A new report from the prestigious Grantham Research Institute at the London School of Economics and Political Science has delivered a sharp assessment of the evolving financial landscape, revealing that climate change litigation is now firmly recognized by “prominent market actors as a financially material risk”. This finding marks a significant pivot in how institutions within the global financial sector perceive and potentially manage legal challenges stemming from climate change impacts and responses.
The report, co-authored by legal experts Catherine Higham and Joana Setzer, underscores the dynamic role of judicial interventions. They argue that court cases challenging climate-related actions, or the lack thereof, by companies and governments are actively reshaping the traditional contours of financial risk. This necessitates that institutions across the financial spectrum, including banks, investors, and financial advisers, enhance their efforts to identify, understand, and ultimately address the exposures resulting from this burgeoning area of law.
Shifting Perceptions: Climate Litigation as Material Risk
The concept of climate litigation reaching the status of a “financially material risk” is central to the report’s findings. In the context of financial markets, a risk is considered material if it is deemed significant enough to potentially influence an investor’s decision or impact a company’s financial performance, value, or stability. The fact that climate lawsuits are now widely seen through this lens by leading market participants signals a growing recognition that these legal battles can translate directly into tangible financial consequences, such as significant monetary damages, legal fees, settlements, or adverse impacts on asset values and profitability.
Direct and Indirect Exposures for Banks
The report gives particular focus to the banking sector, identifying specific pathways through which banks face vulnerability. According to Higham and Setzer, banks face both “direct legal exposure and indirect risk through clients.” Direct exposure arises when banks themselves are targeted by lawsuits, perhaps related to their own operational emissions, their role in financing climate-intensive projects, or alleged failures in disclosing climate-related financial risks. This puts their own balance sheets and reputations at risk.
The indirect risk, potentially even more widespread, stems from banks’ relationships with their clients. If a client—a corporation or even a government entity—faces significant climate-related liabilities or losses due to litigation, this can impact their ability to repay loans or affect the value of securities the bank holds, thereby creating credit risk, market risk, and even significant reputational risk for the bank itself. The report explicitly anticipates that “more significant financial exposures” are likely to emerge as a consequence of landmark climate cases currently progressing through courts around the world, setting potential precedents and increasing pressure on financial institutions.
Evidence from the Financial Sector
The growing acknowledgment of climate litigation as a serious financial threat is supported by observations from senior figures in financial supervision. Frank Elderson, a member of the Executive Board of the European Central Bank (ECB), has publicly highlighted this concern. He warned that an analysis conducted by the ECB indicated that up to 70% of European banks examined could face elevated litigation exposure. This vulnerability, he suggested, is often linked to the misalignment between the climate implications of their credit portfolios—i.e., the types of businesses and projects they finance—and the public commitments made towards global climate goals, such as those outlined in the Paris Agreement.
Furthermore, research cited within the Grantham report provides compelling evidence of this shift in investor perception. Among equity investors and analysts surveyed, litigation risk associated with climate change is now perceived, on average, as being more material than physical climate risk itself. This ranking, placing legal challenges “above physical climate risk” like property damage from extreme weather or asset stranding due to environmental degradation, underscores a growing concern among those allocating capital about the immediate and potentially significant financial penalties and disruptions that climate lawsuits can trigger.
Barriers to Integration and Regulatory Push
Despite this heightened awareness among sophisticated market actors and supervisors, the report notes a reported lag among many financial institutions in fully integrating climate litigation risk into their established risk management frameworks. Several factors contribute to this delay and challenge. The inherent complexity of climate risk itself, particularly when translated into legal causality and potential future damages, poses a significant analytical hurdle. The diverse spectrum of litigation types—ranging from tort claims for damages, challenges to regulatory approvals, complaints about corporate disclosures, to cases arguing breaches of fiduciary duty—requires a broad understanding and different assessment approaches. Compounding these challenges is a widely acknowledged lack of standardized tools and methodologies specifically designed for measuring and quantifying the financial impact of climate litigation risk.
Recognizing the potential systemic risks posed by these vulnerabilities, supervisory institutions are beginning to respond. Initiatives such as the Environmental, Social, and Governance (ESG) risk management guidelines issued by the European Banking Authority (EBA) represent a move towards greater regulatory expectation. These guidelines effectively mandate that banks identify, assess, and take steps to mitigate their exposures to ESG risks, explicitly including climate change and its associated legal dimensions, thereby pushing institutions to accelerate their integration efforts.
Navigating a Litigious Future
The findings from the Grantham Research Institute report reinforce that climate change litigation is rapidly evolving from a theoretical concern to a concrete and quantifiable financial risk for the global financial sector. As the frequency and scope of climate lawsuits continue to expand, driven by increasing climate impacts and greater scrutiny of corporate and governmental actions, financial institutions will face intensifying pressure, both from potential litigants and regulatory bodies, to demonstrate robust capabilities in managing these exposures. The report serves as a critical reminder that effectively navigating the financial landscape of the future requires a clear-eyed assessment and proactive integration of climate litigation risk into core business and risk management strategies.
