Data Loading...
03102021-L2-S2 Flipbook PDF
JC3 L2 Series 2
111 Views
86 Downloads
FLIP PDF 1.07MB
Identifying and reporting climate-related financial risk workshop Series 2 – Climate risk management
03 February 2021
Program overview 27 January 2021
3 February 2021
10 February 2021
Series 1 – Climate-related disclosures
Series 2 – Climate risk management
Series 3 – Climate scenario analysis
Subtopics:
Subtopics:
Subtopics:
1. 2. 3. 4.
1. 2. 3. 4.
1. 2. 3.
Disclosure on governance Disclosure on strategy Disclosure on metrics and targets Panel discussion: adopting Task Force on Climate-related Financial Disclosures (“TCFD”) and its recommendations
Setting the direction and framework Risk assessment Practical data and tools available Panel discussion: identifying, measuring and managing climate-related risks
Scenario analysis Scenario identification and development Scenario assessment
EY team and speakers Gilles Pascual
Russell Marsh
Arina Kok
Sonal Agarwal
Joel Khaw
Partner, EY Corporate Advisors Pte. Ltd
Director, EY Corporate Advisors Pte. Ltd
Director, Ernst & Young Advisory Services Sdn Bhd
Associate Director, EY Corporate Advisors Pte. Ltd
Manager, Ernst & Young Advisory Services Sdn Bhd
Guest speakers
Guest speakers
Matthew Nelson Global Climate Change and Sustainability Services Leader, Ernst and Young
Laura Ramirez Head of Emerging Markets, 2o Investing Initiative (2DII)
Joseph Power Senior Manager, Sustainable Finance, Carbon Disclosure Project (CDP)
Alan N Smith Senior Advisor, Climate and ESG Risk Management, HSBC
Robert Barker Chief Sustainable Business Officer, CIB APAC, BNP Paribas
Pratima Divgi Regional Director, CDP Ingrid Holmes Director, Head of Policy and Advocacy, Federated Hermes Page 2
03 February 2021
Climate risk management
What’s on for today? Series 2 – Climate risk management | Date and time: 3 February 2021, 3.00pm–6.00pm Introduction and opening
•
Short introduction
•
Risk governance
•
Risk management framework
•
Risk appetite
•
Risk identification
•
Risk measurement
•
Risk management
5mins
3.00pm–3.05pm
30mins
3.05pm–3.35pm
45mins
3.35pm–4.20pm
Q&A session
10mins
4.20pm–4.30pm
Short break
5mins
4.30pm–4.35pm
Setting the direction and framework
Risk assessment
Practical data and tools available
•
List of available data and tools
30mins
4.35pm–5.05pm
Panel discussion
•
Identifying, measuring and managing climate-related risks
45mins
5.05pm–5.50pm
10mins
5.50pm–6.00pm
Q&A session
Page 3
03 February 2021
Climate risk management
Content
Technical and concept delivery on
1
2
3
Setting the direction and framework
Risk assessment
Practical data and tools available
Along with a panel discussion with experienced organizations on “identifying, measuring and managing climate-related risks”
Page 4
03 February 2021
Climate risk management
Content
Learning outcomes
• Design and implement governance approach for climate risks • Decide whether to treat climate risk as a standalone or as a cross-cutting risk • Integrate climate risk into existing risk management frameworks, recognize how the linkages between climate risk and established risk types may be identified and understood
• Conduct risk assessment of financial and non-financial risks to identify, measure, monitor and mitigate the risk within an organization’s appetite
Page 5
03 February 2021
Climate risk management
Content
About this topic
1.1 Risk governance
1 Setting the direction and framework
Page 6
03 February 2021
3
• How risk governance can be designed to incorporate and manage climate risks, with clear roles and responsibilities across the three lines of defense
1.2 Risk management framework
• Integration of climate-related risks into existing risk management framework
Practical data and tools available • Defining risk appetite and determining metrics to measure and monitor climate-related risks
1.3 Risk appetite
Climate risk management
Question time!
What are the challenges in assessing and managing climate-related risks?
Please use the whiteboard to give your answer!
Page 7
03 February 2021
Climate risk management
Findings on risk management from the Inaugural Climate Risk Disclosure Barometer (“CRDB”) 2020
9% 40%
Limited focus on climate risk reporting
ERM lacks details on climate risk management
Malaysian public limited companies (“PLCs”) are at a nascent stage in climate risk reporting.
Present disclosures on monitoring and review of climate-related risks and opportunities are generally limited to current environmental issues and performance metrics.
While Malaysian regulators have encouraged the adoption of TCFD recommendations, PLCs are generally adopting a “check-box” approach to climate risk.
Source: EY, Climate Risk Disclosure Barometer (CRDB) 2020
Page 8
03 February 2021
Climate risk management
There are limited discussions on the monitoring and review process for emerging climate-related issues.
Scenario analysis under-utilized Most PLCs have not factored climate risks and opportunities into their current business strategies.
Conducting scenario analysis can better identify climate-related risks and opportunities, process, and assess the resilience of PLCs’ current and future strategic directions.
