• Less valuable assets = Increased weight of liabilities on • Climate risk incorporation into asset prices might also

reduce risks to financial stability

SCR Exam balance sheet > More chances of company defaulting >
Greater loss given default • Sovereign Risk: Examining size & sectoral composition of
their economies; capacity to create adaptive policies &
cheat sheet • A final, related channel is that of pricing effects through
markets for inputs (raw materials) and outputs (products) responses to climate change; debt accessibility; and
specific policy decisions
Firm-specific Liquidity Risk • Stranded Nations: Nations heavily reliant on fossil fuels
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• Liquidity risk is about losing access to liquidity-the ability to exports may turn into stranded nations
Introduction quickly and easily convert assets into cash Climate Risk Measurement
• Key metrics for liquidity risk include loan-to-deposit ratios
• Risk Management is a structured approach to monitoring, (specifically for banks) and bid-ask spreads • Transition risk requires, first & foremost, accurate asset-
measuring, and managing exposures to reduce the • Climate risk drivers can prompt depositors to draw down level and company-level data on GHGs but also data on
potential impacts of uncertain occurrences deposits and debtors to draw down credit lines at the same policy landscapes, technological changes, and consumer
• To manage climate risk, it’s imp to examine how climate time, dramatically increasing (worsening) loan to-deposit preferences to capture the various drivers of transition risk
risk affects various types of financial risk e.g., operational, ratios e.g., after floods people can liquidate all their funds • Physical risk requires data on current & future physical
market, insurance, liquidity, and credit risk hazards, derived from a combination of historical data &
Underwriting Risk climate models; topographical & locational data of assets;
• “You can only manage what you can measure”
• Climate risk drivers can transmit to financial risk through a • This risk only directly affects the insurance sector & information on vulnerability and adaptive capacity
no. of risk types – operational, credit or market • Key metric – Changes in insurance premiums Company level Transition Risk Data
• Many classification schemes of climate risk transmission • Climate risk leads to a concentration of risk due to
channels come from central banks. These schemes underwriting becomes highly risky • Corporate Carbon Footprints: These have shortcomings
distinguish between micro, macroeconomic & financial • 1-in-100-year events, becoming much more common e.g., as most data currently comes from self-reporting. Typically
consequences and drivers heatwaves in Europe unaudited & vary in their breadth and detail.
• Larger insurers with diversified exposure can cross- Company level Transition Risk Data
Micro(Company level) Climate Risks
subsidize to an extent but it’s not possible for smaller ones
Operational Risk • Underwriting risk increases can also affect other types of • The basic data for gauging physical hazards is provided by
risk. No Insurance = No Resilience or hedge for firms global climate models by IPCC e.g., CMIP5 and CMIP6
• Op Risk is the risk inherent in doing business, & it reflects • Only some corporations and financial counterparties have
potential losses from inadequate or failed internal Macro Climate Risk the ability and desire to bring the specialist knowledge in-
processes, systems, human error, or outside events house to make direct use of these models.
• Thai floods 2011 affected global semiconductor supply &
• Op Risk is multifaceted and hard to measure • Some firms provide investors with physical climate risk
had ripple effects across supply chain – a good example of
• One of the strongest effects of climate risk on operational analysis tools of some kind: Acclimatise, Moody's, WRI
the macro effects of operational risk on a macro level
risk is its effect on external risk • Company or asset-level physical risk data and scores are
• Increased counterparty credit risk that results from climate
• Transmission of climate risk into internal process risk is arguably the most easily interpretable approach to physical
change can directly transmit into the financial sector
similar to that of people risk risk analysis in a way that is accessible to lenders,
• Climate risks have a wide reach their impact can create
• Other categories of Op Risk when analysing climate risk – investors, and other stakeholders
systemic level liquidity risk e.g., liquidity crunch after the
Legal Risk, Strategic Risk, Reputation Risk • By combining data on climate hazards with the location of
earthquake in Japan in March 2011
Credit Risk • Climate Minsky moment: A Minsky moment is a sudden companies' factories and warehouses and an estimate of
major collapse of asset values vulnerability, the physical climate risk scores can tell
• Credit Risk measures the creditworthiness, or ability a investors about the relative physical risk of investing in,
• The unavailability of insurance due to climate risk can have
borrower has to pay back a loan say, Volkswagen as compared to Ford or Microsoft
systemic effects
• Key metrics: Probability of default (most general measure • These "heavily digested" scores do have their downsides,
• At the systemic level, climate risk translates into market
of credit risk), loss given default (LGD is expected to be however. The proprietary methods and datasets that they
risk through repricing and dislocation effects as well as
highly sector-specific & requires a high level of derive from remain a "black box" to the investors who pur
through asset-stranding
customization), and exposure at default chase the scores
• Key Metric for Climate led Market Risk – Climate Value at
• One important transmission channel from climate to credit
Risk (CVaR) - captures a rough estimate of climate-related
risk runs through operational risk
financial losses - it includes both transition and physical
• Another important channel operates through valuation
risk as well as economic data and company-level data.
effects, that is, asset stranding

