Boards must show climate risk in action

This shift – explored at a recent event hosted by Pinsent Masons – is significant. This is because many firms still view climate risk through the lens of programme management and implementation, while supervisors are now assessing it through the lens of prudential risk, operational effectiveness and day-to-day decision-making. 

Climate risk has moved into the core prudential framework 

The PRA’s rules are set out in a supervisory statement, SS5/25. One of the most important developments underpinning SS5/25 is the continued maturation of regulatory thinking. Climate risk is no longer treated as a specialist sustainability topic operating at the edge of the organisation. The PRA has reinforced that climate-related risks are prudential, financial risks and should be managed through existing governance, risk and control frameworks. This includes governance and board oversight, risk management processes, scenario analysis, data governance and disclosures. 

This raises important questions for firms to consider. These are:  

• can a board explain how climate risks influenced a strategic decision? 

• can a credit committee demonstrate how climate considerations affected a lending outcome? 

• can management show how scenario analysis informed risk appetite or capital planning? 

• can an insurer evidence how climate risk is being considered on both sides of the balance sheet? 

The evidence gap is emerging as the next major risk 

A recurring theme from our work with financial institutions is what we describe as the "evidence gap". Many firms have invested considerable effort into developing methodologies, frameworks, risk taxonomies and governance structures. Yet when organisations attempt to trace important decisions back to supporting evidence, weaknesses begin to appear.

Supervisors increasingly expect to see a coherent evidence chain linking: 

• climate risk identification; 

• materiality assessments; 

• board and executive oversight; 

• risk appetite and management information; 

• scenario analysis outputs; 

• strategic decisions; 

• remediation activities; and 

• disclosure statements. 

Where that evidence chain is fragmented, firms may struggle to demonstrate effective implementation and sustain supervisory confidence. The firms that are likely to perform best under supervisory scrutiny can clearly show who made decisions, on what basis, supported by what evidence, and how those decisions were monitored and challenged over time.  

Boards face a new accountability challenge 

Another theme emerging from recent regulatory developments is accountability. SS5/25 places considerable emphasis on governance, individual responsibility and effective board oversight. Documentation alone will not be sufficient. Regulators increasingly expect boards to demonstrate understanding, challenge and ownership of climate-related financial risks. This creates a broader governance question. Many firms have focused on creating climate risk governance structures. Fewer have focused on strict accountability and evidencing board effectiveness.

The following questions go to the heart of regulatory expectations. Can the board:  

• demonstrate informed challenge? 

• explain why climate risks were considered material or immaterial? 

• evidence oversight of remediation plans? 

• describe a robust and coherent methodology for how climate considerations interact with prudential objectives, business strategy and financial resilience? 

In our experience, the strongest governance frameworks connect governance processes to demonstrable outcomes. 

Climate litigation is moving up the agenda 

Another notable feature of SS5/25 is the prominence given to litigation risk, with references provided throughout the statement. This reflects a wider market trend.

Research by the Grantham Research Institute at the London School of Economics shows that climate-related litigation is becoming more sophisticated. Recent cases show that courts, investors, campaign groups and claimant firms are increasingly focused on the evidence underlying climate-related claims, commitments and disclosures. For financial institutions this creates an important convergence. The same governance weaknesses that can generate regulatory concern may also create litigation exposure. On the flip side, having a robust evidence base may also help a firm demonstrate reasonable governance and decision-making if its conduct is later challenged, and may provide important defence in future litigation, shareholder action or disclosure-related disputes.

Climate risk governance is therefore no longer solely a regulatory issue. It has become a regulatory, legal and reputational resilience issue.  

Why remediation matters more than perfection 

The PRA has repeatedly recognised that climate risk management remains an evolving discipline. Data challenges remain. Methodologies continue to develop. Scientific understanding continues to advance. However, what supervisors do expect is a credible and ambitious response where gaps have been identified. This is where many firms will distinguish themselves over the next phase of supervision. They will be those able to demonstrate: 

• a robust understanding of their risk profile; 

• clear governance ownership; 

• transparent identification of weaknesses; 

• prioritised remediation actions; 

• documented implementation progress; and 

• evidence of continuous improvement. 

The quality of remediation is rapidly becoming as important as the quality of the original assessment. 

The next phase of climate supervision 

Looking forward, we believe the market is entering a new phase of climate regulation. The first phase was awareness. The second phase was implementation. The third phase, which has now begun, is evidence-based supervision. Boards should expect increasing scrutiny of how climate-related risks are incorporated into governance, risk management, capital planning and decision-making processes.  

For boards, the defining test is no longer the quality of the written climate risk framework, but whether it demonstrably shapes material business decisions and whether those decisions can withstand regulatory, investor and legal scrutiny.