1.1
Risk governance
Page 9
03 February 2021
Climate risk management
Organizational changes and transformation would be required as companies seek to become effective managers of climate risks Formulate climate risk governance
Focus on enablers •
Acquire technical skills required to manage climate risk
•
Develop strategic understanding of how physical and transition risks may affect their activities
•
5
Budget for climate adaptation and mitigation strategies including technology, data, and talent
•
Critical to assess resilience
•
Identify important climate-hazards and primary risk drivers by industry to generate physical and transition climate risk scenarios
•
Quantify the impact by counterparty and in aggregate on portfolio basis
Source: COSO, WBCSD and EY, Applying Enterprise Risk Management to Environmental, Social and Governance-related Risks ; McKinsey, Banking Imperatives for Managing Climate Risk
03 February 2021
Enablers
Climate risk management
Governance
4
2 Stress Testing
Get up to speed on stress testing
Page 10
Risk Management 1
3 Alignment
Framework
•
Crucial importance for top management to set the tone on climate-risk governance and nominate a leader responsible for climate risk
•
Set up effective governance structure covering from assessment, monitoring to reporting
Tailor business and credit strategy •
Embed climate considerations in risk frameworks and capital-allocation processes
•
Introduce policies and procedures such as negative screening, sector specific policies or impose emission thresholds
Align risk processes •
Align climate risk exposure with risk appetite and the business strategy
•
Inject climate risk considerations into all risk management processes, including capital allocation, loans approvals, portfolio monitoring and reporting
•
Review and update risk processes periodically to capture latest risks and disruptions
Setting up climate governance on corporate boards Guiding principles for effective climate governance on corporate boards1
Implementation steps2
1
2
3
Climate accountability
Subject command
Board structure
4
5
Guiding principles
Materiality assessment
Strategic integration
6
7
8
Incentivization
Reporting and disclosure
Exchange
Source: 1 World Economic Forum (2019) : How to Set Up Effective Climate Governance on Corporate Boards:
Page 11
03 February 2021
Climate risk management
•
Deliver a tailored training programme to the board on climate risk and consider using external experts where necessary
• •
Update board committee terms of reference to include climate risk
•
2
Provide periodic regular updates to relevant board committee (s) on:
•
The organization’s progress in preparing for and implementing climate risk management
•
Risk reporting metrics
The board to provide review and challenge on:
• •
Undue or unexpected climate risk concentrations
•
Materiality assessments and scenario analysis by climate outcomes and time horizons
•
Emerging regulatory, reputational and legal obligation
The organization’s strategy/corporate plan, considering the climate risk profile, through a short (e.g., 3-5 years), medium (e.g., 10 years) and long-term (e.g., 30 years) lens
Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Assigning senior management responsibility
Considerations2 •
The board and the highest level of executive management should identify and allocate responsibility for identifying and managing financial risks from climate change to the relevant existing Senior Management Function (“SMF”)1
Consider where responsibility for other financial risks is managed and align with that responsibility. This will depend on the organization, but examples include:
• •
Chief Risk Officer and/or
Chief Financial Officer/Chief Investment Officer
•
SMF responsibility for climate risk should be assigned to an existing SMF and the responsibility should not be shared between too many individuals (i.e., not to more than 2 people is a good starting point, subject to the organization’s legal and corporate governance structure)
•
Update the relevant committee terms of reference and set up a committee or working group, chaired by the SMF holder, with representation across the three lines of defense, to oversee operational delivery
Source: 1 Bank of England Prudential Regulation Authority (2019) SS3/19 Supervisory Statement : 2 Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Page 12
03 February 2021
Climate risk management
Ensuring understanding, oversight and accountability for financial risks arising from climate change at all levels Governing body / Audit committee Senior management 1st line of defense
2nd line of defense
3rd line of defense
Financial controller
Security Risk management
Internal audit
Quality Inspection Compliance
•
•
•
Carry out initial climate risk assessment when onboarding clients or during periodic review of existing clients
•
Set up and own central risk frameworks
•
Develop the tools for identifying and assessing climate risks
Engage with clients to understand carbon intensities and their business plans for mitigating climate risk
•
Deliver climate risk training
•
Develop scenarios and undertake stress testing
Understand, assess and consider uncertainties and developments around timing and channels of climate risk
•
Support first line activity to understand, assess and consider uncertainties and developments around timing and channels of climate risk
•
Review control design and execution
Regulators
Internal control measures
External audit
Management controls
A potential indicator of the organization’s quality of climate risk governance could be based on the extent to which climate risk management is integrated effectively into established risk management Source: 1 EY, Being business-minded about climate change: Ten ways to address climate-related risks and opportunities in 2020 and beyond; 2 Chartered Institute of Internal Auditors, 2018, Governance of Three Lines of Defense: 3 Climate Financial Risk Forum Guide 2020, Risk Management Chapter; Page 13
03 February 2021
Climate risk management
1.2
Risk management framework
Page 14
03 February 2021
Climate risk management
Embed climate-change risk deep into Enterprise Risk Management (ERM) Ultimately, climate change must be built into the organization’s risk management framework. This necessitates embedding it into the risk management lifecycle:
1
2
3
4
Risk identification and assessment
Risk taxonomies
Risk reporting
Risk mitigation
•
Granular analysis of customers and clients by region and sector
•
Bifurcating between physical and transition risks makes the analysis more precise and actionable
•
