Climate Risk Assessment: A New Essential Skill for FRM Professionals

In this blog, we are discussing how climate risk is a potential threat and how the role of the FRMs can bring a positive change in the climate, leading to the upliftment of the organization. 

Introduction to Climate Risk and Its Growing Importance

Climate risk includes the potential threat the climate holds towards the organization, economies, and societies about physical or transitional risks. The growing environmental threats have led business owners and top companies to regulate their principles and ensure that each action complies with the environmental conditions, rendering the least negative impact on the climate. Therefore, a need of FRM  is extremely needed to keep check that the organizational activities comply with the upcoming and changing environmental standards and policies. With time, climate risks are becoming more pertinent and require stricter control of energy consumption. 

Climate risk and managing the risk is extremely important for any organization to ensure that the organizational operations do not lead to health risks and accidents. Apart from the physical hindrance, climate risks also pertain to trillions of dollars of economic activity and physical capital, and the world’s stock of natural capital. Climate risks are potentially important in managing the impact on the performance and stability of the investments. 

What is Climate Risk and Why Does it Matter for FRM Professionals?

Climate risk refers to the potential financial, operational, and strategic threats that might hurt the environment and climate–both physical and traditional. These climate risks can also lead to a negative influence on organizations, sectors, economies, and industries. This is where you need an FRM professional, but before that, you need to have a complete idea of What Is FRM? 

FRM stands for Financial Risk  Management. An FRM  professional is responsible for looking after the organizational activities and ensuring that those activities comply with the environmental standard policies. The primary lookout of an FRM  is to focus on the long-term sustainability and resilience of an organization, minimizing the possible physical and transitional risks. An FRM professional navigates an organization through the possible upcoming climate change that might pose a threat. As a qualified FRM  professional, the professional must know about the complexities of climate change and its international environmental policies and standards. 

The Rise of Environmental, Social, and Governance (ESG) Concerns in Finance

Over the years, the environmental, social, and governance factors have gained huge significance in the financial sectors. This slow but steady shift has taken place because organizations are growing more conscious of the fact that how their business operations will affect the environment and society and how organizations are being governed. ESG principles and policies impact the decision-making process of the organization that includes, including investments, risk management, and corporate practices. ESG practices can have a significant influence on the financial performance of the organization. 

Why ESG  Concerns Are Rising In Finance 

• Regulatory Pressure: One of the major reasons for the growth of ESG  in Finance is that there is a huge regulatory pressure to abide by the environmental standard policies that are being followed on an international platform. For instance, the European Union has enacted the Sustainable Finance Disclosure Regulation (SFDR), requiring financial institutions to disclose how they integrate ESG factors into their investment processes.

• Mitigation of Risks: Often, an organization overlooks possible risks which leads to a negative impact on itself in terms of liabilities, investments, and assets. Some organizations often fail to meet the standard policies of environmental regulations and fail to mitigate those risks, as well. For instance, a poor managerial decision may lead to health issues for an employer, loss of assets, fines, and other negative influences. 
• Consumer expectations: Consumers are more aware and conscious about the products and services that they buy. Most consumers tend to ensure that the product they are buying meets standard environmental policies. Therefore, those companies that ignore ESG might lose a lot of consumer base. Companies should abide by sustainability practices and principles to get stronger customer loyalty. 

Impact of ESG on Financial Risk Management 

The scope of Financial Risk Management has changed a lot after the advent of the ESG in the Finance. Traditionally, an FRM  professional would like into the financial matter of the organization. However, after the inclusion of the ESG, the FRM  professionals also look after the environmental, social, and governance factors that might affect the organization. 

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Understanding Climate Risk Assessment in the FRM Framework

Climate Risk Assessment in the FRM  Framework is a stable system for the identification of potential climate risks in finance. It is a globally recognized system under the ISO 31-000 standard of risk management. The framework operates on the identification of the threats and then analysing the impact of those threats on the investment portfolios of an organisation. 

The Basics of Climate Risk Assessment

The Basics of Climate Risk Management includes the following: 

• Identification of the risks 
• Conducting an assessment of the identified risks, their types, and their impact on the organization 
• Culminate data is the basis of the assessment and take initiatives to mitigate those risks. 
• Decision-making process and implementation strategies
• Lastly, assessment of the impacts held by the implemented strategies. 

How FRM Professionals Can Integrate Climate Risk into Their Analysis

Integration of the climate risk is growing to be more and more important in the scope of FRM. The deterioration of the climate can lead to significant financial and economic implications. The role of FRM is to understand the possible physical threats such as earthquakes and floods and protect the organization’s assets, accordingly. An FRM professional should also be mentoring the fact that the organization must shift to low-carbon emission policies. 

