Climate Change Risk

Question 1

What does transition risk mean?

Answer 1

The risks that arise due to the relative uncertainty created by the global shift towards a net-zero economy

4 subtypes
1. Policy and legal risks
2. Technology
3. Market changes
4. Shifts in consumer and investor sentiments

Question 2

True or false

Physical risks can be split into the following: short-term and long-term

Answer 2

False

It’s acute and chronic

Acute refers to one time events, like floods, wildfires, hurricanes and droughts
Chronic refers to the long-term and gradual changes, like SLR and rising average temperatures

Question 3

Give 4 examples

What are the subtypes of transition risk are there?

Answer 3

1. Policy and Legal risk
2. Technology Risk
3. Market risk
4. Shift in consumer and investor sentiments

Question 4

True or false

For either physical or transition risks to occur, it only needs to have the hazard and vulnerability in place.

Answer 4

False

It also requires exposure (ie: whether the asset will be in that vulnerable place to begin with)

Question 5

What does ‘vulnerability’ mean in the instance of climate risks?

Answer 5

Whether the asset has sufficient resilience, flexibililty and adaptation measures in place to reduce the effects of the hazards

Question 6

What is a ‘stranded asset’?

Answer 6

Assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities

Question 7

Which of these statements are true?
1. Stranded assets from physical risks are likely to be geographically contained
2. Stranded assets from transition risks are more likely to impact the energy and industrial sectors
3. Stranded assets from physical risks can impact all sectors
4. Some sectors are more prone to having stranded assets
5. All of the above

Answer 7

(5) All of the above

Question 8

True or false

There are a wide variety of models to predict the magnitude and frequency of certain hazards, as well as the specific timeframe of occurence and their specific locations.

Answer 8

True

As a result, there can be disagreement on the magnitude or specific outcome, resulting in a degree of **uncertainty when predicting physical risks

Question 9

True or false

Which of these is an issue when asessing direct physical risk?
1. Lack of consensus of models to use
2. Lack of understanding of datasets
3. Difficult to assess the vulnerability, especially on facility level
4. Lack of facility preparedness
5. Difficult to find data

Answer 9

(3) Difficult to assess vulnerability, especially on facility level

Other issues include
1. Difficult to obtain data sets
2. Insufficient granularity of data, especially for local topography
3. May not have a good enough understanding of the interdependencies of the supply chain

Question 10

List 3 things

What other indirect risks exist for physical risks?

Answer 10

1. Supply chain risks
2. Legal risks
3. Systemic Risks

Question 11

Which of these are ways that policy and legal risks can manifest?
1) Government mandated closures
2) Energy efficiency regulations and limits on pollution
3) Class action lawsuits and changes in market valuations
4) Pin liability on firms for their proportional contribution to the physical impacts of climate change
5) Cap-and-trade
6) 1, 3, 5 only
7) 2, 4 only
8) All of the above

Answer 11

(8) All of the above

Question 12

True or false

Technology transition risks poses a threat to older assets that rely on outdated technology

Answer 12

True

This is when outdated technology becomes less economical or even obsolete eg: renewable energy or EV cars

Question 13

Give 3 things

How can market risk contribute to transition risk?

Answer 13

1. Moving from a high-intensity market to low-carbon products and commodities
2. Spikes and shifts in demand will cause market disruptions
3. Shareholder perceptions and pressures from the public market

Looks at the supply, demand, and pricing effects

Question 14

Give 4 examples

In what was can intangible stranded assets present as?

Answer 14

1. Intellectual property
2. Social networks
3. Company reputation
4. Skills and expertise of workers and professionals

Question 15

True or false

Job losses are a direct result of national climate policies

Relating to transition risk and stranded human assets

Answer 15

False

it is actually caused by a lack of social policies and by the investments into another alternative mitigation measures. Therefore, it is critical to provide support to sectors who will be losing out in a low-carbon future and generate new employment opportuntiies

Question 16

Name 4

What are the core elements that the TCFD recommends in Climate-Related Financial Disclosures?

Answer 16

1. Governance
2. Strategy
3. Risk Management
4. Metrics and Targets

Question 17

True or false

The TCFD recommends that Governance and Strategy should be included in financial filings whilst Strategy and Metrics and Targets only need to be provided in annual financial filings so long as the information is deemed material

Answer 17

True

Meant to be able to be applied broadly across sectors and jurisdictions

Question 18

Give 2 examples

In what way can organisations disclose their governance around climate-related risks and opportunities?