Understanding the direct impacts of physical risks on the organization’s operations and third parties is essential
•
•
In order to capture climate risk within existing processes and standards, organizations will need to reevaluate their risk taxonomies to determine whether climate risk is material These granular components will need to be examined across portfolios to inform credit limits and internal ratings to maintain prudent risk management
•
•
•
Develop and maintain a set of risk metrics that capture their own and the counterparty’s climate change risks Able to aggregate those metrics to enable board and senior management reporting and oversight Link to existing portfolios, concentration and exposure threshold and limits
Source: EY, Being business-minded about climate change: Ten ways to address climate-related risks and opportunities in 2020 and beyond
Page 15
03 February 2021
Climate risk management
•
Climate risk analysis needs to support decision-making on how to manage climate risks
•
This may range from:
•
Altering exposure to certain sectors or region
•
Pricing of new loans and underwriting of investments
•
Decisions on how to deploy capital
Climate-related examples aligned to ERM risk categories Credit risk Increase in probability of default of certain exposures (e.g., severe droughts causing defaults in agriculture)
•
Lower collateral values (e.g., lower value of real estate due to higher flood risk)
•
Increase in country/sovereign risk through lower productivity and economic disruption
•
Lower debt repayment capacity of borrowers
•
Increase in probability of default of:
•
Transition risk
Physical risk
•
•
•
Carbon-intensive industries (stranded assets) Assets that turn out to be less green as initially expected (greenwashing)
•
•
•
Destruction of a financial institution’s operations (e.g., buildings, ICT and ATM network)
Business models reliant on carbon intensive activities may no longer be profitable
Risk of lagging behind regarding new green activities and technologies vs risk of new technologies being less promising than expected
Lower collateral values (lower value of real estate due to policy changes)
Source: NGFS Call for Action Report 2019
Page 16
03 February 2021
Business risk
Operational risk
Climate risk management
•
Impact on institution’s capacity to generate sustainable profits (exposures to certain countries/activities become less profitable)
•
Reputational risk if an institution does not manage to adapt its own business models
•
Reputational risk if an offered product does not turn out to be as green as initially expected
•
Liability risk resulting from (e.g., greenwashing)
Liquidity risk •
Underwriting risk
Assets becoming less liquid due to increased credit risk
•
Changing risk profile (frequency, severity)
•
Certain risks becoming uninsurable
•
Increased credit risk
•
•
Funding risk: ensuring investor base remains broad, investors/deposit holders becoming more green finance focused (change market sentiment)
Lack of shared understanding of risk exposures, and their pricing
Initial implementation steps to establish a climate risk management framework1
1Materiality assessment to establish
2Identify existing risk types
exposure and vulnerable sectors/geographies to climate risk
impacted by climate change
3Decision to treat climate risk as a standalone risk type or a crosscutting risk type Principal/standalone risk
Case study: Physical climate risk vulnerability by geography
Develop and implement dedicated framework and policies, as relevant Linkage to other risks is still an important area to consider
The ND-GAIN Matrix illustrates the comparative resilience of countries2
Effects of climate change on business areas
Cross-cutting risk type
Vulnerability
Develop risk definition and subtypes
• Physical risk • Transition risk • Liability risk Illustrative mapping of how climate affects other risk drivers 3 Impact to operating profit
Methodology:
Readiness
Financial
Vulnerability: Measures a country's exposure, sensitivity and capacity to adapt to the negative effects of climate change. ND-GAIN measures overall vulnerability by considering six life-supporting sectors – food, water, health, ecosystem service, human habitat, and infrastructure.
Operational Strategic
Readiness: Measures a country’s ability to leverage investments and convert them to adaptation actions. NDGAIN measures overall readiness by considering three components – economic readiness, governance readiness and social readiness.
Others
Natural Catastrophe
03 February 2021
Climate risk management
Supplier Relationships Human Capital
Develop proposals for integrating into risk-type frameworks Develop risk categories and authority matrix
Consumer Preferences
Cost Commodity Containment Prices Likelihood
Source: 1 Climate Financial Risk Forum Guide 2020, Risk Management Chapter 2 ND-GAIN Country Index, 3Marsh & McLennan Companies, How Climate Resilient is Your Company?
Page 17
Competition
Major
Identify highpriority risk type frameworks to integrated climate risk into
Minor
Identified risk types via ERM
Source: ND-GAIN Country Index
1.3
Risk appetite
Page 18
03 February 2021
Climate risk management
Risk appetite should reflect and communicate the level of climate financial risk that an institution is willing to take Approach towards defining climate risk appetite differs depending on the categorization of climate risk
Initial implementation steps 1
Consider business strategies, the existing portfolio and the type of climate risk faced
2
Engage the board to probe specific aspects of risk appetite
3
Develop and approve a qualitative risk appetite statement
4
Identify metrics which can be used to track climate risks to the organization, and work with business and risk to determine appropriate appetite or tolerance thresholds
5
In the longer-term, assess how metrics can best include the results from scenario analysis and impact assessments or trend analysis
Principal/standalone risk If climate risk is a standalone risk category, the risk appetite should consist of two components:
•
“Statement” – a clear, plain English articulation of the acceptable risk level and
•
“Metrics” – quantitative or qualitative measures which allow the institution to assess adherence to the statement. Each statement may have a number of metrics associated with it which allow the business and risk committees to monitor the risk profile.
Cross-cutting risk type If climate risk is considered within other existing risk categories, the risk appetite may not have a statement specific to climate risk, but there should still be metrics that can be clearly linked to climate risk.
