Climate Risk Measurement & Management Flashcards
Understanding transition risk requires sold data on…
- GHGs attributable to an asset / firm
- Understanding of the policy landscape
- Understanding of technological changes
- Understanding of consumer and broader societal preferences
Risk metrics for Operational Risk
Proportion of facilities exposed to climate risks
Level of preparedness / resilience
Micro level operational risks
Macro level operational risks
Micro:
- physical - weather events disrupt premises / supply chains
- transition - abrupt policy changes cause shutdowns
Macro:
Only in specific circumstances i.e. geographic concentrations
Credit Risk Metrics
PD, LGD, EAD
Credit Risk Micro and Macro level
Micro:
- physical - property damage and business interruption impacts revenue and profits
- transition - asset stranding can worsen firms position (increasing PD & LGD)
Macro:
Significant, sector wide asset stranding potential
Liquidity Risk Climate Metrics
Loan to Deposit Ratio
Liquidity Ratios
Bid Ask Spread
Liquidity Risk Micro & Macro
Micro:
Abrupt events can prompt sharp repricing and evaluation of firm viability
Macro:
Significant, Climate ‘Minsky Moment’ could cause widespread repricing
Underwriting / Insurance Climate Metrics
Change in insurance premiums
Availability
Underwriting / Insurance Micro & Macro
Micro:
- physical - higher in vulnerable areas, many may no longer afford
- transition - less availability & some areas may be refused underwriting
Macro:
Significant - number of insurers withdraw or refuse coverage, some firms will be left without
Market Risk Climate Metrics
Weighted Average Carbon Intensity
Carbon VaR
Portfolio Risk Scores
Market Climate Risk - Micro & Macro
Micro:
Incorporated through asset prices, shifts in asset prices increase risk on FI portfolios.
Macro:
Mixed - countries have diversified economies and geographies.
Impacts to LGDs are likely to be…
High sector specific
Explain how asset stranding impacts credit risk
Company’s core assets fall in value or become worthless
With less valuable assets, a company’s liabilities weigh heavier on balance sheets
More likely that company will default on future debts given company has less collateral
Explain pricing effects
Markets for inputs (raw materials) and outputs (products) may be impacted if raw materials become more $$$ or makes products less valuable
Industry is internalising the link between credit risk and sustainability performance…this can be evidenced through
The risk in sustainability linked bonds and loans
How does a loan to deposit ratio increase due to climate?
Climate drivers may prompt depositors to draw down deposits
& debtors to draw down credit lines at the same time
I.e. post natural disasters
Liquidity risk only manifests as a consequence of climate risk under specific circumstances -
An acute climate related event or imposed authority fines for non-compliance
Which is more gradual credit or liquidity
Credit more gradual
Liquidity more abrupt
Whom does underwriting risk directly impact?
Only the insurance sector
However many corporations and FIs rely on insurance coverage
Insurance coverage works best when
Large pool of participants have small and close to equal change of being stuck by misfortune, when these accidents follow predictable patterns
An 18% probability of occurrence is the same as a return period of ___
5.5 years
Hurricane Harvey’s annual probability of occurrence
1980s vs 2010s
1% vs 6%
Difference between larger insurers and smaller regional insurers
Larger insurers have more diversified exposure and can cross-subsidise to an extent
Smaller, regional insurers without geographic diversity don’t have this luxury
The REPRICING effect occurs through market risk transmission channels…
Define the repricing effect and how it occurs
Repricing effects occur where climate risks are anticipated to impact prices, but these risks have not yet been baked into asset prices. Repricing effect have a quicker impact on asset prices.
What is the main concern within market risk?
How is this reflected?
Increased volatility -
Reflected in Climate VaR
How is standard VaR calculated?
Estimated P&L probability density curve of an investment / portfolio
Then look at the lowest 5% of the distribution to estimate tail risk
+ / - of VaR
+ useful due to cross comparability across different types of investments
- sensitive to the data used to construct it (i.e. if constructed from low volatility period, distribution may be optimistic)
Which sectors are those most exposed to a combination of physical and transition risk according to Climate VaR?
Construction
Coal
Electrical Utilities
It is possible that climate risk can lead to a breakdown of typical correlation patterns between assets.
What does this mean?
That the effectiveness of hedges and banks abilities to actively manage their risk may be reduced
What does empirical evidence suggest about climate risk and asset prices?
Majority suggests that climate risk is yet to be priced into many asset classes yet
What is a reason why repricing due to climate risk has been limited thus far?
Inefficiency and insufficiency of governments and companies in reaching commitments such as the 2*c PCA
What does the PRI’s ‘Inevitable Policy Response’ assume?
As the realities of climate become more urgent, governments and others will be forced to act more decidedly in quite a rapid, abrupt and disorderly way
According to Moody’s physical risk methodology for sovereigns, who are amongst the most vulnerable?
India Pakistan Cambodia Central America Sub-Saharan
Who suggested that countries with higher exposure to physical climate vulnerability face a higher cost of capital?
What is this higher cost up to?
