UK PRA publishes new supervisory expectations for identifying and managing climate-related risks for banks and insurers

Key takeaways

The Prudential Regulation Authority's (“PRA”) new Supervisory Statement (SS5/25) “Enhancing banks' and insurers' approaches to managing climate-related risks” applied immediately upon publication from 3 December 2025.

The PRA makes it clear that the majority of banks and insurers were not doing enough to evaluate and mitigate their climate-related risks.

It updates the previous supervisory expectations with PRA feedback on firms' progress and examples of effective practice and new international guidance.  The new expectations make clear that firms are expected to take a proportionate approach that takes account of the firm's size and risk exposure.

The PRA has updated its expectations for supervised firms for enhanced management of climate-related risks

The SS updates the previous supervisory statement (SS3/19) and incorporates new international guidance for PRA-supervised banks and insurance companies (“firms”) whilst embedding improved understanding of climate-related risk. The SS has a clear focus on governance, including oversight, skills and experience of a firm’s board and senior management function and demonstrated management of climate risk in business models and risk appetite, risk management processes and climate scenario analysis. The SS clarifies the proportionate approach firms are expected to take depending on the firm’s risk exposure and size of the firm, in line with the approach they take for management of other material risks and acknowledges that PRA guidance will continue to evolve with further guidance and case studies to follow.

The PS acknowledges that whilst “firms have made progress in developing climate risk capabilities…progress remains uneven”. The SS updates previous supervisory expectations and consolidates this with guidance contained in PRA Reports and Dear CFO and Dear CEO letters to firms over recent years and updates to international standards for banks and insurers (such as the Basel Committee on Banking Supervision’s (BCBS) Principles and latest guidance supporting the Insurance Core Principles (ICPs) published by the International Association of Insurance Supervisors (IAIS)).

“The risks are systemic. To varying extents, they will affect every customer, every company, in all sectors of the economy and across all geographies. Their impact will likely be correlated, non-linear, irreversible and subject to tipping points. Over time, they are likely to occur on a greater scale than other risks that firms are used to modelling and managing.”²

The SS and PS are the PRA’s response to requests from firms for greater clarity on what the PRA expects them to do to manage the effects of climate change and climate-related risk, incorporating lessons learnt in the UK and internationally over the last five years.

In its consultation paper CP10/25 on 30 April 2025, the PRA identified that it “is in the interest of firms to ensure effective assessment and monitoring, proportionate to their risk exposure, just as it would for any other material risk the firm faces”. It noted that firms are currently underestimating their climate-related risks as a result of inadequate risk assessment of climate-related risk exposures and that some banks do not consider climate-related risk to be a material risk yet, however this conclusion is not based on an adequate assessment of climate-related risk exposures.

The PRA identifies “important data gaps” and firms lacking information on climate projections resulting in inability to link to their assets and lending portfolios. In addition, the PRA found limited evidence that insurers were using results of scenario analysis in their decision-making and that scenario analysis did not consider the impact of a range of plausible future outcomes, such as tail risks, embedding realistic worst-case scenarios and potential tipping points and their implications. They also found that the impacts of transition risk on underwriting and investments were rarely considered.

In the final SS, the PRA recognised that some firms may also wish to recognise litigation risk as a separate transmission channel to physical and transition risks. Firms, especially general insurers, may apply their own judgement as to whether litigation risk ought to be reflected as a subset of physical or transition risk or independent.

How long do firms have to meet the new expectations?

The PS and SS took effect from 3 December 2025. Firms have six months from that date to transition to the updated expectations.

The PRA clarifies that this six-month period “is not an implementation timeline, but a period during which firms would be expected to conduct an internal review of their current status in meeting the expectations set out in the final policy”, making a credible and ambitious plan to address any gaps.

Proportionate application of expectations: two-step process to identify, determine and understand climate-related risks to inform risk management response

Firms must take a proportionate response to the potential impact of climate change to PRA-regulated activities. It recommends that firms consider a two-step process to ensure that the firms’ approach appropriately reflects the materiality of the climate-related risks that it faces.

The PRA has clarified that a firm may choose to tailor its response according to its size. The final SS clarifies the proportionate application of expectations by firms by providing an additional “Overarching aims” section to this section clarifying how firms proportionate application should reflect “their level of exposure to material climate-related risks, as well as the size and complexity of their business”. Put simply, this means that a firm that is materially exposed to climate-related risks would need to take greater action to monitor and manage those risks compared to a firm that is less exposed.

All firms are expected to be able to evidence or explain how they have reached judgements that underpin the outcomes from the above steps.