Source: Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Page 19
03 February 2021
Climate risk management
Mature risk appetite considers impacts over a longer period and includes scenario analysis and impact assessment Example: Options for considering a 30 year timeframe in the risk appetite statement The amount and type of risk an organization is willing to accept in pursuit of its business objectives2
Long-term scenario analysis to project existing metrics
1
Use scenario analysis to understand the projection of metrics that are used to measure and monitor risk appetite under set scenarios. The projected metrics can guide pre-emptive actions.
Defining new metrics and thresholds under specific scenario
2
The scenario analysis could identify that new, additional, metrics with defined appetite and tolerance may need to be added under a specific scenario.
Using metrics which incorporate longer-term view
3
For climate risk, metrics may need to be altered to incorporate the longer-term risks.
Metric
03 February 2021
Climate risk management
Projection of metrics under different set of scenarios in the long-term
Appetite
Tolerance
Current RAG*
Scenario 1 – 2050
Scenario 2 – 2050
Scenario 3 2050
X%
Y%
Z%
A%
B%
C%
Current performance (RAG means Red, Amber or Green)
Metric
Appetite
Tolerance
Current RAG
X%
Y%
Z%
XXXX under disorderly 2 degrees scenario
D%
E%
F%
Metric
Appetite
Tolerance
Current RAG
% high transition risk ratings in portfolio
X%
Y%
Z%
QoQ leverage of high transition risk industries/customers
X%
Y%
Z%
Source: 1 EY, Risk Appetite: The Strategic Balancing Act; 2 Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Page 20
The specific maximum risk that an organization is willing to take regarding each relevant risk2
Using quantitative metrics to measure and monitor climate risk Metric
Examples
Bounding metrics
• • •
Delivery
• • • • •
Monitoring
• Wider CSR/reputational risk/ ESG lens/portfolio steering
• • • •
Carbon asset risk of portfolio – Incorporating carbon intensity as a proxy for transition risk, lifespan of physical assets and EBIT for individual customer names Climate value at risk (“VaR”) – present value of climate costs or profits divided by market value Sovereign exposure to climate-related risks, e.g., Notre-Dame University’s Notre Dame-Global Adaptation Index (ND-GAIN) Expected loss or risk-weighted assets (“RWA”) of portfolio if the temperature rises by 3⁰C Leverage trends/tolerance of specific industries % limit on exposures or investments in high transition risk industries % mortgage portfolio exposure to high physical risk locations under scenario X Performance within underwriting limits which restrict the writing of new primary insurance or reinsurance contracts for thermal coal or other fossil fuel projects Concentration metrics – mortgages and mortgage-backed securities at risk Carbon footprint including supply chain Weighted average carbon intensity, based on relative investment share or lending provided Carbon per revenue (can also provide a proxy for exposure to transition risk) Carbon Delta’s (an environmental FinTech) warming potential metric to assess corporate credit and equities shareholder funds’ alignment with the Paris Agreement 2°C target
Source: 1 EY, Risk Appetite: The Strategic Balancing Act; 2 Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Page 21
03 February 2021
Climate risk management
Case studies on climate-related risk appetites Insurer A – Pathway approach to manage coal exit strategy1
Bank A – Measure and manage financial and nonfinancial risks from climate change2
Risk appetite
Risk appetite
The risk appetite is centered on a plan to limit exposure to companies that generate 25% or more of their turnover from coal by 2022, and 0% by 2040.
How is it operationalized? Insurance
Investing
How is it operationalized?
Involves exclusion for single site coal-fired power plants and individual coal mines, and complemented by scaling up issuance of low-carbon technology insurance.
Own operations
The bank has set and communicated science-based emissions reduction targets to reduce annual greenhouse gas emissions by 90% to 18,000 tonnes by 2050.
Metrics: % of underwriting in coal-related industries
Metrics: Scope 1,2,3 emissions, Emission per full time employees
Gradual divestment from utilities and mining companies that generate a material amount of revenue from coal, and/or are not in line with the 20C threshold set under the Paris Agreement.
Using tools such as the PACTA tool, the bank is working towards emission measurement and building climate alignment capability across their entire lending portfolio.
Metrics: Weighted average carbon intensity of investment portfolio Source: 1Climate Financial Risk Forum Guide 2020, Risk Management Chapter; 2 Standard Chartered: TCFD Report 2019
Page 22
The risk appetite is centered on a plan to measure and manage financial and non-financial risks from climate change, and reduce the emissions related to own activities and those related to the financing of clients in alignment with the Paris Agreement.