Chapter VI: Climate Risk Measurement and Management

 • COSO and WBCSD have recommended starting with
megatrend analysis and then delving deeper through the
SCR Exam use of tools such as SWOT analysis, impact mapping, and
materiality assessment
cheat sheet • Two other key components of strategy with regards to
climate change, and emphasized by the TCFD, are time
horizons and outcome variance by scenario, which can be
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Portfolio level analysis Performance: Tracking and Measuring Risk

• Most relevant to a financial counterparty, such as a lender
or an investor • Tracking performance for ESG & climate risks consists of 3
• Two common metrics: carbon intensity, or GHG emissions sub-components: Risk Identification, Risk Assessment, and
normalized by portfolio market value (for example, tons of Prioritization.
CO2 equivalent/million USO invested), and weighted • Risk identification starts with examining the transmission
average carbon intensity (tCO2e/million USO of revenues). channels of climate risk drivers into financial risk and then
Other method ologies pin a temperature or "warming identifying which of these are the most relevant for a
potential" on an entire portfolio particular organization.
• Aggregating and evaluating portfolio-level physical risk is • Risk assessment involves gathering data on the actual
difficult for equity or bond portfolios, where exposure is to scope of these risks. A financial institution will tend to do
entire companies this sort of analysis at a counterparty level.
• Risk prioritization is especially important in an ERM con
Climate Risk within ERM text, as any large enterprise will be exposed to a multitude
• One of the most widely used frameworks for ERM was of risks, and it is important to rank these in order of
developed by the Committee of Sponsoring Organizations importance. Ranking methods include ranking by likelihood
of the Treadway Commission (COSO) of occurrence, adaptability and complexity, or severity.
• ERM is not considered to simply be a function or a • Risk Responses: Acceptance, avoidance, pursuit,
department, but it consists of "culture, capabilities and reduction, and sharing
practices that organizations integrate with strategy-setting.” Review and Revision
• ERM is a holistic modus operandi across an entire firm
• The review and revision portion of the COSO framework
Risk Governance & Culture mainly refers to additional checks and balances on the
• Successful risk governance starts at the highest level, with ERM framework
the board and senior executives • It’s about being self-critical
• Best practice governance arrangements tend to involve • Can be performed through periodic audit + continuous risk
multiple layers of employees and internal processes management activities
• Culture defined by COSO: Attitudes, behaviors and Communication, Reporting & Disclosure
understanding about risk[...] that influence the decisions of • The larger a company, the less straightforward even
management and personnel and reflect the mission, vision internal communication can be
and core values of the organization • Communicating to external stakeholders, including
Strategy & Setting Goals investors and lenders but also credit rating agencies,
employees, suppliers, regulators, and the public at large, is
• Corporate strategy high-level decisions on an organiza- likewise an important outcome of successful ERM
tion's priorities and mission • Risk management that is practiced fully in private is not
• Understanding the full business context on climate risk successful risk management. It is imp for shareholders &
requires understanding the external environment and lenders to know that a company has solid ERM in place to
megatrends & how the inputs, business activities, and ensure continued value creation in the face of the
outputs of that particular company are affected by climate crystallization of risks such as climate risk
change

Chapter VI: Climate Risk Measurement and Management