Step 1 – risk identification, assessment and sign-off: firms are expected to identify the material climate-related risks they are exposed to and understand how they will impact the resilience of their business model over relevant time horizons and under different climate scenarios. Crucially, firms’ boards are expected to review and agree material climate-related risks identified and record them in the risk register along with an agreed timeline for future board review.

Step 2 – appropriate risk management tools and response: a firms’ risk management response must be proportionate (this term comes up again and again) to the assessed climate-related risk profile of the firm. If it determines that less sophisticated tools are appropriate, it should be aware of the limitations of the tools and take a prudent approach to interpreting information when informing decision-making. Firms should “remain vigilant to increases in the proximity, likelihood and scale of climate-related risks and continue to develop their risk management capabilities accordingly”.

Supervisory expectations

We take the sections of the SS in turn and highlight some of the key expectations for banks and insurers.

1. Governance

   A key message in the SS is that boards need to better understand the impacts of climate-related risks, including transition and physical risks, under different climate scenarios and time horizons and be able to address those risks effectively in the firm’s overall business strategy and risk appetite.

   The board will be expected to periodically review and agree material climate-related risks identified in the risk register and put in place criteria which trigger early review. The PRA expects firms to define and assign responsibilities for the board, sub-committees and the management body. A sufficiently senior person should have individual responsibility for identifying and managing climate-related risks (and this should be reflected in that person’s statement of responsibilities and their remuneration package).

   Board members will need training to understand the PRA’s updated expectations and to build relevant skills and experience to enable them to have an adequate understanding of the issues, make decisions and offer informed and effective challenge as climate-related risks continue to evolve. This means making time to discuss climate risk and the outcomes of climate scenario analysis to inform decision-making and making resources available for the consideration of climate-related risks.

   The PRA expects that if a firm has adopted goals or targets, that it should be able to demonstrate, on request, how it plans to meet those goals and targets are integrated into firm strategy, including assumptions made. This has parallels with transition plans but this evidence is not intended to be made public.

2. Risk management

   Firms are expected to regularly carry out risk assessments to identify material climate-related risk exposure and understand how they affect the resilience of the business model over different time horizons and climate scenarios. Assessments of risk appetite, climate-related risk management practices and strategy should be regular and periodic (with the frequency of review in line with risks of similar materiality) and there should be criteria in place to trigger ad hoc reviews if there are changes to climate-related risks. The board should look to the management body, and the relevant Senior Management Function holder, to implement this review. To inform a firm’s risk identification and assessment process, the PRA expects firms to identify and understand “client, counterparty, investee and policyholder risk”, identifying material relationships with clear materiality criteria.

   The incorporation of climate-related risks into existing risk frameworks may require significant resource input for firms. The PRA has clarified in its PS that “firms should use their judgement to assess whether material climate-related risks should be incorporated into their existing risk register or within a supplementary sub-register”.

3. Climate Scenario Analysis (“CSA”)
   

   The complexity in constructing and implementing CSA is a common challenge for firms. As is understanding and using the outputs to inform and quantify exposure to climate-related risks. This results in many firms lacking adequate understanding of the climate-related risks they face and without evidence that they appropriately account for those risks in their decision-making and risk management.

   Firms that are materially exposed to climate-related risk are expected to take greater action than those less exposed to climate-related risks. And this is particularly true of CSAs. Firms should run CSA with clear objectives and document and demonstrate the rationale for the range of selected scenarios which should be clearly defined and agreed by the board. They should show how the results inform their decision-making. Scenarios should be calibrated, including severity, time horizons and frequency, in line with their approach to proportionality and use the CSA to inform business strategy, risk management, capital setting and valuation. Multiple CSA exercises will be required for each different objective. Reverse stress tests should also be considered – identifying a range of adverse climate events which would make their business unviable.

   The board should understand the inputs, assumptions, design, outputs, application and sources of uncertainty and should review and update scenarios in line with modelling and scientific advancements and the changing nature of risks to the firm. They should understand the capabilities and the limitations of the models and toolkits being used and should account for those when making decisions. Firms will need to communicate the rationale for their scenario selection, calibration and how objectives were met internally, to the PRA and in relevant public-facing disclosures. The PRA clarified in the final SS that narrative-based scenarios can be appropriate for understanding longer-term and less likely scenarios.