03 February 2021
Climate risk management
Financing
Metrics: % of exposure to carbon-intensive sector, financed emissions intensity
Content
About this topic
2 Risk assessment
Page 23
03 February 2021
2.1 Risk identification
3
• Identification of the types of risks and the impact upon overall financial statement metrics and other relevant metrics 2.2 Risk measurement
• How risks can be quantified, assessed and scored using heatmaps, peer comparisons and stress testing
Practical data and tools available • How resilient is an organization’s strategy after taking into consideration different climate-related scenarios within a defined time horizon
2.3 Risk management
Climate risk management
2.1
Risk identification
Page 24
03 February 2021
Climate risk management
Risk identification and risk assessment
Risk identification
Risk assessment
• •
Management and stakeholders broadly identify exposure using risk statements Example of a risk statement: "we face a risk from increasing levels of drought impacting our agricultural clients and their ability to repay loans"
•
Based on the risk statement, assign a risk score equivalent to the likelihood of the risk multiplied by the impact of the risk
•
Exposures on physical and non-physical assets related to the financial institutions need to be taken into account. Assets which are owned by customers and funded by the banks should also be considered
•
Non-physical assets include:
• • • •
Customer and staff safety Financial exposures such as market risk
Responsible investment and corporate social responsibility Reputational risk and loss of shareholder value
•
Key stakeholders then form a collective view of the priority of the risk – a plan will be developed in response to priority risk
•
Non-priority risk can still be identified and monitored going forward
Exposures on physical and non-physical assets related to the financial institutions need to be taken into account Source: 1Climate Risk Management for Financial Institutions, Actuaries Institute’s Climate Change Working Group, November 2016
Page 25
03 February 2021
Climate risk management
Risk categories that were considered to be the most material and applicable across the financial sector Climate risks
Financial risks Insurance underwriting risk
Transition risks
Risk that an insurance company will suffer losses due to climate change impacts on reserving and pricing
Policy and legal Technology Impact on cash flows
Credit risk
Credit risk reflects the potential financial loss that may arise due to diminished creditworthiness or default of counterparties
Financial market risk
Financial market risk is the risk of losses on financial investments caused by changes in market value or asset and liability management impact
Operational risk
Operational risk represents the potential economic, reputational or compliance impact of inadequate or failed internal processes, people and systems or from external events, including legal risk and the risk of a material misstatement in financial reporting
Market Impact on balance sheet Consumer
Physical risks Acute Chronic
Impact on functioning of organization
Source: Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Page 26
03 February 2021
Climate risk management
Approach to identify climate-related financial risks Insurance underwriting risk Climate change will impact both sides of the balance sheet of (re)insurance companies:
Risk factor mapping to climate change factors Risk factors
Research
Liabilities Impacted by more severe or frequent weather events, climate-related litigations, changing policyholder savings behaviors, etc.
mapping to risk factors
Property and casualty
• Transition risks
Assets
•
As the assets are often long-dated to match the duration of the liabilities or related to insurance saving products, they are exposed to credit risk and in particular real estate may be exposed to weather events.
Physical risks
•
Natural catastrophes (e.g., flood, hail, storm, earthquake) Geopolitical risks (e.g., terrorism) Man-made risks (e.g., liability, motor)
Key sources of underwriting exposure (business)
Life and health
•
Mortality
•
Morbidity
•
Longevity
•
Lapse
Mapping of risk factors to products
•
Property contracts
•
Casualty contracts
•
Special lines (e.g., agriculture, credit and surety, marine/aviation/transport, engineering)
•
Life contracts (e.g., WOL, unit-linked)
•
Health contracts
•
Securitization
Others
•
Economic risks
•
Climate change*
* May be included depending on the chosen model approach
(Re)insurance firms can apply a forward-looking approach through active monitoring/research, e.g., by using: Longer-term risks
•
Emerging risk – supports the review of early signals. It involves external and internal sources, e.g., databases and literature, and subject matter experts from different business areas.
•
Own Risk and Solvency Assessment (ORSA) processes – organizations could assess their longer-term strategy as part of their ORSA
Source: Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Page 27
03 February 2021
Climate risk management
Approach to identify climate-related financial risks Credit risk Case Study: An international banking group embedded climate risk into counterparty ratings2
Exposure to climate risk The client could be exposed to severe climate risk:
•
Either physical risks to its operations and assets (breakdown of supply chains due to weather events or subsequent financial losses)
•
Transition risk to its sector of operation (e.g., an automotive company focused on manufacturing diesel cars)
•
If the climate risks manifest, the client’s probability of default (“PD”) could increase and/or its loss given default (“LGD”) could increase
Climate considerations would be expected to be mapped to existing processes1:
•
Emerging risks in the bank’s risk identification
•
Incorporated in the risk appetite statement
•
Know Your Customer (“KYC”) process
•
Credit due diligence
•
Credit and rating policies (global and sectorial)
•
Collateral monitoring policies
•
Head office portfolio reporting
Assessment for an integrated utility
Risk level
Physical risk Anchor score A. Idiosyncratic adjustment
Transition risk
Geographical physical risk anchor
Industry physical risk anchor
Geographical transition risk anchor
Industry transition risk anchor
+
+
+
+
03 February 2021
Reliance on fossil fuels
=
= Inherent risk score B. Mitigation and adaptation capability
Inherent physical risk score
Inherent transition risk score
-
Quality of climate-risk management
Business model protection in response to climate change
Business model change in response to climate change
=
= Residual-risk score
Residual physical risk score
Residual transition risk score
Overall residual risk score
Source: 1Climate Financial Risk Forum Guide 2020, Risk Management Chapter; 2 McKinsey & Company, Banking imperatives for managing climate risk
Page 28
Carbon intensity
Physical risk adjustment
Climate risk management
Approach to identify climate-related financial risks Financial market risk Financial market risks manifest themselves differently between banks, insurers and asset managers. Longer-term investments
Sensitivity to physical risk should be measurable on real assets but can also directly impact asset values:
Risk identification
Most relevant for insurers and asset managers •
•
Market value (“MV”) loss due to societal, legal and technological response to climate change, particularly affecting bonds and loans, commodities and equities (i.e., transition risk) or MV loss due to concern over actual climate/weather events (i.e., physical risk). Physical risk will particularly affect property/real estate and commodities but can also impact corporates more broadly, such as the impact of rising temperatures or loss of water supply on production facilities.
