Managing the Financial Risks of Climate Change

Some Regulators Are Ahead of the Game

Citi GPS Insights

  • Climate change is a concern for financial regulators: Greenhouse gas emissions, global warming and climate change are not only existential issues for those concerned with the future of humanity, they are also immediate concerns for financial regulators. Climate change poses a ubiquitous risk to financial bottom lines, even for corporations that do not have any direct exposure to ESG issues.
  • The good news is that some key financial regulators and supervisors across the world are aware of these risks and are acting upon it. One leading central banker has recently argued that central banks should take into account climate risks not only to ensure financial stability in their roles as regulators and supervisors, but also when conducting monetary policy in the pursuit of price stability or of a dual mandate like price stability and full employment.
  • Financial risks associated with climate change can be divided into two broad categories: (1) financial risks associated with effective policies and other public and private efforts to contain climate change (transition risk or mitigation risk associated with a transition to a low(er) carbon future); and (3) financial risk associated with a failure to address climate change effectively (physical risk associated with adaptation to a high(er) carbon future). Mitigation risk – stranded assets – is the price of success in the fight against global warming. Physical risk is the price of failure.
  • Both risks have the potential to be huge. However, there remains significant uncertainty regarding: (1) the precise manner in which these risks may materialize; (2) the likely transition or adaptation outcomes; and (3) the valuation of the possible losses (and, for some assets, gains) that could be involved.
  • We don’t’ consider it likely that climate risks will be treated by corporates as a separate risk class. Instead it is likely to be treated as a threat amplifier to existing risks. Climate science can help us get a better understanding of the evolving distributions of climate risks and their expression in weather-related disasters.