4. Data

   Firms should identify and assess data gaps and quantify the extent of uncertainty when setting risk appetite and developing risk management tools. Sustainability disclosure rules in the UK, Europe and many other jurisdictions may help to provide needed data, but sustainability reporting is in its infancy. In the meantime, firms should balance appropriate use of data from external suppliers with the appropriate development of in-house capabilities over the short- and long-term. The PRA suggests that firms should actively engage with clients, counterparties, investees and policyholders to collect data. This is interesting given the current pushback in the context of the EU omnibus simplification package around requiring data from small and medium-sized entities but highlights the rationale for sustainability reporting regimes. The PRA clarified in the final SS that firms do not need to choose conservative proxies for inadequate, unreliable or missing data, but the proxies need to be appropriate.

5. Disclosures
   

   The PRA highlights the much anticipated changes in disclosure requirements in the UK – from TCFD-aligned to UK Sustainability Reporting Standards (which will reflect ISSB standards) – but notes that otherwise no further changes are expected from the PRA in disclosure requirements.

Finally, the PRA set out some specific expectations for banks and insurance companies managing climate-related risk. We set out the key points out below.

Banking-specific issues

The PRA has identified that previous policies and expectations related to financial reporting, such as the Internal Capital Adequacy Assessment Process (“ICAAP”), the Internal Liquidity Adequacy Assessment Process (“ILAAP”), credit risk, market risk and reputational risk, need to more appropriately reflect climate-related risks. The SS is intended to address this gap reflecting the importance of high quality and consistent accounting of climate-related risks for effective supervision.

Financial reporting: The PRA expects banks to have appropriate processes to ensure the timely capture of climate-related risks for financial reporting purposes, ensuring that there is responsibility for this and appropriate oversight in the financial reporting function. Banks also need to have practices and procedures to support assessment and measurement of climate-related risks in their financial statements, ensuring that relevant climate-related risk drivers are appropriately identified and assessed.

Expected credit losses: The PRA expects banks to have the practices and policies necessary to recognise climate-related risk drivers of expected credit losses (“ECL”) and integrate them into ECL calculations. Firms should carry out periodic reviews of these processes, identifying data requirements needed to effectively factor climate-related risk drivers into loan-level and collective portfolio level ECL estimates.

ICAAPs: The PRA has observed that many firms do not provide sufficient contextual information for supervisors to understand how firms have estimated the scale of physical and transition risks they face. The PRA therefore now expects banks to provide information to demonstrate how climate-related risks have been incorporated into ICAAP and that they are adequately capitalised. The PRA expects banks to use CSA as a key tool for these capital adequacy assessments. Compliance with these new expectations will enable the PRA to scrutinise more closely whether a firm’s capital provision properly reflects its exposure to climate related risks.

ILAAPs: The PRA requires banks to assess whether climate-related scenarios could cause cash outflows or depletion of liquidity buffers, assuming stressed scenarios. Banks should be able to evidence that material exposures included in the firm risk register are appropriately funded, giving detail of the methodologies, scenarios, assumptions, judgements and proxies used.

Risk types: Banks should recognise how climate-related risk can be integrated into credit risk, market risk and reputational risk. Recognising the need to perform its own due diligence on credit ratings and understand how additional volatility and negative price shocks can affect hedges and instruments’ market prices. Banks need to manage their reputational risk understanding that this risk can stem from supporting certain activities but also from withdrawing support from certain activities. This may lead to strategic tensions, especially for global banks with broad product offerings.

Insurance-specific issues

The SS sets out expectations that insurers and reinsurers are expected to manage their climate-related risk that might emerge over long- and short-term horizons to ensure that exposures stay within firms’ chosen risk appetite. The PRA notes that “[c]limate-related risks could be a driver of underwriting, reserving, market, credit, liquidity and operational risks faced by insurers as well as reputational and litigation risks. There is potential for these risks to be interrelated and thus magnified, and to increase over a longer time horizon”.

In managing asset portfolios, insurers should consider risks on both sides of the balance sheet as well as their interrelationships, ensuring that where assets have longer term liabilities they may be affected by sudden transition risks. Solvency II insurers should consider whether there is an excessive accumulation of climate-related risk in their portfolios and mitigants should be identified if risk accumulation is found to be excessive.

ORSAs: Climate-related risk should be considered in Own Risk and Solvency Assessments (“ORSAs”) and potential impact of climate change including climate scenarios where climate-related risks are material should be integrated into risk models. Sufficient detail should be provided to the PRA to enable the PRA to form a view of the reasonableness of each action. Suitable trigger points should also be identified when planned management actions would occur. Insurers should consider reputational and litigation risks stemming from historical underwriting activities, climate commitments and wider engagement on climate change and net zero. As with banks there may be strategic tensions due to geographies and products offered.

