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Understanding principles for managing climate-related financial risk

Jennifer C. Monaghan
12/19/2023
Principles for managing climate-related financial risk

Newly released, voluntary principles can help large financial services organizations identify and mitigate climate-related financial risks and be seen as leaders in sustainable finance.

Climate-related changes have the potential to affect the safety and soundness of financial services organizations, which is why the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., and the Board of Governors of the Federal Reserve System jointly issued the final principles for climate-related financial risk management for large financial services organizations in October 2023.

The principles are a set of nonmandatory guidelines intended to provide a framework that can help large financial services organizations identify, assess, and manage climate-related financial risks, which can include both physical risks (such as damage from extreme weather events) and transition risks (such as changes in government policy or consumer behavior). The principles also describe how climate-related financial risks can be addressed in the management of traditional risk areas, including credit, market, liquidity, operational, and legal risks.

While the guidance is intended for large organizations, smaller organizations with material exposure to climate-related risks will also benefit from this framework, which provides a consistent resource to manage climate-related financial risks.

The guidelines define a large financial services organization as having more than $100 billion in total consolidated assets, including foreign banking organizations with combined U.S. operations of greater than $100 billion or any branch or agency of a foreign banking organization that individually has total assets of greater than $100 billion.

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The principles’ 6 areas

  • Governance. The board of directors and senior management should have oversight of climate-related financial risks and make sure that they are integrated into the organization’s overall risk management framework.
  • Policies, procedures, and limits. The organization should have written policies and procedures for identifying, assessing, and managing climate-related financial risks. These policies and procedures should be tailored to the organization's specific risk profile and should include limits on exposure to certain types of climate-related risks.
  • Strategic planning. The organization should consider climate-related financial risks in its strategic planning process. This planning includes identifying opportunities to support customers in transitioning to a low-carbon economy and managing risks to the organization’s own business model.
  • Risk management. The organization should integrate climate-related financial risks into its existing risk management processes. This integration includes identifying and assessing climate-related risks, developing and implementing risk mitigation strategies, and monitoring the effectiveness of those strategies.
  • Data, risk measurement, and reporting. The organization should collect and maintain data on climate-related financial risks. This data should be used to develop and implement risk management strategies and to report on the organization’s climate-related financial risk exposure.
  • Scenario analysis. The organization should conduct a scenario analysis to assess the potential impact of climate-related financial risks on its portfolio. Scenario analysis can help identify and manage risks that might be difficult to quantify using traditional risk measurement methods.

Benefits of following the voluntary principles 

Financial services organizations that follow the voluntary principles can:

  • Better identify, assess, and manage risks, protecting their financial stability and long-term viability. Climate change poses significant financial risks to financial services organizations, including physical risks from extreme weather events and transition risks from policy changes and technological advancements.
  • Demonstrate their proactive approach to managing these risks, maintaining investor confidence, and attracting capital. Investors increasingly scrutinize companies and financial institutions for their exposure to climate-related risks.
  • Potentially stay ahead of the regulatory curve and avoid potential disruption or penalties. As climate change becomes more prominent, governments will likely implement stricter regulations to address climate-related financial risks.
  • Position themselves as leaders in sustainable finance by being proactive in climate-related financial risk management, which can attract new customers and partners who share their commitment to environmental responsibility.

The transparency provided by following these principles promotes accountability and allows stakeholders to assess the organization’s commitment to sustainability because the principles encourage financial services organizations to publicly disclose their climate-related financial risks and their strategies for managing them.

How to implement these principles

  • Establish a robust governance framework by defining clear roles and responsibilities for climate risk management and actively engaging the board of directors and senior management.
  • Identify a dedicated cross-functional team that draws key people from departments such as internal audit, legal and risk compliance, information technology, human resources, operations, and investor relations.
  • Develop climate-related expertise by providing training and education to staff and all levels of management as well as hiring outside specialists in climate risk management.
  • Identify available data, explore how it can be used for climate risk management, and consider how to enhance data collection processes and develop controls over climate-related data.
  • Perform a climate risk assessment of the organization’s exposure to climate-related risks, including physical and transition risk, and identify potential opportunities.
  • Engage with stakeholders, including investors, customers, regulators, and employees, about climate-related issues.

Though the application of these principles will depend on the size, nature, scope, and risk profile of a specific financial services organization, implementing them in some capacity can strengthen resilience to climate change and help contribute to a more sustainable financial system.

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Jennifer Monaghan
Jennifer C. Monaghan
Partner, Audit & Assurance
+1 502 420 4509
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