Buhr
C.1.2%
Explain how a substantial proportion of national wealth may permanently lose its value
Reduced demand for fossil fuel exports may mean fuel reserves become commercially unattractive - stranded assets lose value
Define SCOPE 1
Emissions resulting directly from a company’s operations
Define SCOPE 2
Includes upstream emissions from purchased electricity, heating and cooling
Define SCOPE 3
All other upstream emissions from supply chains, as well as downstream emissions resulting from the use or disposal of products and services sold by the company (excluding energy consumed)
Corporate carbon footprints have some shortcomings. Other than coming directly from companies themselves, name another mechanism for quantifying these
Annual questionnaire by CDP (Carbon Disclosure Project)
Voluntary disclosures are typically audited, however vary in breadth and depth
Name some issues around emissions disclosures
Few firms disclose all of Scope 1, 2 & 3
Issues of double counted need to be considered - i.e. Industrial firm’s scope 2, would be counted as part of the electricity utility’s scope 1
Suggest some approaches being sought to achieve CORPORATE ALIGNMENT
Science based targets
Transition Pathway Initiative
Temperature Scores - shorthand way of understanding
Give examples of free open source data bases for the below risks :
- projected sea level rise
- water stress
- wildfire vulnerability
Sea level rise - CLIMATE CENTRAL
Water Stress - WORLD RESOURCES INSTITUTE
Wildfire Vulnerability - MAX PANCK INSTITUTE
What is the precision like with free data?
What is the comparison to 427 scores?
Free data is fairly raw
427 scores allow investors to gain a sense of exposure of assets through overlaying location with physical risks - scores normalised on 0-100 scale, available by hazard or overall score
Disadvantages of physical climate risk scores
Many are ‘heavily digested’ - proprietary methods remain a ‘black box’ to investors who purchase the scores.
Normalisation of raw data means they are relative, not absolute scores
Define CARBON INTENSITY
GHG normalised by portfolio market value
Tonnes of CO2 equivalent / millions $ invested
Equation for weighted average carbon intensity
CO2 / million USD of revenue
Why is sensibly aggregating and evaluating portfolio level physical risk difficult for quite and bond portfolios?
Exposure is to the entire companies
Who is COSO?
What did they do?
Committee of Sponsoring Organisations of the Treadyway Commisssion
Most widely used framework for ERMF, released in 2004
What does COSO mean by climate is a ‘transversal’ risk?
Affects all ‘traditional’ categories of risk in some way at a micro and macro level
Name the 5 ERMF categories included by the COSO
- Governance & Culture
- Strategy & Objective Setting
- Performance
- Review & Revision
- Information, Communication & Reporting
Governments - Should - Prioritise - Reviewing - Information
ERMF is not a function or department, it is instead
‘Culture, capabilities and practices that organisations integrate within strategy setting’
Examples of COSO Category: Governance & Culture
- Exercises Board Oversight
- Defines desired culture
Examples of COSO Category: Strategy & Obejctives
- Analyse business context
- Define risk appetite
Examples of COSO Category: performance
- identify risk
- assess severity & prioritise risk
Examples of COSO Category: review and revision
- review risk and performance
- assess substantial changes
Examples of COSO Category: Information, Communication & Reporting
- Leverage information and technology
- Reports on risk culture and performance
Through what Forum do the UK’s two financial regulators brig together industry representatives?
Climate Financial Risk Forum
COSO: Risk Governance & Culture
Best governance arrangements …
Start at the highest level (board)
Involve multiple layers of employees
COSO: Risk Governance & Culture
How is culture defined?
Attitudes, behaviours and understanding about risk…influence the decisions of management and reflect the mission, vision and core values of the organisations
COSO: Strategy & Target Setting
How is corporate strategy defined?
High level decisions on an organisation’s priorities and mission
COSO: Strategy & Target Setting
What does the WBCSD recommend?
Starting with mega trend analysis and then delving deeper through other risk tools (i.e. SWOT analysis)
COSO: Strategy & Target Setting
What is SWOT analysis?
Strengths, weaknesses, opportunities, threats
2X2 matrix to compare internal and external - used for strategic planning
All organisations face unique challenges - materiality assessments allow companies to assess the relative importance of various risks
Name a framework for assessing
SASB Materiality Assessment Framework
COSO: Performance
What are the three steps
Risk Identification
Risk Assessment & Prioritisation
Implementation of Risk Response
COSO: Performance
Define Risk Assessment
Gathering of data on the actual scope of these risks - portfolio level analysis done to determine overall risk to the portfolio
COSO: Performance
Define Risk Prioritisation
Risk Prioritisation based on
Likelihood of occurrence ; adaptability ; complexity ; level of impact vs level of control
COSO: Performance
Name the x5 types of risk responses
- Acceptance
- Avoidance
- Pursuit
- Reduction
- Sharing
COSO: Performance
Explain what ‘pursuit’ as a risk response is
Converting risks into opportunities
COSO: Performance
Explain ‘reduction’ as a risk response
Improving processes, systems or strategies to reduce risk
COSO: Performance
Explain what ‘sharing’ is as a risk response
Collaborating as a risk-mitigation strategy with suppliers, regulators, associations etc.
COSO: Review & Revision
Comprehensive ERM involves…
Having processes in place to monitor the implementation of the ERM and provide checks & balances
Being self critical and responsive with regards to the effectiveness of the ERM
COSO: Communication, Reporting & Disclosure
How can disclosures have a systemic effect?
Help competing firms an the entire sector to transition to net-zero
What is a paleoproxy?
Something we can measure that tells us what the climate was in the distant past
what sort of board structure Did ING have in their climate risk oversight
Two tiered board structure
Supervisory board responsible for the climate risk oversight on the supervisory board level
What did local and regional risk committee is formed as part of ING’s climate risk governance structure
2LOD
What is represented ING’s third line of defence
Internal audit
Who represented IMGs first line of defence
Line manager is responsible for climate risk oversight as a business unit level
In the IEA net zero scenario what must happen to unabated Coal
Phased out in advanced economies by 2030
In the IEA net zero scenario What is the projection for wind electric by 2050
70% by 2050
In the IEA net zero scenario what must global electric generation be and by when
Net zero by 2040
