The Bank of England's climate-related financial disclosure 2022

Foreword

The Bank of England’s mission is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability. A key aspect of delivering this mission is to manage the financial risks and economic consequences arising from the physical effects of climate change and the transition to net-zero emissions on our policy functions and internal operations. This report sets out our approach and assessment of climate change risk which we have produced in line with the framework developed by the Taskforce on Climate-related Financial Disclosures.

Over the past year, we have made progress with the completion of several multiyear climate risk related initiatives. This includes reporting on the progress banks and insurers have made against our climate related supervisory expectations, setting out our initial views of how climate change is reflected in regulatory capital requirements, publishing a comprehensive framework to green our corporate bond holdings, supporting the UK Government in its presidency of the G7 and hosting of COP26, and the publication of the results of our climate change scenario exercise.

In February 2022, we announced our plan to wind down our stock of corporate bond holdings and will consider the impact of greening as we do so, to the extent consistent with wider aims. This year’s report reflects detailed analysis of the climate risk profile of our portfolios, including through better measurement methodologies and more sophisticated scenario-based assessments of climate risks.

Our physical operations remain on track to achieve our target to reduce emissions by 63% in 2030 from 2016 levels and next year we will publish our transition plan for achieving net-zero emissions from our physical operations.

Looking ahead, we will continue to advance our understanding of the macroeconomic implications of climate change and net-zero transition, both domestically and internationally through groups like the G7 and the Network for Greening the Financial System.

We continue to be ambitious in our approach and hold ourselves to the same high standards that we require of the firms we regulate. For example, we will consider how the recommendations of HM Treasury’s Transition Plan Taskforce and the emerging disclosure standards from the International Sustainability Standards Board could be reflected in our future disclosures.

Ben Stimson
Chief Operating Officer of the Bank of England

Executive summary

The Bank has committed to publish annual climate disclosures. This is the third climate disclosure the Bank has produced, setting out the key climate-related developments in the year to February 2022. It builds on the Bank’s second climate disclosure by reflecting: the progress the Bank has made on its climate work plan over the past year; advances in climate data and modelling applied to its financial asset portfolios; progress on reducing emissions from its physical operations; and progress in the domestic and international climate agenda. In response to these developments, the Bank has refreshed the priorities that underpin its climate strategy.

Climate change and the transition to a net-zero economy are relevant to the Bank’s mission to promote the good of the people of the United Kingdom by maintaining monetary and financial stability. The physical effects of climate change and the transition to a net-zero economy can create financial risks and economic consequences, which can affect: the safety and soundness of the firms the Bank regulates; the stability of the financial system; and the economic outlook.

To respond to the broad range of climate-related financial risks in an effective and strategic manner, the Bank has designated Climate Change as one of its seven strategic priorities covering the four-year period to February 2024. In support of this the Bank will continue to fulfil its obligations under its remits and mandate, while focussing its efforts on where it can make the biggest contribution domestically and internationally.

As with the Bank’s previous climate disclosures, this year’s disclosure follows the structure recommended by the Financial Stability Board’s (FSB’s) Task Force on Climate-related Financial Disclosures (TCFD), covering four key elements: governance; strategy; risk management; and metrics and targets.

Governance

Climate-related risks (climate risks) are incorporated within the Bank’s internal governance and risk management frameworks, complemented by climate-specific processes where appropriate. As part of this, climate risks are discussed regularly at the Bank’s senior executive committees prior to decisions being implemented by management across the Bank. Climate risks are also subject to additional governance processes due to the inclusion of Climate Change as one of the Bank’s seven strategic priorities.

The Bank’s climate work is led by two Executive Sponsors: Sarah Breeden (Executive Director for Financial Stability Strategy and Risk) covers the Bank’s policy functions and Ben Stimson (Chief Operating Officer) covers the Bank’s physical operations. Climate change is relevant to many parts of the Bank; from sourcing polymer for banknote production to setting risk management expectations for banks and insurers regulated by the Bank, through the Prudential Regulation Authority (PRA). For that reason, the Bank has an Executive Director level steering group to co-ordinate and to deliver climate-related work across the Bank.

Strategy

The objective of the Bank’s work on climate change is to play a leading role, through its policies and operations, in ensuring the financial system, the macroeconomy, and the Bank are resilient to the risks from climate change and are supportive of the transition to a net-zero economy.

Our work is also supportive of the UK’s commitment in the Climate Change Act (2008) to achieve net-zero greenhouse gas (GHG) emissions by 2050. Furthermore, HM Treasury has included in the remit and recommendation letters to the Bank’s policy committees the need to have regard to the UK Government’s economic strategy of a transition to a net-zero economy.

To achieve its objective the Bank’s climate strategy is built around five key goals:

Progress has been made against these goals over the past year, such as the publication of the results of the Bank’s CBES exercise for major UK banks and insurers. Delivering against these priorities in the longer-term will fulfil the Bank’s role in building system-wide resilience and supporting the transition to net zero.

Risk management, metrics and targets

The Bank is itself exposed to climate risks across both its physical operations (eg emissions from its buildings and travel) and its financial operations (eg financial asset portfolios held for monetary policy purposes). This climate disclosure sets out the Bank’s approach to measuring and managing these risks.

Over the past year the Bank has implemented a number of enhancements to its management of climate risk. Since approval in June 2021, the Bank’s critical metrics for climate change risk have been reported regularly to the Bank’s executive and non-executive risk committees and periodically to the Bank’s Court of Directors (Court), which acts as a unitary board. The Bank has also produced internal guidance to assist business areas in assessing and reporting climate change risks, with the aim of encouraging more comprehensive thinking about the impact of climate change risk and to foster increased consistency of reported risks.