Physical risk
Investment decision process Factor in both current and forward-looking climate risk assessment
Identification of climate risk as part of company, sectorial and underlying analysis
Real assets Cost of dealing with a disaster or disruption
Catastrophe bonds/ insurance-linked securities/sovereign bond prices
Trading book short-term market risk
Most relevant for a bank’s trading book •
Traders and market risk analysts following short-term trading books should expect to experience more market shock events on specific sectors, individual names or region.
Source: 1Climate Financial Risk Forum Guide 2020, Risk Management Chapter Page 29
03 February 2021
Climate risk management
Macro scenarios Significant wildfire or weather events or large scale policy announcement
Impact to a country’s economy
Market Organizations
Asset values
ROA linked to underlying assets/ receivables such as ABS
Micro scenarios would call for the analysis of specific names or sectors at risk of shock events. It may include:
•
Local policy
•
New carbon pricing
•
Floods
•
Physical asset repricing
•
Market reaction to advanced corporate disclosure
Approach to identify climate-related financial risks Operational risk Case Study: Geo-mapping of own property footprint Operational risks arising from climate change, whether from physical or transition, should be fully incorporated and mapped into the operational risk management cycle.
•
Risk identification
•
Risk measurement
•
Risk management
•
Risk monitoring and reporting
Operational risk is a broad category and its economic, reputational or compliance impacts can often be financially material.
One global bank is working with its property insurers to understand their property portfolio in areas most likely to be impacted physical risks. Steps underway include:
•
Defining the definition of climate change risks (e.g., flooding, high winds)
•
Mapping climate change risks to understand inherent risk
•
Establishing criticality of building location
•
Producing heatmap for monitoring
•
Aligning controls with geo-mapping
•
Cross-referencing design resilience and operating controls
•
Understanding residual risk
•
Understanding how does this map to risk appetite
For the future, the aim is to assess the heat map and residual risk under different climate scenarios and compare against risk appetite.
Source: 1Climate Financial Risk Forum Guide 2020, Risk Management Chapter Page 30
03 February 2021
Climate risk management
Question time!
Which of the following climate-related financial risks do you think would significantly impact your organization ?
Please use the poll to give your answer!
Page 31
03 February 2021
Climate risk management
2.2
Risk measurement
Page 32
03 February 2021
Climate risk management
Approach to measure climate-related financial risks Insurance underwriting risk Heatmaps1
Metrics 1
•
Can give an indication of potential impact from climate change factors for certain lines of business
•
•
Possible dimensions of the heatmap are the:
• •
Establish metrics to track the potential impact from climate change at portfolio or segment level
Probability of certain risks materializing Potential impact of certain risks materializing
•
Annual expected losses
•
Average annual losses
•
Aggregate exceedance probabilities
The following relevant indicators and frameworks are being developed:
•
EC initiatives on sustainable finance
•
Underwriting specific carbon foot printing
Example of heatmap by UNEP Principles for Sustainable Insurance 2
Climate change
Air pollution, greenhouse gas emissions, and transition risks
Disclosure of climate-related emissions in operations and/or products Breakdown of fuel/material/carbon intensity mix relevant to the client or transaction Environmental and social impact assessment (“ESIA”) covering negative health impacts, mitigation and decommissioning where relevant
Decarbonization transition plan/targets, customers fitting new emission mitigation technology, TCFD disclosures Physical risks
Nature-based solutions (e.g., Sustainable flood or coastal defense management, broader climate resilience adaptation plans)
Source: 1 Climate Financial Risk Forum Guide 2020, Risk Management Chapter; 2 UNEP FI Managing environmental, social and governance risks in non-life insurance business
Page 33
03 February 2021
Climate risk management
Logistics
Utilities (2)
Real estate
Healthcare
Finance
Oil and gas
Legend:
Coal
Energy
Economic sectors Electronics/ technology
Risk mitigation examples and good practices
Chemicals
Risk criteria
Agriculture (1)
Theme
Potential risk
Potential elevated risk Potential high or direct risk Notes: (1) Risk assessment is the same for all agriculture types (i.e., Live stock, fishing, paper and forestry) except for ESIA and decarbonization transition plan, which are only “potential risk” for fishing and forestry. Physical risk is A “potential elevated risk” for paper and forestry sector. (2) Utilities represents water and waste sector
Approach to measure climate-related financial risks Credit risk Banks should start to build historical data sets with a long-term goal of quantifying these risks in terms of PD and LGD. In the meantime, most banks have adopted a qualitative approach – either using risk categories (e.g., high, medium, low) or in financial loss terms (e.g., dollar/absolute loss thresholds or percentage loss thresholds).
