The Bank of England has published a discussion paper seeking feedback on its proposals for a series of 2021 stress-tests on climate-related risks for the largest banks, insurers and the financial system. The stress tests will help to quantify potential climate change risks faced by the financial system and enable market participants and oversight bodies like the BoE to develop measures to prepare for those risks. Responses to the consultation should be submitted by March 18, 2020. The final stress testing framework will be published in the second half of 2020 with the results of the exercise published in 2021.
The Bank of England has made climate change a priority, with the U.K. Financial Conduct authority and U.K. Prudential Regulation Authority each publishing feedback this year on the 2018 consultations they held on climate change risks and appropriate regulatory responses in 2018. Climate change is expected to pose physical risks (through the increasing severity and frequency of climate events) and transition risks (through the economic adjustments made to manage climate change) to the financial system. The Bank of England’s proposed 2021 “biennial exploratory scenario” sets out a framework for the BoE to test the resilience of relevant financial market participants to climate-related risks. Key elements of the BoE’s framework are:
- U.K. bank participants that participate in the 2021 annual cyclical scenario and selected large insurers that participate in the PRA’s 2021 Insurance Stress Test would be expected to participate in the climate change stress tests;
- Transition and physical risk would be tested via three distinct scenarios: (i) the early policy action scenario, (ii) the late policy action scenario; and (iii) the no additional policy action scenario, each of which refer to the anticipated impacts that different policy approaches would have on climate change;
- A two part test, the first part focusing on quantifying the change in value of participants’ assets and liabilities at different points in the three scenarios, the second part assessing how participants would change their business models in response to the risks in each scenario; and
- Use of a 30-year modelling horizon to reflect the fact that climate change risks are likely to crystallize over a much longer time horizon.