The Bank’s financial operations

The Bank continues to seek to demonstrate best practice in climate risk reporting by disclosing climate risk analysis of its asset holdings, and enhancing its analysis to align with the latest guidance. For the first time, this year the Bank has broadened its carbon footprint metrics to include financed emissions, a TCFD-recommended measure that seeks to estimate the amount of absolute emissions associated with an investment. The Bank also continues to strengthen its forward-looking risk measures by incorporating the revised scenarios issued by the Network for Greening the Financial System (NGFS), reflecting the latest climate science.

There are several external features driving emissions estimates in the Bank’s financial operations in this year’s climate disclosure. As well as the result of decarbonisation initiatives across sovereign and corporate issuers, lags in emissions data mean that the impact of Covid-related lockdowns in 2020 is being seen for the first time in data on climate footprints in the corporate sector. Lags are longer in sovereign emissions data and so Covid-related impacts will not yet show up in the Bank’s holdings of sovereign assets.

For the Bank’s sovereign asset holdings, climate performance across a range of indicators remained better than reference portfolios and in line with previous trends. The carbon footprint of the Bank’s sovereign holdings – as measured by the Weighted Average Carbon Intensity (WACI) – fell, and remained lower than a G7 reference portfolio. This reflects the UK’s lower carbon footprint relative to a number of other large nations. On a forward-looking basis, enhanced commitments made by countries prior to the twenty-sixth session of the Conference of the Parties (COP26) in 2021 mean the issuers of the assets held by the Bank are now committed to outcomes consistent with a ‘below 2°C’ scenario – and are closer to, though not yet consistent with a 1.5°C scenario – if those targets are met. Uncertainties remain, however, over how governments will implement the necessary actions to deliver those targets. Measures of exposure to physical and transition risks in the Bank’s sovereign portfolios were also low relative to reference portfolios, remaining broadly similar to last year’s climate disclosure.

In November 2021, in line with HM Treasury’s update to the Monetary Policy Committee (MPC) remit earlier in the year, the Bank announced its intention to align its Corporate Bond Purchase Scheme (CBPS) portfolio with the UK’s overall commitment to achieve net-zero greenhouse gas emissions by 2050. The Bank published a comprehensive framework to support that goal, including an interim target of reducing the WACI of the portfolio by 25% between 2020 and 2025.^{footnote [1]} An initial programme of reinvestment operations to deliver that goal was completed between November 2021 and January 2022. For that round of purchases, the Bank refined the eligibility criteria to be consistent with the UK Government’s net-zero strategy and purchases of issuers were tilted towards stronger climate performers in accordance with a climate scorecard. Subsequent to those announcements, the MPC announced in February 2022 that it would reduce the stock of sterling corporate bonds through a programme of bond sales, winding down the entire portfolio, to be completed no earlier than towards the end of 2023 or in early 2024, subject to market conditions. In making these sales, the Bank will have regard to the ongoing diversification of the portfolio including greening. While the corporate holdings are to be unwound, the Bank’s framework, on which the subsequent reinvestments were based, supports climate transition by providing an example for other investors in the public and private sectors of how to green a corporate bond portfolio.

Using headline metrics, the carbon footprint of the Bank’s corporate holdings materially improved – though some of this reflected temporary Covid-related factors. The WACI of the CBPS in February 2022 fell 8% year on year to 233 tonnes of CO₂ per £ million of revenue (tCO₂e/£mn revenue), 18% below levels in the 2020 climate disclosure. Estimates for the financed emissions of the portfolio also indicated emissions reductions across the portfolio. This fall in overall emissions was driven by a combination of firms’ decarbonisation efforts and the temporary emissions reductions experienced during national lockdowns.

While the aggregate emissions profile of the Bank’s corporate holdings has improved, some Covid-related effects may unwind in future disclosures and so forward-looking climate metrics for corporate bonds may be more mixed. As set out by the MPC, the Bank will aim to complete sales of its corporate holdings by the end of 2023 or early 2024. Companies are increasingly setting more ambitious, science-based emission reduction targets. However, the more stringent forward-looking NGFS climate scenarios used this year suggest that corporate assets may be exposed to higher transition risks than under previous estimates. If companies issuing such debt do not make sufficient progress towards their stated emissions reductions targets, future impacts of the valuation of that debt could be more severe than previous models suggested. The revised NGFS scenarios used in those models highlight the need for widespread, rapid decarbonisation in the corporate sector to ensure the transition to net zero is orderly and financial risks are minimised.

The Bank’s physical operations

This year the Bank’s carbon footprint has continued to reduce due in part to the continuing effects of Covid, which are not expected to be sustained. It has fallen by 9% (1,027 tCO₂e) compared to 2020/21, and by 51% (10,311 tCO₂e) compared to the baseline year of 2015/16, against which the Bank measures progress.

The most significant contribution to the emissions reduction relative to 2020/21 was a decrease in both the number and carbon intensity of banknotes printed (801 tCO₂e). While the Bank works with suppliers to permanently improve the carbon intensity of the notes, the number of banknotes printed is driven by demand and is therefore variable.

The reduction relative to the baseline year (2015/16) was driven primarily by a fall in air travel influenced by Covid restrictions (4,197 tCO₂e) and the Bank’s shift to renewable sources of electricity (5,562 tCO₂e). While the reduction due to decreased air travel is expected to unwind as the impact of Covid diminishes, the Bank anticipates that it is unlikely to revert to 2019/20 levels due to new ways of working. The Bank’s move to a contract for the supply of renewable electricity is a permanent change, from which the Bank expects to benefit in future years.

