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I have always firmly believed that businesses should play a larger role in leading our society towards a net zero economy. As you can imagine, I was one of the many who welcomed the Bank of England’s announcement of the 2021 Biennial Exploratory Scenario (BES). The 2021 BES is a stress test that aims to explore the financial risks posed by climate change by testing the resilience of participants – the largest banks and insurers.

In May 2020, the PRA announced that the planned BES would be postponed until at least mid-2021 to alleviate the operational burdens affecting firms due to COVID-19. However, this is not a reason to delay preparing for BES. Instead, you should see this is as opportunity to get on the front foot. As your business adapts to the challenges caused by the recent pandemic, you should consider how the lessons learned from this crisis can be applied to climate risk (as laid out in our recent publication). Consider what strategic plans you can implement to avoid similar future shocks. 

The scope and breadth of the BES will undoubtedly be challenging, especially for firms who have not yet begun to assess their exposure to climate risk. Here are some ways in which your business can start to prepare for the BES:

  1. Engage key counterparties: Firms are required to perform financial analysis of individual companies. This counterparty-level assessment should aim to cover 80% of the firm’s nominal exposure to corporates.  In order to pinpoint sectoral and geographical vulnerabilities, you need to understand key counterparties’ business models and engage these companies to pave the way for financial analysis.
  2. Close the data gap: “Bottom-up” cash flow and collateral value modelling is a resource intensive exercise. Furthermore, this process requires integration of counterparties’ current mitigation and adaptation plans. As a credible credit rating regime for climate related financial risks does not currently exist, your business should begin to gather quality data and develop reasonable assumptions to close the data gap. Assessment of data assumptions should consider your firm’s business models.
  3. Develop governance practices: Your business will need appropriate governance arrangements to identify management actions in response to the financial risks quantified. Start by establishing clear roles and responsibilities, as well as devoting appropriate cross-functional teams to climate risks and opportunities. 

The race towards effectively managing climate risks looks a lot more like a marathon than a sprint. Your business will need to take a strategic approach to ensure that climate risk frameworks can be used and embedded into risk management processes on an ongoing basis.

You should expect to encounter significant blind spots along the way, as many of the tools and related data are still under development. However, as Sarah Breeden, the Bank of England’s Executive Sponsor for Climate Change, made clear in her recent address, “imperfection is not an excuse for inaction.”

Co-Head, EMA FS Regulatory Insight Centre

KPMG in the UK