Five climate change issues for operational risk scenario analysis

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For operational risk teams, climate change is starting to present a range of new challenges. Firms should consider using scenario analysis to identify ways in which related emerging risks could impact their firm.

Climate change – a hot topic in the media – is now becoming an important area for operational risk managers to pay attention to. Scientific studies are now pointing to a range of impacts that climate change will have on the planet, including rising temperatures. In response, action is starting to be taken to reduce emissions to reverse the temperature rises, and to prepare for potential side effects such as rising sea levels. As a result, the ground is starting to shift quickly in the financial services industry as new risks emerge, so firms need to start focusing on understanding risks related to:

  • Physical infrastructure – The UK, as an island, is particularly vulnerable to extreme weather such as storms, which can batter coastal communities and result in flooding. However, London is particularly susceptible to the impact of climate change, with one recent report from C40 Cities saying that “Climate impacts put assets worth £200bn at risk, as well as 1.25 million people living along the Thames river in London and surrounding areas” by 2050. This is because London is located in a “low-elevation coastal zone” and faces the threat of flooding in three different ways – of tidal flooding from the North Sea, fluvial flooding from the Thames and the river’s tributaries and surface water flooding as a result of heavy rainfall. There is a growing body of good research into the impact of climate change on physical infrastructure. Operational risk managers should explore this material for insights into how the changing climate could impact office buildings, bank branches, data centres, call centres, and critical third parties, for example. Organizations may want to make strategic decisions about physical facilities based on the potential for flooding, for example, or update their business continuity plans.
  • New climate-related technologies – Financial services firms are starting to implement new climate change-friendly technologies, from more energy-efficient lighting to data centres with solar panels on the roof. Innovative technologies are being made available every day, and the pace of adoption of these new approaches looks set to accelerate as a result of social, political and economic forces. These technologies are an important part of the battle against climate change, but like all new technologies, they bring their own risks. Operational risk managers should make sure they are aware of how these new technologies are being adopted in the organization, and consider how they might interact with the firm’s risk profile.
  • Regulatory and compliance – In financial services, climate change is going to drive regulatory change, including a range of new compliance demands. For example, the FCA is finalizing rule changes requiring Independent Governance Committees (IGCs) to oversee and report on firms’ environmental, social and governance (ESG) and stewardship policies. As well, the regulator is “clarifying its expectations around consumers’ access to green financial products and services and taking appropriate action to prevent consumers being misled.” For op risk teams, these moves should prompt engagement around governance risks as well as compliance risk within the new product approval process. Regulatory change will most likely accelerate – operational risk teams should consider how ready compliance processes are to adapt to new rules as they emerge.
  • Reporting – Regulatory reporting and reporting to investors are already beginning to evolve. The Financial Stability Board’s (FSB’s) Task Force on Climate-Related Financial Disclosures released recommendations for climate change reporting in June 2017 and the approach has been adopted by a range of banks and other financial firms. JP Morgan and others are already producing climate change financial reports that include information on governance, strategy, risk management, and metrics and targets.  The industry can expect this type of reporting to become more extensive and detailed over time – for example, the FCA has announced plans to consult on climate change reporting over the next few months.
  • Reputation and brand – Perhaps the biggest concern that operational risk managers should have in this rapidly-evolving space at the moment is risks to reputation and brand. There is considerable attention from pressure groups, consumers, and the media on the climate change issue, and firms can risk finding themselves in difficulty seemingly overnight. It’s important for firms to be proactive here by communicating good news regularly and being prepared with a communications plan in the event of a bad news cycle striking.

In summary, climate change is starting to have an impact on the operational risk profile of organizations. Emerging risks are already coming to the fore – and others will evolve. To be better prepared, operational risk teams should consider using operational risk software to conduct scenario analysis exercises, which could help firms identify ways in which they may be impacted, and suggest ways in which risks could potentially be mitigated.

Learn how risk management software could help with climate change scenario exercises, or speak to us about your organization’s  scenario analysis training needs.

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