The majority of the Bank’s carbon footprint this year came from either natural gas usage (30%) or polymer substrate used in the production of banknotes (67%). Although gas usage will remain a key emission in the medium term, the Bank is actively working to minimise emissions by taking steps to optimise gas consumption and exploring options for decarbonising its heating systems in the longer term.

The Bank remains on track to meet its 2030 target to reduce absolute greenhouse gas emissions by 63% from 2016 to 2030. This target has been verified by the Carbon Trust as in line with the reduction in emissions needed to be consistent with limiting the rise in global average temperatures to 1.5°C above pre-industrial levels.

The Bank is exploring its strategy to reduce the emissions from its physical operations to net zero by 2050 at the latest, and aims to publish its net-zero transition plan for its physical operations as part of next year’s climate disclosure. This net-zero strategy will cover the full scope of the Bank’s physical operations and is consistent with the target in the Climate Change Act 2008.

1: Approach to climate disclosure

Climate change and the transition to net-zero emissions present both risks and opportunities for individual institutions and the wider economy and financial system. The disclosure of these risks and opportunities is therefore essential for consumers, investors, businesses and policymakers to make better informed decisions, such as where to spend their money, how to manage their risks, and how to design effective climate policies.

The benefits of climate disclosures increase with the scale of their adoption. Consequently, the Bank has sought to promote global adoption of high-quality, comparable and comprehensive disclosures. In April 2019, the Bank decided to produce its own annual climate disclosure to improve transparency over how climate change was affecting its policy functions and operations. This is the Bank’s third annual climate disclosure and relates to the year ended 28 February 2022. In it, the Bank sets out its own approach to managing climate-related risks (climate risks) across its operations and in pursuit of its statutory objectives, as reflected in the Bank’s remit. The climate disclosure is published at the same time as the Bank’s Annual Report 2022.

The Bank has carefully considered its approach to climate disclosure as a central bank and set out some of its key design choices below:

Framework

The Bank continues voluntarily to seek to align with the structure and framework recommended by the Financial Stability Board’s (FSB’s) TCFD, as described below.^{footnote [2]} This is now the most commonly used framework by public companies and other organisations to disclose key climate-related information. Its recommendations provide a foundation to improve visibility of climate risks and opportunities, guided by four core elements: governance; strategy; risk management; and metrics and targets.

This climate disclosure covers each of the TCFD core elements in turn, with the aim of setting out how the Bank currently considers climate risks across its governance, strategy and risk management functions, including how the Bank uses metrics and targets to monitor and manage those risks. However, reflecting the fact that the TCFD recommendations aren’t tailored to central banks, the Bank exercises discretion in the way in which it interprets the recommendations in the context of its own climate disclosure. Annex 1 provides a summary of the way the TCFD recommendations have been reflected in this climate disclosure. The Bank has also factored in Network for Greening the Financial System (NGFS) guidance for central bank disclosure on financial operations, to which the Bank contributed.

The Bank is an official supporter of the TCFD recommendations and has a track record of supporting progress towards a global TCFD-aligned climate change disclosure standard.^{footnote [3]}

Building on the work of the TCFD, in November 2021 the IFRS set up the ISSB to establish consistent global sustainability disclosure standards. In March 2022, the ISSB published exposure drafts for ‘Climate-related Disclosures’ as well as ‘General Requirements for Disclosure of Sustainability-related Financial Information’, and are expected to publish a final global climate disclosure standard in 2022, which is expected to be based on the TCFD but will clarify climate disclosure requirements at a more granular level. The UK Government has announced that the ISSB standards will ‘form a core component of the UK Sustainability Disclosure Requirements^{footnote [4]} (SDR) framework and the backbone of its corporate reporting element’. The Bank welcomes the increased clarity that the new standards will bring and will review the standards as they develop to consider how they might inform the contents of future Bank climate disclosures.

Scope

As a public body, the Bank recognises the need to be transparent and as comprehensive as possible in disclosing the potential impacts of climate risks across its policy functions (monetary policy, financial stability policy, and prudential regulation) and operations (financial asset holdings and physical operations).This section sets out some of the main scoping decisions taken in relation to this climate disclosure.

The Bank was the first central bank to include analysis of the climate risks in financial portfolios held for monetary policy purposes in its climate disclosure. Specifically, the climate disclosure scope covers the Bank’s Asset Purchase Facility (APF) as well as the Bank’s own securities holdings for both policy implementation and funding the Bank’s policy functions (which are classified as Scope 3 emissions under the Greenhouse Gas (GHG) Protocol).

Figure 1.1: An indicative illustration of the scope of the Bank’s climate disclosure 2022 with reference to the four TCFD pillars

Footnotes

• Source: Bank of England.

