As Robert Peston put it, when it came to subprime, the Financial Services Authority “got it wrong to a mind-boggling extent in an absolutely core area of its regulatory responsibilities”.
The FSA, of course, is no more. Due to the City’s spectacular regulatory failure, the government restructured financial regulation and abolished the FSA. Mervyn King, the Bank of England’s governor at the time, became one of the most powerful central bankers in the world, with a new remit to prevent the build-up of risk in the financial system. Now it is the job of the Bank of England to make sure the UK has safe and sound banks and a resilient financial system.
Fast forward fifteen years and the industry needs to be less worried about loans extended to individuals with poor, incomplete, or nonexistent credit histories. The new subprime mortgages won’t involve problematic borrowers – it’s the assets that sit behind them that could sabotage these loans. As climate change affects the country’s property stock, many residential and commercial buildings could see their values fall. Equity will be lost.
This time, the regulator – the Bank of England now – is on the case. The Bank has already asked lenders to check their back books. The next stage will be to oblige lenders to check how much the properties upon which new loans are set will be affected by climate change.
The Bank has launched exercises to assess the resilience of major UK banks and has put forward proposals to ensure banks do not underestimate long-term risks from climate change. It has explicitly stated climate change comes with two key risks that will affect the financial system and the economy: extreme weather events – such as floods and heatwaves; and changes to our climate – such as rising sea levels.
The relevant bodies can see trouble on the horizon. And well they might.
We’re already experiencing some of the effects of climate change on flooding. Back in 2019, Sir James Bevan, chief executive of the Environment Agency was already saying that climate change is likely to mean more frequent and intense flooding. “Floods destroy – lives, livelihoods, and property, our flood defences reduce the risk of flooding, and our flood warnings help keep communities safe when it threatens. But we can never entirely eliminate the risk of flooding.” Climate change due diligence in property transactions is becoming more important. At its heart is the degree of capital exposure and the role that valuers and conveyancers have in advising on adverse issues.
Lenders will need to decide how they manage these risks in the future. Their valuers will need definitive insight on how major environmental risks could affect their valuation assessment of a property – factors which, while they can have a very material effect on lending security, are not always visible during visits. It’s not just about in-depth data, mapping, and tables either. They will need explicit, detailed guidance and recommendations on environmental liability, loan security risks, and potential property value impacts. In short, valuers will need professional opinions on banking security from an environmental risk perspective.
Now, plenty of big banks use environmental due diligence reports for commercial properties – we provide them, in fact. Our commercial report was developed in association with major UK lenders and is now accepted by all major UK financial institutions – it’s the report of choice for Santander, NatWest and Barclays Bank, for instance – with bespoke recommendations as standard for all sites identified as Moderate to high and High risk.
But, when it comes to residential lending, the industry has yet to figure out how to address the potential threats, so if lenders want to comply with the Bank of England’s guidance, a residential equivalent looking forward will be needed. And it needs to be one that looks at both the physical (environmental) and transitional (e.g. energy saving measures) in a way that works for the conveyancing due diligence process which places the current liability on the property lawyer.
Ideally, the industry will collaborate to tackle the risk to banking security posed by climate change. For example, lenders need to work to a common approach on updates to the advice in their relevant sections of the Conveyancing Handbook. Much of this should focus on the data and formats required for easy understanding by all stakeholders including the end customer. The role of environmental data in retail lending decisions is now becoming more prominent in tandem with our ever more severe weather events and the need to safeguard sustainable lending decisions into a more uncertain future.
David Kempster is a director of Groundsure
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