Answer 18

1. Describe the Board’s oversight of the risks and opportunities
2. Describe management’s role in assessing and managing climate-related risks and opportunities

Question 19

Which of these are ways in which an organisation’s strategy an be disclosed?
1. Describe the organisation’s processes for identifying and assessing climate-related risks
2. Disclose the organisation’s processes for managing climate-related risks
3. Describe the organisation’s resilience, considering the different climate-related scenarios such as the 2C or lower scenario
4. Describe the targets used by the organisation to manage climate-related risks and opportunities and the performance against metrics

Answer 19

(3) Describe the organisation’s resilience, considering the different climate-reated scenarios such as the 2C or lower scenario

1) Refers to a risk management disclosure recommendation
2) Refers to a risk mangement disclosure recommendation
3) answer
4) Refers to a metrics and targets disclosure recommendation

Question 20

True or false

This is a TCFD recommendation for strategy disclosure:

Describe the impact of climate-related risks and opportunities on the organisation’s business, strategy and financial planning

Answer 20

True

Question 21

Which of these is a TCFD recommendation for Governance?
1. Provide a description of what they consider to be relevant short, medium and long-term time horizons, taking into account the useful life of the organisation’s assets or infrastructure
2. Provide a description of specific climate-related issues potentially arising in each time horizon that could have a material financial impact on the organisation
3. Organisations should calculate their GHG emissions to be aligned with the GHG Protocol Methodology and allow for aggregation and comparability across organisations and jurisdictions
4. Disclose the frequency and processes by which the board and/ or board commmittees are informed of climate-related issues
5. Describe how their processes for identifying, assessing and managing climate-related risks are integrated into their overall governance

Answer 21

(4) Disclose the frequency and processes by which the board and/or board committees are informed of climate related issues

Question 22

Name 4 things

What are the basic risk types that affect companies

Answer 22

1. Credit risk
2. Market Risk
3. Liquidity risk
4. Operational risk

Question 23

How is market risk identified?
1. By using statistical models
2. By evaluating a borrower’s capacity to repay debt
3. By monitoring changes in market conditions
4. By reviewing a borrower’s financial statements

Answer 23

(1) By using statistical models

Risk managers measure market risk using statistical models to quantify the potential loss due to market movements

Question 24

What is credit risk?

Answer 24

The potential loss incurred if a borrower or issuer fails to meet their obligations in accordance to the agreed terms and defaults on payment

Question 25

How do risk managers identify credit risk?
1. By reviewing a borrower’s financial statements
2. By monitoring changes in market conditions
3. By monitoring changes in interest rates
4. By evaluating a borrower’s capacity to repay their debts

Answer 25

(1) By reviewing a borrower’s financial statements

By reviewing the financial statements, risk managers can then evaluate whether they have the ability to repay their debts

Question 26

How is market risk assessed?
1. By calculating the potential losses from changes in market prices
2. By analysing market trends
3. By assessing the creditworthiness of market participants
4. By measuring the volatility of market prices

Answer 26

(1) By calculating the ptoential losses from chnges in market prices

Question 27

Which of these is the correct credit assessment process?

1.Identify scope of policies, identify areas of opportunity, assess borrower’s financial status, estimate borrower’s risk of default, lend money
2.Identify credit opportunity, evaluate prospective borrower, make credit decision, disburse credit, monitor credit
3. Identify potential borrower, determine risk of default, evaluate prospective risks, disburse credit
4. Identify risk of default, review structural processes, Board decision, disburse credit, monitor credit

Answer 27

(2) Identify credit opportunity, evaluate prospective borrower, make credit decision, disburse credit, monitor credit

Question 28

What are the 5Cs of Credit Analysis?

Answer 28

1. Character
2. Capital
3. Conditions
4. Capacity
5. Collateral

Relevant to SMEsas they typically don’t have access to financial markets that larger entities have access to

Character = Capital is given to borrowers with good credentials and references.
Capital = The higher the equity, the more stable the entity will appear
Conditions = Need to look at the ecnomic conditionsthat the company is operating in (eg: country, financial dynamics of the relevant industry)
Capacity = Based on whether the borrower can meet current and proposed obligations with its current and expected cashflow
Collateral = If borrower doesn’t have sufficient capacity to pay back debt, the lender can seize control over other assets to satisfy the original terms of agreement

Question 29

How do credit rating agencies evaluate the creditworthiness of borrowers?

Answer 29

Ratings on individual debt instruments

Determined by many factors:
* qualitative, quantitative and legal data about the borrowers’ ability to repay debt
* Conditions of the borrowers’ industry
* For sovereign borrowers - economic and fiscal strength of country, stability and viability of social and political system

Question 30

How do you calculate the Expected Losses of credit risk?