SCRs: In relation to Solvency Capital Requirements (“SCRs”), insurers need to reflect the impact of climate-related risks on underwriting, reserving, market, credit and operational risks to ensure that climate-related risk is not underestimated for capital requirements purposes.

Underwriting and reserving risk: Non-life insurers are expected to consider the impact of climate change on their natural catastrophe risk. Insurers should be aware that larger claims may be incurred than is expected from historical experience only so adjustments should be made to models to reflect climate-related perils. Life insurers should consider the impact of climate change on mortality and morbidity assumptions, for example due to an increase in extreme weather events or increased respiratory or water borne diseases. Insurers may need to make detailed changes to investment and underwriting models in response to climate-related risks, including metrics and indicators they would monitor to inform decisions and details of how they would strengthen robustness of management actions.

So that’s climate-related risks but what about nature-related risks?

Although not specifically covered in the SS, the latest Remit and recommendations for the Financial Policy Committee (FPC) dated 26 November 2025 states the government strategic economic strategy includes transition to a nature positive economy. The letter recognises that the climate and nature crisis is the “greatest long-term global challenge that we face” and states that the Committee should “continue to consider the materiality of nature-related financial risks for its primary objective”.

Firms may therefore wish to start (if they have not already) considering and identifying nature-related financial risks and integrating these into risk management frameworks. Given that boards are required to consider all material financial risks as part of satisfying their directors’ fiduciary duties, this is arguably already required and will also be useful for firms preparing for future nature-related risk reporting using, for example, the TNFD framework.

What should banks and insurers think about or do now?

Firms should read both the policy statement and the supervisory statement to understand the new requirements. They should assess the extent to which climate-related risks are already integrated into risk management processes and produce a gap analysis as to what more needs to be done. This may vary depending on how risk is managed as a group and the geographical regulatory requirements which apply to a firm and also may vary based on the size of the firm and nature and extent of its exposure to climate-related risk.

The PRA notes that there will be a cost associated with getting up to speed with the expectations and conducting a gap analysis (comparing current firm practice with the updated PRA expectations) as well as the initial changes to firms’ systems and approaches to meet the expectations. Firms should make provision for these expenses and increased cost going forward. There may also be some indirect costs if firms adjust portfolios as a result of improved assessment and management of climate-related risk, resulting in changed lending volumes, reduced holdings in assets with high climate risk and increased asset prices.

The PRA recognises that practices are evolving in this area and that implementation of the final policy will require ongoing effort and collaboration across industry groups to collectively develop and advance best practice. To support firms, the PRA will continue to engage with, and support, industry groups in developing further guidance and case studies. Specifically, the PRA intends to invite the Climate Financial Risk Forum (CFRF) to update, consolidate and evolve its guidance and tools over time to reflect, and support firms in meeting, the PRA’s updated supervisory expectations. Firms need to act now as they have six months to complete their gap analysis, which supervisors may ask to see. The PRA also encourages firms to continue engaging with their supervisors to ensure that their approach to managing climate-related risks remains proportionate and effective as the risk landscape evolves.

Firms must also act now to ensure that board members have the knowledge and capacity to understand climate-related risks and how they are integrated into risk management so that they can monitor and challenge the models. To do this they will also need to undergo training and put aside board time to discuss climate-related risk management and integrate this into their strategic business planning. Climate scenario analysis is likely to become increasingly sophisticated but firms only need to apply this in a way that is proportionate for the firm. A member of senior management will need to be responsible for ensuring that the SS is implemented and the board sets the firm’s risk appetite in relation to physical, transition, legal and reputational risk and is kept fully abreast of how these risks are being managed in accordance with the firm’s business strategy.

For insurers, the SS sets out clear expectations on addressing and capitalising for climate-related risks in ORSA and SCR calculations. To ensure that liabilities to policyholders can be met now and in the future, boards will need to understand and make sure this is implemented.

Integrating climate-related risk management into strategic decision-making and pricing is essential – especially as firms navigate evolving market dynamics and given that climate change and energy security affects consumer behaviour, government policies and the economy.

Our global Sustainable Finance & Investment group brings together a multidisciplinary global team that provides clients with best-in-market support. We are following developments relating to ESG regulation, so please get in touch if you would like to discuss.

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This note is intended to be a general guide to the latest ESG developments. It does not constitute legal advice.

Authored by Rita Hunter, Emily Julier, Sinead Meany, and Kirsten Barber.