explore some of these developments below, and some provide initial thoughts on implications for senior management and prudent steps to be taking.
The UK Regulators: PRA and FCA
It’s been heartening to see the effect of Green Great Britain Week has had on financial regulators – with not one, but two important papers being released on the topic of climate change on 15 October 2018.
The Prudential Regulation Authority (‘PRA’) went first, publishing a consultation paper on a draft supervisory statement. The draft statement sets out expectations on how firms should approach managing financial risks from climate change. It applies to all UK insurers, banks, building societies and PRA designated investment firms (‘firms’).
The PRA’s concern is that these firms need to take a much more “forward-looking, strategic approach” to climate change if financial risks are to be minimised. The PRA has set out its expectations of firms in that regard, and intends to embed the monitoring of these risks into the existing regulatory framework.
The PRA expects clear board level engagement in managing these risks and ensuring that these responsibilities are included in the Responsibility Statements of Senior Management Function holders (linking in with the Senior Managers Regime and Senior Insurance Managers Regime). It also expects firms to:
(i) address the risks through their risk management frameworks;
(ii) conduct scenario analysis to determine the impact of financial risks from climate change on business strategy; and
(iii) consider the relevance of disclosing information on how these risks are integrated into governance and risk management processes.
Any further regulation by the FCA and PRA, or other regulators globally, will sit alongside the various existing disclosure requirements under regulation (e.g, the FCA Disclosure and Transparency rules) and company laws that are currently in place for companies around the world, and which apply to climate change risks.
The consultation period on the PRA’s draft statement ends on 15 January 2019.
On the same day that the PRA statement was released, the FCA also published a discussion paper on climate change and green finance. The paper discusses how climate change is relevant to its objectives of protecting consumers, improving market integrity and advancing competition. The FCA has asked for views on the paper by 31 January 2019.
The FCA said that it and the PRA have been “working closely together to develop a joined-up approach to enhance the resilience of the UK financial system to climate change”. This collaborative approach is further evidenced by the FCA and PRA creating a Climate Financial Risk Forum which will involve senior staff from the insurance industry and technical experts. Membership is due to be finalised by the end of November with meetings kicking off in early 2019.
Recent Climate Change claims
Alongside current and anticipated future regulations, there has been an increase in climate-change focused claims against large corporates – both in the UK and globally:
1. In 2016, claims were filed against Exxon and three of its individual directors and officers by its shareholders alleging that figures within Exxon's annual reports misled investors regarding estimates around future costs and reserves associated with climate change risks. On 15 August 2018, the claimant shareholders crossed their first hurdle in pursuing the case with Exxon's motion for dismissal being denied.
2. In August 2017, two major shareholders of the Commonwealth Bank of Australia (CBA) sought 'world-first' proceedings for the CBA's alleged failure to disclose climate change risks in its annual reports. The proceedings were dropped in July 2018 following disclosure of climate change risks by the CBA in its 2017 annual report
3. In August 2018, Client Earth, an environmental advocacy group, filed complaints with the FCA against three large UK insurers. Although the rationale behind the filings may differ to those made by shareholders against the CBA and Exxon, the basis of the complaints remains the same, that the disclosure around climate change risks is inadequate. The complaints filed with the FCA highlight the insurance industry’s vulnerabilities to climate change risks, including physical risks (claims paid arising from natural disasters and climate-change related events), reputational risks, and future governmental policies and consumer trends. Client Earth alleges that without formalised disclosure around these risks, shareholders cannot make a well-informed decision when investing in insurance companies.
Implications for Senior Management
So where does that leave us? We are likely to see climate change related claims against directors and officers hotting up. It is clearly another risk that can lead to these individuals being in the firing line of regulators, shareholders and consumers. It is therefore important that the cover provided by directors' & officers' (D&O) insurance policies adequately responds to these scenarios so that the personal assets of senior managers are protected to the fullest extent available.
To ensure this, particular attention needs to be given to the scope of pre-investigation and investigation cover in D&O policies (including internal investigations by firms), and ensuring that the policy triggers around self-reporting and whistleblowing. This means that senior management who are implicated in actions are covered for the costs of legal representation at the earliest opportunity. Pollution exclusions must also be sufficiently restricted to ensure that any investigations or claims faced by senior management relating to climate change are not excluded from cover.
Climate change risks are just one of the many ‘future’ risks that are becoming the focus of regulators, shareholders and consumers. Companies should consider how best to protect against these risks not only in terms of risk management, operational risk and disclosure, but also from a risk transfer perspective. This may include purchasing higher limits of D&O cover, or placing greater focus on the structure of their D&O insurance programme (for example, by ring-fencing parts of the limit to protect senior management). These are all things to be considered in the current climate, and the papers released by the FCA and PRA are likely only to focus minds on that.
For further information, please contact;
Carey Lynn, Senior Partner, Financial Lines Group on +44 (0)20 7558 3521 or email firstname.lastname@example.org
Sarah Lightfoot, Claims Handler, Financial Lines Group on +44 (0)20 7558 3810 or email email@example.com