Survey: More financial institutions using scenario analysis to manage climate risk

Conducted by the GARP Risk Institute (GRI), the “Third Annual Global Survey of Climate Risk Management at Financial Firms” garnered responses from 78 financial institutions around the world—comprising banks, asset managers, insurers, and other firms—that collectively hold roughly $46 trillion of assets on their balance sheets and total assets under management around $50 trillion.

“Over the last few years, as we’ve taken a look at climate risk management and strategies developed by financial institutions, we’re seeing that firms are evolving their capabilities in a significant way,” said GRI President Jo Paisley.

The survey found scenario analysis has become more mainstream among financial institutions in developing climate change strategies, with 70 percent of firms stating they use it as a regular part of their risk assessments. “Climate risk management and scenario analysis are evolving at pace, and the GARP annual survey shines a light on how firms are responding,” said Adityadeb Mukherjee, head of climate risk management at Standard Chartered Bank.

Part and parcel with this finding, regulatory activity on climate risk is intensifying, as indicated by 80 percent of firms who reported regulators have published formal expectations for climate risk management. Further, 65 percent stated regulators now require them to report climate-related risks.

In a speech delivered Oct. 7 at the Federal Reserve Stress Testing Research Conference, Fed Governor Lael Brainard stated financial institutions would be wise to conduct climate scenario analyses that “model the possible financial risks associated with climate change and assess the resilience of individual financial institutions and the financial system to these risks.”

Firms also were asked in the GARP survey about the use of metrics (measures used to assess climate-related risks), targets (the outcome the organization aims to achieve), and limits (the worst outcome the organization is prepared to accept without taking corrective action) within their climate-related risk management processes. Collectively, these help firms to understand these risks and incorporate them into their risk appetite statements, the GRI said.

According to the GRI, around three quarters of respondent firms use metrics, while roughly half use targets. Only a quarter use limits. Another quarter indicated they do not measure their climate risk at all, while a similar percentage use all three—metrics, targets, and limits.

Governance structures

From a governance standpoint, 91 percent of firms said they’ve increased their level of staffing dedicated to climate risk over the past two years, but how they structure their staff varies greatly. According to the survey, 42 percent of firms have created a dedicated climate risk team. While these teams most frequently are set up as an independent function, sometimes they are embedded within another established risk team (e.g., risk management, frontline staff, ESG, or corporate responsibility). Additionally, the survey found practices vary by type of financial institution, with a dedicated climate risk team being more common among banks and insurers than asset managers.

More than 90 percent of climate risk teams are led by senior staff (those with more than 10 years’ experience), according to the survey. Sixty percent indicated these individuals sit in the head office, and more than half the respondents noted the person who heads the climate risk effort reports directly to a C-suite member—most commonly the chief risk officer or CEO.

At the board level, 92 percent of respondents said their boards oversee climate risk management, and more than 90 percent said C-suite-level executives are accountable for climate risk assessments and management efforts.

Barriers and challenges

The most pressing concerns for firms are the availability of reliable models, followed by regulatory uncertainty, according to the GRI.

Relatedly, the survey found only 6 percent of firms believe climate risk to be priced correctly, with most indicating it was either not included in the market’s pricing of products or only included partially.

“With few firms believing climate risk is properly priced, there is clearly an opportunity for significant changes in valuations and associated impacts on financial performance,” Paisley said.

Firms that felt climate risk is reflected (at least partially) in prices pointed to a few areas, including emerging market sovereign bonds, green bond prices, and some insurance lines, according to the survey. “Firms continue to find it difficult to source robust and reliable data on climate risk that will allow them to price the risk,” the GRI stated.

The survey also found that while firms are confident in the resilience of their climate risk strategies in the short term, they are less certain over the long term. According to the findings, 77 percent of firms think their strategy is resilient over the next one to five years, but that confidence drops to 22 percent when considering the resiliency of their strategy 15 years and beyond.