As Figure 1.1 illustrates, in three of the four TCFD core elements (governance, strategy and risk management) the scope of this climate disclosure includes all areas of the Bank’s work. Decisions have been taken to limit the scope of the ‘targets and metrics’ element for reasons of practicality and utility. The key scope limitations have been set out below:

• The analysis of key climate risks to the Bank’s physical operations captures Scope 1 emissions (use of natural gas, fuel and refrigerants), Scope 2 emissions (electricity) and travel emissions (which are classified as Scope 3) using the GHG Protocol. Certain Scope 3 emissions from physical operations (emissions associated with the Bank’s supply chain) are currently out of scope due challenges related to data availability. However, the Bank is part-way through a multi-year project working with the Bank’s most carbon intensive and sophisticated suppliers to capture their Scope 3 emissions. The project is due to complete in early 2024 and will help to inform the Bank’s climate disclosure to be published in June 2024. The Bank expects to publish details of how this work will be broadened to include the Bank’s smaller suppliers in the Bank’s forthcoming strategy for reaching net-zero emissions in its physical operations, which is discussed in section 4.
• As in prior years, the financial operations analysis covers all long-term corporate and sovereign bond assets, including those held within the APF to implement monetary policy. It excludes: short tenor traded assets (given the very limited link between such assets and the incentives to effect lasting climate change); Bank purchases of commercial paper (CP) on behalf of HM Treasury between March 2020 and March 2021 as part of the Covid Corporate Financing Facility (CCFF) – all of which was under 12 months maturity, closed to new purchases on 23 March 2021, and had fully unwound by March 2022;^{footnote [5]} and the Bank of England Alternative Liquidity Facility (BEALF), which accounts for only 0.008% of the Bank’s overall balance sheet, and holds only supranational assets, the climate risk evaluation of which remains under development.
• Although the Bank’s pension fund is operationally independent from the Bank of England, for completeness it was included in the Bank’s financial operations climate disclosure in previous years. However, in line with new disclosure requirements from The Pension Regulator,^{footnote [6]} from this year the Bank’s pension fund will publish its own climate disclosure and therefore the portfolio is no longer included in this climate disclosure.

2: Governance

The Bank’s organisation-wide governance framework has been designed to be appropriate to the nature, scale and complexity of its operations. As a source of risk integral to the Bank’s mission, functions and operations, climate-related considerations are embedded in our approach to governance. This section sets out how the governance of the Bank’s climate-related work is applied.

Court of Directors’ oversight of the Bank’s management of climate-related risks

The Bank’s management of climate risks is overseen by its Court of Directors (Court). Their role is supported by established responsibilities for climate matters, which have been allocated across the Bank’s executive committees, steering groups, and management team. Decisions are supported by regular management reporting on climate strategy, risk management, metrics and targets.

Acting as a unitary board, Court sets the Bank’s strategy and budget, and takes key decisions on resourcing and appointments. Court is responsible for matters that concern the Bank as an organisation, while policy responsibilities are reserved for policy committees. The Audit and Risk Committee (ARCO), a sub-committee of Court, assists Court in its responsibility for maintaining effective risk management, internal controls and financial reporting. In line with these responsibilities, both Court and ARCO oversee the Bank’s approach to climate risk management and climate disclosure. At a minimum, Court reviews the Bank’s progress against climate risk targets on an annual basis as part of its review of the Bank’s Annual Report.

The executive-level committees are the most senior executive policy-making bodies beneath Court. They review and approve the Bank’s climate strategy at least once a year.

The Bank’s three statutory policy committees are the Monetary Policy Committee (MPC), the Financial Policy Committee (FPC), and the Prudential Regulation Committee (PRC). The Chancellor of the Exchequer provides remit and recommendations letters to the Bank’s policy committees. In recent years these have been updated to include, among other things, the UK Government’s economic strategy for a ‘transition to an environmentally sustainable and resilient net-zero economy’.^{footnote [7]} And this year the Bank received two additional climate-related recommendations, one for each of the FPC and PRC, requiring the committees to ‘…have regard to the Government’s energy security strategy and the important role that the financial system will play in supporting the UK’s energy security – including through investment in transitional hydrocarbons like gas – as part of the UK’s pathway to net zero’. The Bank’s climate strategy takes account of the policy committees’ remit and recommendations letters, as described in section 3 and Annex 2.

Our climate work has featured in discussions across the Bank’s policy committees, executive committees, and at ARCO and Court.

Figure 2.1: Organogram illustrating Bank committees and steering groups relevant to the governance of the Bank’s work on climate change ^{(a) (b) (c) (d) (e) (f) (g)}

Footnotes

• Source: Bank of England.
• (a) While reserving certain key decisions to itself, Court has delegated to the Governor the day-to-day management of the Bank. The Governor delegates certain decisions to individuals or committees within the Bank, and takes advice on others. The principal forums for such advice are the executive-level committees.
• (b) Ben Stimson is Chief Operating Officer and Executive Sponsor for climate change across the Bank of England’s internal operations. Ben jointly signs off the Bank’s climate disclosure, together with Sarah Breeden and Afua Kyei.
• (c) Sarah Breeden is Executive Director of Financial Stability Strategy and Risk, and Executive Sponsor for climate change across the Bank of England’s policy functions. Sarah is also holds the Bank’s Senior Manager Function responsible for the financial risks from climate change. Sarah jointly signs off the Bank’s climate disclosure, together with Ben Stimson and Afua Kyei.
• (d) Andrew Hauser is the Executive Director of Markets, the directorate responsible for leading the Bank of England’s market operations and analysis of the climate impact of the Bank of England’s financial asset portfolios.
• (e) Afua Kyei is the Bank’s Chief Financial Officer and is responsible for the Bank’s Annual Report. Afua jointly signs off the Bank’s climate disclosure, together with Ben Stimson and Sarah Breeden.
• (f) ARCO is a sub-committee of Court.
• (g) The Executive Directors’ Climate Steering Group (EDCSG) is a cross-Bank steering group to facilitate discussions on climate-related work. The EDCSG can make recommendations to, and review papers prior to going to, the Bank’s executive-level committees, ARCO, and other Bank committees where relevant. The EDCSG is not a formal Bank committee or decision-making body.