Answer 30

Probability of Default X Loss Given Default X Exposure at Default

probability of default = The likelihood that the borrower will fail to make their repayment in the given time horizon
loss given default = The proportion of the loss, if there is a default
Exposure at default = The remaining value of the loan payment at point of default

Question 31

What financial istrument would a firm use to identify how much they expect to lose over a specified time horizon at some level of confidence?

Answer 31

Value-at-Risk

Difference between VaR and Expected Loss (EL) is the Unexpected Loss (UL)

Question 32

True or false

Credit risk managers can manage credit risk through whole loan sales, syndication, securitisation and credit default swaps.

Answer 32

True

Whole loan sales = By selling a specific loan/ set of loans to another FI:. reduces their own exposure
Syndication = By sharing a portion of the loan with another FI :. allows them to diversify their rissk to acceptable levels based on their risk appetite
Securitisation = By pooling or bundling assets and either selling them to other FIs or into the capital markets :. creates a more diversified portfolio of loan assets and reduces the risk of an individual loan
Credit default swaps = Similar to insurance, where buyer has transfered their default risk to the default protection seller in return that the buyer makes periodic payments to the seller

Question 33

Which of these is the main type of market risk?
1. Credit spread risk
2. Volatility risk
3. Correlation risk
4. All of the above

Answer 33

(4) All of the above

Other major risks include:
1. Stock price risk
2. Interest rate risk
3. Commodity price risk
4. Exchange rate risk

Question 34

What is the most common method for measuring market risk?
1. Monte Carlo Simulations
2. VaR
3. Stress tesing
4. Regression analysis

Answer 34

VaR

calculates the maximum loss that a portfolio can expect ot experience over a certain time horizon

Question 35

What is NOT a disadvantage of using VaR?
1. Does not indicate how large the losses might be
2. Can cause traders to remain in the VaR limit rather than take risks
3. It is difficult to calculate, making it hard to relay to borrowers
4. The calculated VaR might end up being higher than component assets

Answer 35

(3) it is difficult to calculate, making it hard to relay to borrowers

One of the benefits of VaR is how easy it is to calculate and how it can be consistently applied across different sectors and contexts

Question 36

True or false

Stress testing is only used in scenario analysis rather than as a complementary tool

Answer 36

False

Stress testing can be a useful complementary tool for VaR and Expected Shortfall and involves analysing the potential outcome of a specific change to a risk model parameter

Question 37

What is liquidity risk?

Answer 37

The potential loss incurred if an institution does not have sufficient funding to meet its short-term financial obligations.

Question 38

Give 3 ratios

What indicators can be used to measure liquidity risk?

Answer 38

1. Quick ratio
2. Current ratio
3. Debt to equity ratio

The quick ratio is the company’s ability to pay off its current liabilities without needing to sell its inventory or obtain additional funding
The current ratio is the value of current assets to current liabilities
The debt to equity ratio is the company’s total liability against stakeholder equity

Question 39

How many subtypes of operational risk are there?

Answer 39

5

• internal process risks
• people risk
• systems risk
• external risk
• legal risk

Question 40

What does internal process risk mean in relation to operational risk?

Answer 40

The potentail loss due to the failure of a firm’s prescribed procedures and policies

Question 41

Give 5 examples

What sort of internal process risks exist in operational risks?

Answer 41

1. Lack of controls
2. Marketing errors
3. Money laundering
4. Documentation or reporting failures
5. Transaction errors

Question 42

Which of these are a systems risk in relation to operational risk?
1. Data corruption
2. Inadequate project control
3. Inadequate documentation
4. Overreliance on key staff
5. Overreliance on ‘blackbox technology
6. 1, 2, 5
7. 2,3,4
8. 1, 3, 5

Answer 42

(6) 1, 2, 5

Other systems risk include
* programming errors
* system unsuitability
* System security problems

Question 43

True or false

External risk relates to the events that occur beyond the company’s remit or direct control. They include things like the stock price crashing.

Answer 43

False

Although external risk does relate to things outside of the company’s direct control, they usually are for things like pandemics, terrorist attacks, wars, riots, and civil protests. The stock price crashing would be a market risk.

Question 44

True or false

Legal risk is associated with the uncertainty of legal actions or the application or interpretation of contracts, laws, or regulations.

Answer 44

True

Question 45

Give 5 examples

What ways can risk managers identify operational risks?

Maps provide a lot of experience for analysing your surroundings

Answer 45

1. Process mapping and building flow charts
2. Existing business experience
3. Analysis of existing records
4. Scenario analysis
5. Risk and Self Control Assessments (RCSA)