Financial firms are struggling to quantify climate-related risk, according to the sector watchdog the Prudential Regulatory Authority (PRA).
After analysing audit reports for 2021-2022, it wrote to firms in October highlighting key areas of note. Firms have taken action to enhance governance, data and risk assessments relating to climate change. However, auditors failed to identify specific risks of material misstatements in financial reporting.
Lack of data
In fact, lack of reliable data was a major concern. “Auditors noted a lack of reasonable and supportable data available to management about their exposure to climate risk, and available to auditors to substantiate the impact of climate risks on the balance sheets,” Victoria Saporta, executive director of PRA’s prudential policy. “Where data was available, firms’ control environments around the quality of new data sources and use of proxies were immature.”
Some firms had made good progress in identifying the relevant risks so that they can be accurately reflected on balance sheets. PRA said it was important to link better risk management practices with accounting disclosures.
Increase quantitative analysis
PRA wanted to see more quantitative analysis of climate-related risk. Currently, much of the data available to audit committees and auditors is qualitative.
It wanted to see firms to embed quantitative analysis on the impact of climate risk on balance sheet valuations. This analysis should be reported to the audit committee to support decision-making. In addition, PRA recommended firms set up management information on their progress towards creating more effective reporting models in this area.
PRA recommended that firms develop “…a centralised process to source, manage, and enhance data needed to factor climate risk into balance sheet valuations.” Increasing automated data collection to improve controls over data would help, it said.
Model risk
The regulator also spelt out weaknesses in firms’ modelling for risk. In particular, organisations were often too slow to react to rapid shifts in the economy.
“We continue to regard it as essential that firms develop capabilities to perform more comprehensive economic sensitivity analysis more quickly, and improve their use of timely, granular, and comparable peer benchmarking data, to support robust governance,” it said.