Internal options for assessing climate risk exposures1 Top 10 Lists •
Materiality of climate change on customers (carbon footprint or potential financial loss), being assigned High, Medium, Low or on a numerical scale
•
May be incorporated into a matrix assessment including the impact of customer on the bank (e.g., level of exposure and RWA)
Heat maps
Peer comparison
•
•
Within each sector, identify the progress of a counterparty in terms of climate consideration
•
Whether a counterparty adaptation to the transition is influenced by factors such as its level of climate change-related R&D spend, fossil fuel inputs, and degree of physical risk
800B
80%
600B
400B
200B
0B
60%
40%
20%
0%
70B
8%
60B
7% 6% 5%
40B
4% 30B
3%
20B
2%
10B 0B
1% 3.3%
Total exposure
Holistic assessment of acute and chronic climate change – Utility company financial analysis (examples)
Assets
50B
Balance
100%
% of total balance
1000 B
Non flood zones
Balance
Example of mortgage exposure to flood risks2
Qualitative assessment lend themselves to a “heat map” type approach covering risks such as direct and indirect emissions, regulatory risks, capacity to adapt, and exposures to stranded assets
0%
Flood risk category
Liabilities and Equity
(+) Expanded and strengthen assets (-) Goodwill impairments due to brand damage (-) Increased depreciation as assets have shorter depreciation life
Revenue
(+) Loss of credit rating (-) Reduced profitability
Expenses
Increased peak and total demand Acute – Heat degrades carrying capacity of transmission Chronic heat rise weakening operating efficiency Positive impact
(+) Increased debt
03 February 2021
Climate risk management
Inputs Impact on Sectors: 1. Policy risk 2. End demand risk
3. Technology risk 4. Legal and reputational risk
(+) Increased energy costs
Adaptability:
(+) Acute – Unplanned repair and right of way maintenance costs
1. Comparison of emission vs. government targets 2. Comparison of emission vs. peers 3. Assessment of qualitative factors
(+) Chronic – Increased capex for storm/weather resilience
Negative impact
Source: 1 Climate Financial Risk Forum Guide 2020, Risk Management Chapter; 2Bank of England, Transition in thinking: The impact of climate change on the UK banking sector Page 34
Assessing transition credit risk for corporate customers Transition Risk Rating by Customer Adaptability
Leading Good Avg. Below Avg.
Legend: “IH” Immediate High “MT A” Medium-term Average
Sector/Country Score I H
MT H
MT A
2
3
3
3
2
3
3
3
1
2
3
3
1
1
2
2
“MT H” Medium-term High “L” Low
L
Approach to measure climate-related financial risks Financial market risk Assessing the impacts on assets and markets Climate metrics included as part of regular portfolio monitoring and increasingly scenario analysis
Climate reporting
•
Climate metrics and evaluation are increasingly included as part of monitoring of a portfolio of assets or securities.
•
Asset owners and fund evaluators are increasingly interested in the carbon profiling of funds
•
Most practices today focus around point-in-time analysis
•
•
Quantitative metrics which are frequently used to evaluate a portfolio’s carbon involvement and risk include:
Leading practices include these metrics in client reporting while fund rating providers evaluate carbon profiles of various funds
•
Where voting and ownership rights exist in asset level equities, increasingly climate risk is incorporated into voting decision and policies
•
Scope 1, 2 and 3 emissions standards proposed by the Greenhouse Gas Protocol Portfolio carbon intensity measured as GHG emissions per $ of revenue earned A “value at risk” approach (which differs significantly from the bank traded book VaR calculations) can be used to estimate the risk of an investment Climate scenario analysis and stress testing
•
The value of stewardship and voting activities are maximized once investors have first identified red flags using portfolio climate monitoring and analysis tools
• •
•
Scenario analysis combines top down and bottom up views of physical and transition risk Top-down perspective
Strategic asset allocation/asset liability management
Transition risk Portfolio Sector Company
Source: Climate Financial Risk Forum Guide 2020, Risk Management Chapter
03 February 2021
•
The company’s multi-factor corporate bonds now apply additional targets to halve their carbon footprint relative to their benchmark indices, based on CO2 emissions data scope 1 and 2
•
The multi-factor management approach targets investors seeking to better control their risks within a diversified portfolio, and is based on quantitative analysis of fundamental indicators and market data
Physical risk
Bottom-up perspective
Page 35
Case study: A large multinational asset management company implemented a 50% carbon footprint reduction mechanism for two multi-factor fixed income funds
Climate risk management
Approach to measure climate-related financial risks Operational risk Risk assessment should consider the following aspects: Location strategy, business continuity arrangements and operational resilience
Not meeting customers’ expectations on climate and ESG related demand
1
Impact of the office locations for organizations
1
Risk of companies greenwashing to meet customers’ requirements
2
Impact of location of data centers and outsources
2
Quality of data used for decision making and available data sources
3
The ability of the workforce to travel to the office
3
Consistency of data published
Litigation risk
1
2
3 4
Preparations and assessments 3rd party suppliers have made themselves, and the mitigating actions
Source: Climate Financial Risk Forum Guide 2020, Risk Management Chapter
Page 36
03 February 2021
Climate risk management
Increasing policy recognition of the critical role financial services have in enabling the transition to a low carbon economy and building resilience The advent of TCFD disclosure means it will be easier for the public and the media to understand how different organizations are approaching climate change and expect them to deliver on their promises Failure to approach climate change strategically may also fail to position appropriately for fundamental changes, resulting in loss for the business or failure to maximize the opportunity relating to climate change
Question time!
Has your organization started to measure climate-related financial risks?
Please use the poll to give your answer!
Page 37
03 February 2021
Climate risk management
2.3
Risk management
Page 38
03 February 2021
Climate risk management
Businesses can address climate-related risk in an integrated manner to maximize the synergy across the business Integrated approach to climate change Climate strategy governance
Climate compliance governance
•
Net zero commitments
•
Climate risk assessment
•
Sustainability products (e.g., Green bonds, sustainability linked loans, etc.)
