Climate risks may impact financial market infrastructures: study

CLIMATE change may pose some risks to the stability of financial ecosystems, particularly financial market infrastructures (FMIs), according to a white paper released by the Depository Trust & Clearing Corporation (DTCC) on Thursday (Feb 2).

The post-trade financial company posited that FMIs may be impacted by both climate-related physical risks and transition risks, which have the potential to result in economic costs or financial losses.

Physical risks include acute extreme weather events, as well as longer-term gradual climate shifts. These can impact financial institutions: real-estate valuations can drop suddenly as a result of floods or wildfires; they can also decline more gradually through chronic risks.

The DTCC said that while FMIs’ existing business-continuity programmes are sufficiently robust to withstand the impact of extreme weather events, they should be bolstered to prepare for potentially more frequent and damaging climate-related events in the future.

Business disruptions, a weakened ability to repay bank loans, as well as increased loan default rates and credit risk can also impact financial institutions through a drop in profit.

Meanwhile, transition risks include changes in policies, technology or market preference or public sentiments which may emerge in the process of adjusting towards a low-carbon economy. The DTCC said that such events could be disruptive, unpredictable or disorderly. 

Carbon-intensive “brown” companies, such as those in the oil and gas or coal industries, would be more exposed to transition risks compared to green companies. Energy-transition policies, technological innovations, and shifts in consumer preference in favour of less carbon-intensive assets could also decrease market demand for brown companies.

The DTCC recommended that FMIs apply existing regulatory frameworks and standards, to mitigate climate-related financial risk challenges. It specifically pointed to the Principles for Financial Market Infrastructures, issued by the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions.

While it acknowledged green bonds’ significant role in contributing to funding needed to address climate change challenges, the DTCC said these instruments should not be given preferential treatment if used for collateral purposes, or when it comes to risk management. 

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“To do so, in our opinion, would be to prioritise environmental considerations above the core mandate of FMIs of ensuring a resilient post-trade infrastructure for the securities industry,” said the company’s chief systemic-risk officer Michael Leibrock. 

The DTCC said that regulators and policymaker should “continue working on standardising robust disclosure requirements across the financial services industry”, to support FMIs in conducting “meaningful assessments of their clearing members’ climate-related financial exposures, and internal risk controls”.