For decades, that climate risk is financial risk has been at the center of our work with the world’s largest banks and investors. Finally, in the last few years, we’ve seen banks and regulators around the world not only acknowledge that fact, but also recognize that climate risk is a systemic risk. During the past two years, U.S. financial regulators began integrating climate risk into the practices and policies that govern capital markets in order to reduce the worst financial impacts of the climate crisis. And seven of the top 10 banks in the U.S. have committed to aligning their lending and investment portfolios with net zero emissions by 2050 or sooner.
While the details of these findings get quite technical, many of the resulting recommendations build on those of Ceres’ previous reports and provide further impetus for banks to take actions that investors and regulators are already asking for. Banks should:
Analyze and disclose the contributions of their derivatives portfolios to their overall climate risk and opportunity.
Update default probabilities in Credit Valuation Adjustment (CVA) calculations to include climate risk factors.
Proactively advocate for smart financial regulations and policy actions in support of enhanced climate risk management of their derivatives activities.
Continue to engage with their borrowers to help them develop transition plans and start including derivatives activity in these engagement initiatives over time.
Account for derivative transactions as additional sources of financed emissions and include these in their disclosure of firm-wide total financed emissions.
Update their 2030 targets (and 2050 commitment if necessary) to include derivatives.
We hope that the findings of this report will spur banks to conduct further internal analysis to understand how their derivatives portfolios fit into their net zero plans. While this is complex work and may not proceed quickly, it should start as soon as banks finalize their initial transition plans for commercial lending, a milestone the leading U.S. banks should reach in 2023 or 2024. We are releasing this report now to spur banks to consider the climate impact of derivatives, so that they can be ready to act on them once the lending book risk is well understood. The report can also provide a basis for investors and regulators to ask banks questions about how this critical and understudied asset class could affect climate risk, enterprise value, and the stability of the financial system more broadly.