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Key Components of Climate Risk Assessment for FRM Professionals

• Risk management analysis 
• Climate risk disclosure 
• Transition risk 
• Physical risks 
• Liability risks 
• Climate-infused governance

Identifying Physical and Transition Risks in Climate Assessments

In simpler terms, the physical risks are the direct risks that come from the environment or climate change, such as floods, earthquakes, fires, etc. On the other hand, the transition risks are those risks that are caused as a result of human activities. 

Physical Risks: Floods, earthquakes, wildfires, changing precipitation range, sea-level rise, etc. These risks can lead to physical damage to an organization like damage to assets and loss of livelihood. 

Transition Risks: Change in laws, policies, and international standards. New technology taking over the old ones.  Change in people’s beliefs and preferences. Market share losses, etc. 

How to Quantify Climate Risk in Financial Terms

Climate risk can be quantified or put in numbers by the financial model known as Climate Value-at-Risk (Climate VaR). Through these models, one can understand how the climate risks and threats can be a potential damage to investment portfolios. 

Climate Risk Assessment Tools and Methodologies

Climate Value-at-Risk (Climate VaR)

A quantitative model that assesses climate-related risks and opportunities in an investment portfolio 

Climate Risk Scores (CRS)

Reflect the impact of climate change on different hazards, such as river and flash floods, and storm surges. 

Global Climate Risk Index (CRI)

Provides information on the impacts of declines in climate regulation services on human well-being

Popular Tools for Climate Risk Analysis in the FRM Field

Some popular tools that are used in risk analysis in the FRM  field are the following: 

• EcoAct Climate Risk Tool (ECLR)
• Climate Assessment for Financial Institutions (CAFI)
• Climate Risk Toolbox (CRTB)
• Aware
• Climate Value-at-Risk (Climate VaR)

Strategies for Effective Climate Risk Mitigation in Finance

The first step in the mitigation of any risk is its identification. To mitigate the risks, the potential risk needs to be identified. After the risks are identified, they need to be managed to incur the least possible threat to the organization. 

• Identification of the risks that can be a pertinent threat to the organization’s health, finances, or investments. 
• Incorporate those identified risks into traditional risk mitigation frameworks. 
• Once the risks are identified, the organization should understand how to navigate through those risks and adapt to the low-carbon economy. 
• Continuous reviewing and monitoring of the upcoming possible threats to the organization 
• Create risk management models and frameworks that help in the mitigation of the current risks and also upcoming risks, as well. 
• Communicate the potential risks and mitigation strategies with the stakeholders.   

How FRM Certification Can Prepare Professionals for Climate Risk Challenges

The Financial Risk Manager (FRM) certification from the Global Association of Risk Professionals (GARP) can help a professional to identify, analyse, and mitigate the possible threats possessed to the organization. The FRM Programme helps in creating adaptable frameworks and design tools that help in the mitigation of the risks that are about the organization. FRM professionals have a skilful knowledge of risk management concepts like market risks, credit risks, and operational risks. 

Incorporating Climate Risk Topics into the FRM Curriculum

The FRM Curriculum strengthens its focus on the varied aspects of risk management. The spectrum of FRM syllabus highlights risk modelling through quantitative methods and valuation, advanced risk management, operational risk, and credit risk. However, along with these risk analyses, the need for incorporating the climate risk is also very significant. Scenario-based tools and techniques need to be incorporated into the FRM  curriculum to ensure that the pertaining threats in the environment can render the least harmful impact on the organisation. 

Financial Institutions Addressing Climate Risk

Financial institutions can be able to address climate risks by including climate-change elements in their operational decisions, risk management, and product offerings. 

Conclusion: The Future of Climate Risk Assessment in the FRM Profession

In conclusion, it could be stated that climate risk assessment in the FRM  field will continue to evolve in the future. With the continuous threats increasing in the climate due to pollution, the need for climate risk assessment would become irreplaceable. In the future, the FRM professionals will have to adapt to various strategic tools and framework to reduce the carbon effect on the environment. 

FAQs on Climate Risk Assessment

Is a SCR certificate worth it?

Yes. For anyone willing to enhance their skill set in sustainability, this certification is very helpful. 

What is climate risk in finance?

Climate risk in finance refers to the potential shift in climate and environment that might hamper the financial investments of an organization. 

What is a climate-related financial risk report?

A climate-related financial risk report is a document that informs the public about how an organization identifies, assesses, and manages climate-related risk.

What is the standard for climate risk assessment?

ISO 14091:2021 is the standard for climate risk assessment. 

Anant Bengani, brings expertise as a Chartered Accountant and a leading figure in finance and accounting education. He’s dedicated to empowering learners with the finest financial knowledge and skills.