Management’s role in assessing and managing climate-related risks

Governance of the Bank’s climate-related work at a management level is led by the Bank’s two Executive Sponsors for climate change: the Executive Sponsor for the Bank’s policy functions (Sarah Breeden, Executive Director for Financial Stability Strategy and Risk); and the Bank’s Executive Sponsor for climate change across the Bank’s internal operations (Ben Stimson, the Bank’s Chief Operating Officer). The Executive Sponsors work closely together in order to deliver the Bank’s climate work.

Sarah Breeden has also been allocated the Senior Management Function^{footnote [8]} (SMF) responsible for the financial risks from climate change, and is therefore responsible for recommending the Bank’s climate change strategy to the executive Committees, overseeing its execution, and co-ordinating climate-related work across the Bank. Ben Stimson has responsibilities for climate risks to the Bank’s internal operations.

The primary management forum responsible for effective co-ordination on climate-related work across the Bank is the Executive Directors’ Climate Steering Group, which is chaired by Sarah Breeden as the SMF holder. This group acts as a forum for Executive Directors across the Bank to discuss strategic climate-related issues and has been active in supporting Court and the Bank’s executive and policy committees in their work on climate change.

To embed consideration of climate change across the Bank’s functions, it operates a ‘hub and spoke’ model. At the centre sits the Climate Hub, a dedicated division of climate specialists, which supports the SMF and implementation of the Bank’s climate strategy across the organisation. Each area of the Bank, or spoke, has one or more climate leads responsible for directing climate-related work within their area, and co-ordinating with the Climate Hub and across other spokes. This balances development of climate expertise with embedding consideration of climate risk across the Bank.

3: Strategy

The Bank’s approach to climate change

The Bank’s mission is to promote the good of the people of the United Kingdom by maintaining monetary and financial stability. Climate change is relevant to the Bank’s mission as the physical effects of climate change (eg sea-level rises and more frequent severe weather events) and the transition to a net-zero economy (eg changes in government policy, consumer preferences, and technology) create financial risks and economic consequences.

These risks and consequences can affect the safety and soundness of the firms the Bank regulates, the stability of the wider financial system, and the economic outlook.^{footnote [9]} Since the publication of the Bank’s previous climate disclosure, the Bank has agreed seven strategic priorities for 2021 to 2024. These are detailed in the Bank’s Annual Report and include climate change (strategic priority 5).

The objective of the Bank’s work on climate change is to:

‘Play a leading role, through the Bank’s policies and operations, in ensuring the financial system, the macroeconomy, and the Bank are resilient to the risks from climate change and supportive of the transition to a net-zero economy.’

The Bank builds this resilience and supports the transition by ensuring that climate-related financial risks are proactively identified and effectively managed through its policy functions (eg its supervision of banks and insurers) and the Bank’s management of its own operations (eg the carbon footprint of its buildings).

The importance of the Bank’s work in this area is also reflected in the remits and recommendations that HM Treasury provides to the Bank’s three policy committees – the Monetary Policy Committee, the Financial Policy Committee, and the Prudential Regulation Committee. Each policy committee has a different set of responsibilities. Collectively, they discharge the Bank’s statutory functions in relation to monetary policy, financial stability and prudential regulation. For further information on the Bank’s policy committees, the remit setting process, and a summary of the climate-related elements of the committees’ remits, please see Table A2.1 in Annex 2.

The Bank’s work to meet its strategic goals

This year the Bank has refreshed the individual priorities that underpin its climate strategy to reflect the progress the Bank has made and broader shifts in the domestic and international climate agenda. The Bank has articulated its climate strategy as playing its part across five key goals:

(1) Ensuring the financial system is resilient to climate-related financial risks

The Bank is using its micro and macroprudential toolkits to build resilience to climate-related financial risks at both an individual firm and system-wide level.

In April 2019, the PRA became the first prudential regulator to publish a comprehensive set of supervisory expectations for how banks and insurers should enhance their approaches to managing the financial risks from climate change. This was followed by guidance and industry-wide feedback for firms, including the PRAs expectations that firms hold adequate capital for climate-related financial risks. The PRA set a deadline for firms to embed the supervisory expectations as far as possible by the end of 2021. In addition, the PRA worked with the Financial Conduct Authority (FCA) to co-convene the Climate Financial Risk Forum (CFRF), an industry group established to share best practice on climate issues and accelerate firms’ capabilities to address climate change. The CFRF published a series of climate-related practical guides and toolkits in 2020 and 2021.

In October 2021, the PRA published a report on its assessment of progress firms had made on its supervisory expectations, how its supervisory approach would evolve going forwards, and initial findings on the relationship between climate change and regulatory capital requirements for banks and insurers.

The report found that firms had made good progress in some areas such as incorporating climate risks into governance frameworks, but overall there was still much further to go. Data gaps and modelling complexities continue to be cited as common challenges, but alternatives such as use of proxy data, expert judgement and assumptions can help bridge the gaps in the interim.

The report noted that the PRA’s supervisory approach would evolve from the end of 2021 with the PRA shifting gears from assessing implementation of its supervisory expectations to actively supervising against them. Firms should expect to demonstrate effective management of climate-related financial risks through regular supervisory engagements and reviews. Where progress is insufficient and assurance or remediation is needed, the PRA will request clear plans and, where appropriate, take action in response.^{footnote [12]}

The report found that regulatory capital for banks and insurers could be used to support resilience against the financial consequences of climate change, but not to address the underlying causes of climate change. The latter requires reducing GHG emissions across the wider economy and is a role for the UK Government, which will be driven by UK Government policy and the actions of industry and individuals. The Bank and PRA will undertake further work in 2022 to explore whether changes need to be made to the design, use, or calibration of the regulatory capital framework. To support this, the Bank has put out a call for research and will be hosting a climate change capital requirements research conference in October 2022. The Bank and PRA intend to publish an update of their views on this topic by 31 December 2022. In addition, during 2022 the PRA will review firms’ own assessments of their climate-related capital needs in banks’ Individual Capital Adequacy Assessment Plans and insurers’ Own Risk and Solvency Assessments.

