A risk universe is a handy checklist of the types of risks your organisation may encounter, and you can use it as a completeness check when performing a risk assessment of a process or of a project. It does not define the specific risks your organisation will face, but it gives pointers to help you identify them.
This week, Sarah Breeden of the Bank of England highlighted in a speech the publication of guidance from the Climate Financial Risk Forum, also published this week.
The guidance concerns climate-related financial risks and is aimed at financial services organisations, but reporting requirements are expected to extend eventually to all PLCs.
First of all, is climate risk a separate risk category in your risk universe, or is it intrinsic to all your risk categories? If it is separate, you need to define it separately and then link it to all the relevant risk categories. You also need to develop a climate risk policy and appetite. If not separate, then you need to define how, say, credit risk for example is affected by climate change and adjust the policies and appetites to take account of it.
The Climate Financial Risk Forum Guide provides the following example for mortgage lenders: “it will be important for them to assess the flood vulnerability of the properties on which they have lent mortgages. Not only will location data be important, but also the availability of insurance. At what point might insurance become unavailable? What might happen to house prices in these scenarios? How might this impact on loss given default if the customer cannot repay their loan? If borrowers suffer from negative equity, what might happen to local consumption patterns?”. These are risks that should be highlighted and also disclosed, along with the various assumptions.
Not only is it a question of physical (e.g. extreme weather) and transition (e.g. regulation and consumer opinion) risks, it also depends on the pathways – how the world reacts. Does it take action now and keep warming down to 2°C, or does it continue, as now, toward 4-4.5°C – the outcomes and the risks to individual organisations are very, very different.
For chronic risks (such as rising average temperatures, impacts on crops and sea-levels, etc) the effects are long-term, but those effects are determined by actions taken today – this is the tragedy of the horizon – and so your appetite measures need to be measures that are applied right now, but which are worked backwards from longer-term potential outcomes.
I would be interested to know how your organisations are currently addressing these risks, and if you care to share (to firstname.lastname@example.org), I will produce an overall anonymised summary and include it in a future post about the opportunities around these risks.
Data Sources: Speech by Sarah Breeden, Bank of England, 1 July 2020; Climate Financial Risk Forum Guide 2020