This article examines the real estate transition risks posed by the UK's Net Zero climate policies and the challenges banks face in measuring these risks. It also provides guidance on how to mitigate the transition risk measurement challenges.

Residential and commercial mortgages make up the largest loan exposure for UK banks. As the government works towards its 2050 Net Zero target by implementing stricter climate policies for the built environment, banks with significant real estate exposure could face financial consequences.

The Minimum Energy Efficiency Standards regulations, a climate policy measure introduced to improve the energy efficiency of UK properties, require that all privately rented properties in the UK have a minimum Energy Performance Certificate rating of E by 2023, with stricter requirements for other types of properties (owner-occupied, social housing and mortgaged properties) proposed at later dates. These targets may be challenging to meet, as many properties requiring upgrades are old, and retrofitting is costly. The retrofitting costs to meet the minimum energy efficiency standards could affect borrowers’ affordability and creditworthiness which presents financial risks to banks.

To address these risks, banks need to adapt their risk models, adjust their real estate lending portfolios, and consider the potential impacts on their capital and liquidity. However, the measurement of transition risk has some challenges, particularly issues with data quality and completeness, and methodology harmonisation.

In this article, we recommend the following 5 steps on how banks can start preparing for their transition risk measurement:

• Engage: establish relationships that will drive data governance and engage with borrowers’ transition plans.
• Measure: measure current portfolio performance, adapt downscaled Net Zero climate scenarios and enhancing their data capabilities.
• Set Targets: identify carbon risk at asset and portfolio levels and set intermediate and long-term targets.
• Implement: decarbonise portfolio by implementing transformation programmes and products.
• Iterate: adopt an iterative and modular approach to risk management and stay up to date on the relevant regulations and developments in the industry.

Find out more on Real Estate transition risk measurement by downloading the full article or by contacting one of the authors or key contacts listed below.