The Bank has also undertaken work to explore the macroprudential risks from climate change. For example, the Bank recently concluded its Climate Biennial Exploratory Scenario (CBES) exercise and published the results on 24 May 2022. The exercise was designed to: (1) size the financial exposures of individual firms and the financial system to climate change; (2) understand how firms might respond to different climate scenarios and the impact on their business models; and (3) improve firms’ management of the financial risks from climate change.

The results of the exercise found that an ‘early action’ scenario, where policies are introduced in a timely manner to deliver an orderly transition to net zero by 2050, resulted in the lowest costs and greatest opportunities for the financial sector. Other scenarios where climate risks are higher bring greater costs for the financial sector and greater potential costs for the real economy, including through the withdrawal or increase in price of financial services to certain businesses and households.

There is also increasing awareness of the potential for changes in the environment beyond those directly attributable to climate change to create financial risks. Central banks and supervisors around the world have begun to explore these ‘nature-related financial risks’ such as biodiversity loss. The Bank is undertaking work in this area to establish the potential materiality of these risks and the transmission channels through which they might arise. This work draws on existing literature, such as ‘The Economics of Biodiversity: The Dasgupta Review’, and international work by the NGFS and other bodies. The Bank’s work in this space supports its contribution to the requirements in the Environment Act 2021 for public bodies to consider how they can support conservation and biodiversity.

(2) Supporting an orderly economy-wide transition to net-zero emissions

The Bank’s role in the transition is to understand how different transition pathways could affect the macroeconomy, the stability of the wider financial system, and the safety and soundness of the firms it regulates. The Bank’s policy response will be calibrated to address the risks that these pathways pose to its objectives, but its actions cannot direct the pathway the economy or financial system ultimately faces.

The primary levers for driving an orderly economy-wide transition to net-zero emissions rest with UK Government in setting climate policy. Clarity over the future path of climate policy and implications for different sectors will better allow the UK economy to adjust effectively, and the financial system to support that adjustment, reducing the risks of a later, sharper, and more disorderly transition. However, the Bank’s actions can in some circumstances help magnify the effects of UK Government climate policy, not least since a resilient financial system will be better able to support the transition.

Over the past four years the Bank has chaired the Macrofinancial workstream of the NGFS, which has worked with a consortium of climate scientists and modellers to develop climate scenarios. These scenarios have been used by central banks and policymakers around the world in climate scenario exercises (like the CBES) and for a wider range of analysis.^{footnote [13]} Scenario analysis is a critical tool to help navigate the uncertainty associated with climate-related physical, policy, and macroeconomic models that look decades into the future, by enabling assessment against a range of possible outcomes. As such, the development of frameworks to undertake scenario analysis, and the development of the climate scenarios themselves, are central to the Bank’s strategy to support the transition. In 2022, the Bank’s tenure as chair of the Macrofinancial workstream will end, but it will continue to play an active role in the future development of climate scenarios.

Improving understanding of the macroeconomic effects of climate change, including under different transition pathways to net-zero emissions, will be a key area of focus for the Bank going forwards. This is a relatively unexplored area with limited research to date. The Bank will undertake analysis to explore the size of the impacts, the transmission channels, and the potential implications for monetary and macroprudential policy. The Bank’s policy response will be calibrated to address the risks that these pathways pose to its objectives, in accordance with its remit. The Bank’s actions aim to support an orderly transition to net zero as a key component of the Bank’s work to maintain financial stability.

The Bank anticipates that individual and sector-level transition plans will assist its role as both a central bank and a financial regulator to identify the risks to firms and insurance policyholders and at the macro-level the systemic risks that may impact the economy as a result of transition. To that end the Bank is also an observer on HM Treasury’s recently established Transition Plan Taskforce (TPT). The TPT will help to define the standards for transition plans by establishing robust criteria and the effective use of science-based targets.

The Bank can also use its work to create conditions that help facilitate investment in the transition. For example, the Bank, alongside HM Treasury and the FCA, convened an industry working group to facilitate investment in productive finance. While this work has been sector-agnostic and considers a broad range of assets, unlocking financing for longer-term and less liquid assets could also benefit productive sustainable investment in areas such as green technologies and renewable energy infrastructure. The working group published its first report in September 2021. The impact on sustainable investment will be kept under review as the working group progresses.

(3) Promoting adoption of effective TCFD-aligned climate disclosure

The Bank has supported the adoption of the climate disclosure framework established by the TCFD since its inception, including recent guidance for central banks published by the NGFS.^{footnote [14]} The information in these climate disclosures needs to be consistent, comparable and comprehensive to be useful. Climate disclosure is important not only for transparency and for risk management purposes, but also as a way to enable the flow of capital towards investments that are consistent with an orderly economy-wide transition to net-zero emissions. Consequently, it is also integral to the UK’s legislative commitment to reach net-zero emissions by 2050.

