At the end of last year, the Bank of England (“BoE”) issued a discussion paper on its proposals for stress testing the financial stability of insurers and banks under future climate change scenarios. This stress test exercise for large banks and insurers is referred to as the “biennial exploratory scenario” or “BES”.

If adopted, this stress test exercise will go far beyond the stress testing already undertaken across the industry, including in the 2019 Insurance Stress Test from the Prudential Regulation Authority (“PRA”).

Under the current proposals, climate scenarios would dictate input variables for firms’ modelling and the onus will be on the firm to perform a “bottom-up” assessment of how their individual counterparty exposures respond to changes in these variables. These variables span “climate” (think future emissions levels), the “macro-economy” (e.g. GDP growth) and more traditional “financial” variables (such as government bond yields).

Additionally, firms will be required to set out the actions they may take in each of the scenarios – not only to mitigate the risks, but also to respond to new business opportunities.

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