•
Stress testing
•
Task force on climate-related financial disclosures (TCFD)
•
Sustainable supply chain finance
•
Servicing sectors in transformation
Banking
Asset management
Securities
Banking
Asset management
Securities
Training and internal communications Risk management (compliance, control framework, monitoring, reporting, …)
Risk management (compliance, control framework, monitoring, reporting, …)
Data and methodology Technology
Source: EY
Page 39
03 February 2021
Climate risk management
There are two clear drivers for climate change across Financial Services businesses: •
Climate risk assessment and compliance, driven by regulations
•
Climate strategy and new product development, driven by market needs and potential opportunities for value creation
Businesses need to address climate change in an integrated manner to provide a holistic response while identifying synergies for the transformation needed across the business.
Types of strategies to address climate risk Reducing exposure to risk e.g., reducing the FI’s own carbon footprint
Mitigation
Transferring or hedging the risk to third parties Insurance is the common practice to transfer risk
Transfer or hedge
Strategies to address climate risk
e.g., insurance for renewable energy solutions, to provide natural hedge to the business growth
Resilience
Reducing damage or cost after exposure
Adaptation
e.g., encouraging all residential mortgage holders to buy property insurance to prepare for severe weather impacts
Aligning FI’s business plan e.g., in order to withstand severe weather events that have flow-on financial impacts, FIs can consider to hold an additional capital buffer
Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures, June 2017
Page 40
03 February 2021
Climate risk management
Risk management tools to help customers reduce climate risk There has been a number of FIs that excludes fossil fuel investment or financing strategies
Improvement to building standards to be more resistant to climate risk Building standards
companies from their
FIs can encourage adaptation by
Improved product choices for customers
decreasing insurance prices when customers deploy adaptation measures Pricing
Risk management tools for customers
Collaboration
Financing
FIs can work with government to
encourage climate conscious policy decisions and development of infrastructure to
Education
adaptation measures
improve resilience
FIs can educate
customers on their exposure to climate risk and encourage them to reduce this risk
Final Report: Recommendations of the Task Force on Climate-related Financial Disclosures, June 2017
Page 41
03 February 2021
Banks can offer loans to customers to fund
Climate risk management
Short break (5 mins)
Page 42
03 February 2021
Climate risk management
Content
About this topic
3 Practical data and tools available
Page 43
03 February 2021
3.1 List of available data and tools
3
• How data can be obtained from externally and internally, and introducing useful tools for risk management, such as hazard maps, footprints and catastrophe models
Guest speakers: • 2 Degree Investing Initiative
Climate risk management
Laura Ramirez Head of Emerging Markets, 2o Investing Initiative (2DII)
Sharing session by 2DII
Page 44
03 February 2021
Climate risk management
Panel discussion: Identifying, measuring and managing climate-related risks
Page 45
03 February 2021
Climate risk management
Panel discussion: Identifying, measuring and managing climate-related risks
Laura Ramirez Head of Emerging Markets, 2o Investing Initiative (2DII)
Page 46
03 February 2021
Climate risk management
Alan N Smith Senior Advisor, Climate and ESG Risk Management, HSBC
Robert Barker Chief Sustainable Business Officer, BNP Paribas
Webinar feedback
Did you find the workshop useful?
Please use the poll to give your answer!
Page 47
03 February 2021
Climate risk management
Webinar feedback
Was the workshop effective in increasing your understanding of climate risk management?
Please use the poll to give your answer!
Page 48
03 February 2021
Climate risk management
Contact us EY Team
Russell Marsh
Arina Kok
Director, EY Corporate Advisors Pte. Ltd [email protected] +65 6309 6542
Director, Ernst & Young Advisory Services Sdn Bhd [email protected] +603 7495 8856
Sonal Agarwal Associate Director, EY Corporate Advisors Pte. Ltd [email protected] +65 6309 6025
Page 49
03 February 2021
Climate risk management
Joel Khaw Manager, Ernst & Young Advisory Services Sdn Bhd [email protected] +603 2388 9500
What’s next? Series 3 – Climate scenario analysis | Date and time: 10 February 2021, 3.00pm – 5.30pm Introduction and opening
•
Short introduction
•
Types of climate-related risks
•
Risk exposure and materiality assessment
•
Components of climate scenario
•
Developing climate scenarios
5mins
3.00pm – 3.05pm
30mins
3.05pm – 3.35pm
45mins
3.35pm – 4.20pm
Q&A session
10mins
4.20pm – 4.30pm
Short break
5mins
4.30pm – 4.35pm
35mins
4.35pm – 5.10pm
Q&A session
10mins
5.10pm – 5.20pm
Closing remarks
10mins
5.20pm – 5.30pm
Scenario analysis
Scenario identification and development
Scenario assessment
Page 50
03 February 2021
•
Assessing the financial impact of climate risks in different scenarios
•
Challenges and barriers
Climate risk management
EY | Building a better working world EY exists to build a better working world, helping create long term value for clients, people and society and build trust in the capital markets. Enabled by data and technology, diverse EY teams in over 150 countries provide trust through assurance and help clients grow, transform and operate. Working across assurance, consulting, law, strategy, tax and transactions, EY teams ask better questions to find new answers for the complex issues facing our world today. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. Information about how EY collects and uses personal data and a description of the rights individuals have under data protection legislation are available via ey.com/privacy. EY member firms do not practice law where prohibited by local laws. For more information about our organization, please visit ey.com. © 2021 EYGM Limited. All Rights Reserved. EYG no. 000604-21Gbl ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, legal or other professional advice. Please refer to your advisors for specific advice.
The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.
ey.com