The Bank is working with the UK Government and other financial regulators to support the rollout of mandatory TCFD-aligned climate disclosure requirements across the economy by 2025.^{footnote [15]} These requirements are complemented by the PRA’s existing supervisory expectation that banks and insurers should report their climate-related financial risks as part of their public climate disclosures, and where material in their Pillar 3 regulatory disclosures. The wider rollout of climate disclosure requirements is being delivered through a combination of regulations and legislation, as described in the UK SDR.

Climate risks are global and therefore the coherence and consistency of climate disclosure requirements and sustainability standards across jurisdictions is important for promoting effective risk management and supporting climate action. In light of this need, the Bank is supportive of multilateral work including the establishment of the IFRS Foundation’s ISSB, which published its initial exposure draft of a comprehensive global baseline of sustainability-related disclosure standards on 31 March 2022.

The Bank is also supportive of the development of robust forward-looking metrics which take into account the future emissions associated with companies’ activities. The Bank is engaging with a number of external stakeholders developing forward-looking metrics and associated frameworks.

(4) Working towards a timely and co-ordinated international approach to climate change

The consequences of climate change are global and so the effectiveness of climate policy and the need for a robust understanding of climate risks, are not solely domestic concerns. They must be delivered in a co-ordinated and timely fashion at an international level. The Bank supports this through its work with other central banks, through its roles in international fora, and by working with UK Government to deliver progress on climate through the G7, G20 and via the twenty-sixth session of the Conference of the Parties (COP26).

The Bank is a founding member of the NGFS and sits on the steering committee. The NGFS was co-founded by eight central banks and supervisory authorities in December 2017. As of June 2022, membership has grown to 114 members and 18 observers representing countries responsible for around 85% of global GHG emissions and responsible for supervising 100% of globally systemic banks. Through the NGFS the Bank aims to share its own experience, learn from others, and promote consistent and effective responses to climate risks by central banks and supervisors across the world. In future the Bank will be chairing the NGFS Workstream 3, which will be considering the formation of monetary policy in relation to climate change. The Bank also provides training to other central banks and regulators on topics including climate-related financial regulation through the Bank’s Centre for Central Banking Studies.

The Bank also co-founded the Sustainable Insurance Forum (SIF) to advance supervisory responses to climate change in the insurance sector across the globe. SIF is a global network of insurance supervisors and regulators working together on sustainability challenges facing the insurance sector, including climate change. In 2020, the SIF published a climate-related question bank for insurance supervisors and, alongside the International Association of Insurance Supervisors (IAIS), published a landmark draft paper on the supervision of climate risks in the insurance sector. Anna Sweeney, Executive Director of Insurance Supervision at the Bank, is the chair of the SIF.

In addition to these climate-focused fora, the Bank continues to engage in the climate-related workstreams of standard setters and international bodies. The Bank is participating in the Basel Committee on Banking Supervision's (BCBS) Task Force on Climate-related Financial Risks (TCFR), contributing to enhancing global stability. The TCFR is undertaking work on identifying the gaps within the Basel framework and potential measures to better capture climate related financial risks, including regulatory, supervisory and disclosure elements. It is also a key forum through which the Bank will advance discussions internationally on its research into the relationship between climate change and regulatory capital requirements. In addition to a stocktake and analytical reports published last year, the BCBS recently published on new ‘Principles to effectively manage and supervise climate related financial risks’. Progress in implementing and embedding the Principles will be monitored by the BCBS. The Bank is also participating in the IAIS Climate Risk Steering Group to support insurance supervisors in developing their own scenario analysis, to integrate data collection, and to explore climate-related amendments to the Insurance Common Principles. Victoria Saporta, Executive Director of Prudential Policy at the Bank, is chair of the IAIS.

The FSB’s Standing Committee on Supervisory and Regulatory Cooperation, chaired by the Governor, has recently published a report providing recommendations to help regulatory authorities identify relevant and useful climate-related data through supervisory and regulatory data collection. Through the G20 Sustainable Finance Working Group the Bank is helping to develop a transition finance framework that will set out high-level principles for authorities to enable financial flows to support the transition and help firms formulate consistent and credible transition plans. And via the Organisation for Economic Co-operation and Development the Bank is contributing to high-level principles for climate transition-relevant finance.

The Bank has also worked to ensure consistency and comparability in climate disclosure frameworks, initially through a report to the G20 last year promoting climate-related disclosures, and subsequently in its support for the IFRS’s ISSB and its draft standards.

(5) Demonstrating best practice through the Bank’s own operations

The Bank holds itself to the same high standards that it expects of the firms it regulates and the financial system it oversees. As such, the Bank is taking steps to ensure its own operations conform to best practice in the measurement, management and mitigation of climate risks. This includes emissions from both the Bank’s physical activities (such as its buildings, production of banknotes, and travel) and its financial market operations undertaken in pursuit of its public policy goals. The Bank has considered how its approach to its own operations, where relevant, maps to the supervisory expectations it has set for PRA-regulated banks and insurers.

For the Bank’s financial operations, in November 2021 the Bank published a comprehensive framework to green the Corporate Bond Purchase Scheme (CBPS) portfolio. The ultimate objective was to incentivise economy-wide transition and take into account the climate impact of issuers. A programme of reinvestment operations based on the new framework was completed between November 2021 and January 2022. Subsequently, the MPC announced in February 2022 the Bank would be reducing the stock of sterling corporate bonds through a programme of bond sales to be completed no earlier than towards the end of 2023 or in early 2024, subject to market conditions. While the corporate holdings are to be unwound, the Bank’s framework, on which the subsequent reinvestments were based, supports climate transition by providing an example for other investors in the public and private sectors of how to green a corporate bond portfolio.

