Climate Risk Modeling: Scenario analysis

Speech setting regulatory expectations regarding efforts to build, iterate, and enhance climate risk modeling

Amy S. Matsuo

Amy S. Matsuo

Regulatory and ESG Insights Leader, KPMG US

+1 919-664-7100

In a recent speech, Federal Reserve Board Governor Lael Brainard helped to set regulatory expectations regarding efforts to build, iterate, and enhance climate risk modeling. In particular, she stated the FRB:

  • Is developing scenario analysis to model the possible financial risks associated with climate change and assess the resilience of individual financial institutions and the financial system to these risks
  • Anticipates providing supervisory guidance to large financial institutions for measuring, monitoring, and managing material climate-related risks
  • Suggests transition risk could be modeled in much the same way as economic modeling of policy changes
  • Expects “consistent, comparable, and, ultimately, mandatory disclosures … to enable market participants to measure, monitor, and manage climate risks on a consistent basis across firms.”

Governor Brainard described scenario analysis as “a useful tool in assessing the links between climate-related risks and economic outcomes because it requires assessing the implications for financial stability and individual financial institutions in a systematic way.” Drawing parallels with early efforts to develop bank stress tests, which were intended to “provide a more systematic way to assess the effects of complex and interrelated exposures within the financial system,” she suggested the first generation of climate scenario analysis might be “rudimentary” but would help to identify risks and potential issues and inform subsequent modeling, data, and disclosure.

The FRB acknowledged some challenges, including:

  • Hard-to-predict policy, technology, and behavioral changes
  • Current and significant data gaps that are further complicated by inconsistencies and incompleteness in reporting disclosures/requirements.

Earlier this year, the Administration issued an Executive Order on Climate-Related Financial Risk that directed the federal financial agencies to develop, and execute on, a strategy to quantify, disclose, and mitigate the financial risk of climate change on both public and private assets. (See KPMG Regulatory Alert here.) A new Executive Order (issued October 12, 2021) is intended to make more climate information publicly available, which may expand data for climate-related modeling and research.

FRB Governor Brainard’s speech is available here.

KPMG Regulatory Insights Regulatory Alert covering the Executive Order on Climate-Related Financial Risk is available here.

Watch for more climate-related thought leadership in advance of the United Nation’s Climate Change Conference of the Parties (COP26), scheduled for October 31 through November 12, 2021.

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