4: Risk management, metrics and targets

Risk management

The Bank has a risk management framework that spans all of the Bank’s functions. The Risk Management Framework specifies the Bank’s risk tolerance and provides an approach for managing both financial and non-financial risks within tolerance. It is underpinned by an internal classification of risk types (a risk taxonomy), which all areas of the Bank use to categorise their risks.

Within the risk taxonomy, the Bank identifies a small number of risk types (Key Risk Types), which are overseen by a named ‘Risk Custodian’. The Risk Custodian for climate change risk is Sarah Breeden, one of the Bank’s Executive Sponsors for climate change and SMF responsible for the financial risks from climate change. Risk Custodians, supported by the Bank’s second line risk function, are responsible for defining a set of risk metrics and tolerances; monitoring and reporting them and, where appropriate, co-ordinating the timing and implementation of mitigants. Development of the Bank’s climate change metrics drew on expertise across the Bank, aiming to capture the full range of climate risks to which the Bank is exposed. The metrics will be refreshed periodically, reflecting the pace of development in the field and frequency of reporting of underlying data.

The Bank uses its risk management framework to monitor exposure to climate change and how it could impact the resilience of its financial and physical operations. To help analyse climate risk in both these areas, the Bank focuses on two climate-related risk drivers:

• Transition risks arise from the changes required to move towards a net-zero economy. Changes in policy, technology, shifting consumer and societal sentiment, and interpretations of the law could prompt a reassessment of the value of a large range of emissions intensive assets.
• Physical risks arise from changes in the earth’s climate. These changes can be acute (eg increased severity or frequency of extreme weather events such as floods and wildfires) or chronic (eg rise in sea levels over the medium to long term). Physical risks can damage property and other infrastructure, disrupt business supply chains, impact human working conditions and health and, more broadly, can lead to internal displacement and conflict. Without counter-balancing factors, all of these outcomes reduce asset values, resulting in lower profitability for companies, damaging public finances, and increasing the cost of settling underwriting losses for insurers. Indirect effects on the macroeconomic environment, such as lower output and productivity, exacerbate these direct impacts.

The Bank’s approach to risk management is influenced by three distinct characteristics, which the Bank sees in both transition and physical climate risks, and which mean that addressing climate risks presents unique challenges:

• The impact is far-reaching in breadth and magnitude: climate change risks will affect all parts of the economy and society, across all sectors and geographies. The risks will be correlated and their impact nonlinear and irreversible.
• The risks are foreseeable: while the exact outcome is uncertain, some combination of transition and physical risks will crystallise.
• The magnitude of the future impact is dependent on actions today: this includes actions by governments, central banks and regulators, financial firms, businesses, and households.

While these three characteristics mean that climate risks present unique measurement and management challenges, the Bank recognises that delay in taking action will impair its ability to both measure the risks the Bank is taking in the short term and assess the long-term consequences of those decisions. As such, the Bank is taking a forward-looking approach to climate risk management and is prioritising development of the necessary skills and knowledge to tackle risks as they develop.

The process for managing risks related to climate change will continue to develop as the Bank’s understanding of underlying risks improves, technical capabilities are enhanced, and methodologies evolve and become more standardised. Several developments have been implemented since last year:

• In 2021, the Bank reported that critical metrics for climate change risk were in development. Following approval by ARCO in June 2021, these metrics have since been reported regularly to the Bank’s executive and non-executive risk committees, and periodically to Court.
• Specific guidance has been created to assist business areas with assessing and reporting climate change risks. The aim of this guidance is to encourage more comprehensive thinking about the impact of climate change risk and to foster increased consistency of reported risks.

The remainder of this section sets out the key climate risks the Bank has identified to its financial and physical operations.

Key climate-related risks to the Bank’s financial operations

The Bank engages in a range of market operations for the purposes of implementing monetary and financial stability policy, and – to a much smaller degree – and funding its wider activities (Figure 4.1). This involves purchasing sovereign and corporate assets and offering secured lending to counterparties through the Bank’s facilities. As part of managing the financial risks involved in this, the Bank conducts credit risk assessments and manages a wide range of collateral.

Figure 4.1: The Bank’s policy and balance sheet tools ^{(a) (b) (}c^{) (}d⁾

Footnotes

• Source: Bank of England.
• (a) This diagram excludes the CCFF. All CP held by Covid Corporate Financing Facility Limited (CCFFL) was of less than 12 months maturity and the scheme officially closed on 18 March 2022.
• (b) In this context ‘SMF’ refers to the Sterling Monetary Framework, and ‘SSAs’ refers to bonds issued by sovereigns, supranationals and agencies.
• (c) This figure excludes the Term Funding Scheme with additional incentives for SMEs (closed to new drawings) and the short-term non-sterling liquidity facilities, including the Liquidity Facility in Euros (currently inactive) and US Dollar Repo.
• (d) The full range of the Bank’s policy and balance sheet tools are set out in the Bank of England Market Operations Guide.

The Bank has taken a number of steps to incorporate climate risks into its financial risk management processes. A schematic showing the sequencing of the Bank’s programme of internal climate risk integration initiatives is outlined in Figure 4.2, where the Bank’s current performance is indicated by the row labelled ‘2021/22’.

The Bank has enhanced its collection of climate-related risk data (for example, emissions intensity) and has made initial updates to its credit risk assessment methodologies for each of the asset classes the Bank is directly exposed to through its market operations (corporate, sovereign and financial institution). For each of these asset classes the Bank has a framework for identifying climate risks and, where appropriate, incorporating relevant metrics into its risk assessment templates.