Climate Risk Management And Scenario Analysis - Exposure Draft
Climate Risk Managementand Scenario AnalysisExposure DraftApplicable to:1. Licensed banks2. Licensed investment banks3. Licensed Islamic banks4. Prescribed development financial institutions5. Licensed insurers, including professional reinsurers6. Licensed takaful operators, including professional retakaful operators7. Financial holding companiesIssued on: 27 December 2021BNM/RH/ED 028-19
This exposure draft sets out the proposed requirements and guidance on climate riskmanagement and scenario analysis. The proposed specific requirements and expectationsare to ensure that financial institutions strengthen the management of financial risksstemming from climate change to enhance the resilience of the financial sector againstclimate-related risks and to facilitate an orderly transition to a low-carbon economy.This exposure draft complements the Climate Change and Principle-based Taxonomy(CCPT), the Value-based Intermediation Financing and Investment Impact AssessmentFramework (VBIAF) and the VBIAF Sectoral Guides.Submission of feedback for the exposure draft –a. The Bank invites written feedback on the proposals in this exposure draft, includingsuggestions for specific issues or areas to be clarified or elaborated further andalternative proposals that the Bank should consider. The responses should beconstructive and supported with clear rationale and appropriate evidence. Whereappropriate, please specify the applicable paragraph and provide examples andillustrations.b. Feedback received may be made public unless confidentiality is specificallyrequested for the whole or part of the submission.c. In addition to providing general feedback, all financial institutions are expected torespond to the specific questions set out throughout this exposure draft.d. Feedback must be submitted electronically by 31 March 2022 and must be in theprescribed format. Please use accompanying excel file.e. Feedback must be submitted by emailing climatechange@bnm.gov.my andaddressed to Encik See Thuan Eu and Encik Nik Faris Nik Sallahuddin.When preparing the feedback, specific queries can be directed to the following officers:1.2.3.4.5.6.7.OfficerKong Ei-JeanSeow Qin Rui (Raymond)Muhamad Shukri Abdul RaniChuah Kue PengLoong Sok SimLodylia ShahrilFong Sook FunIssued on: 27 December 2021AreaGovernance and StrategyRisk ManagementScenario AnalysisMetrics and TargetsDisclosureRelated Matters Specific toInsurance and .mylody@bnm.gov.mysookfun@bnm.gov.my
Climate Risk Management and Scenario AnalysisPage 1 of 48TABLE OF CONTENTSABBREVIATIONS. 2PART A OVERVIEW. 31.Introduction . 32.Applicability . 43.Legal Provisions . 44.Effective Date . 45.Interpretation. 56.Related Legal Instruments and Policy Documents . 5PART B REQUIREMENTS AND GUIDANCE . 67.Level of Application . 68.Governance . 79.Strategy . 910.Risk Appetite. 1111.Risk Management . 1212.Scenario Analysis . 2013.Disclosure . 2414.Implementation Plan . 2615.Supervisory Process . 26PART C APPENDICES. 27PART D GLOSSARY . 45PART E ADDITIONAL RESOURCES . 48Issued on: 27 December 2021
Climate Risk Management and Scenario AnalysisPage 2 of 48ABBREVIATIONSBCBSBasel Committee on Banking SupervisionCAFCapital Adequacy FrameworkCCPTClimate Change and Principle-based TaxonomyCoPVBI Community of PractitionersESGEnvironmental, Social and GovernanceGHGGreenhouse GasIAISInternational Association of Insurance SupervisorsICAAPInternal Capital Adequacy Assessment ProcessIEAInternational Energy AgencyIPCCIntergovernmental Panel on Climate ChangeITOsInsurers and takaful operators, including professional reinsurers andprofessional retakaful operatorsJC3Joint Committee on Climate ChangeNGFSNetwork of Central Banks and Supervisors for Greening the FinancialSystemNDCNationally Determined ContributionsTCFDTask Force on Climate-Related Financial DisclosuresUNEP-FIUnited Nations Environment Programme Finance InitiativeVBIAFValue-based Intermediation Financing and Investment ImpactAssessment FrameworkIssued on: 27 December 2021
Climate Risk Management and Scenario AnalysisPage 3 of 48PART A OVERVIEW1.Introduction1.1Climate change is a complex collective action problem that may create material financialrisks to impact the safety and soundness of financial institutions, giving rise to broaderimplications on the stability of the financial system and sustainable economic growth.1.2In view of the risks that climate change poses for financial stability in the long run, theBank expects financial institutions to respond –(a) urgently 1 , through taking early actions to implement changes towards buildingclimate resilience;(b) strategically, by accounting for how actions today affect future outcomes under arange of scenarios and time horizons over the long term;(c) comprehensively, when strengthening the risk management frameworks toaddress these financial risks from climate change (hereinafter climate-relatedrisks). In particular, financial institutions are to manage these risks by recognisingthe distinctive 2 elements of climate-related risks: far-reaching in breadth andmagnitude, foreseeable but highly complex due to uncertainty, nonlinearity,irreversibility and dependency on short-term actions; and(d) holistically, through greater collaboration across a wider spectrum of stakeholders3when managing the systemic impact of climate-related risks. Financial institutionsstand to gain from greater collective coordination and harmonisation, notablythrough industry-wide platforms4, including that facilitated by the Joint Committeeon Climate Change (JC3) and VBI Community of Practitioners.1.3Recognising the characteristics of climate-related risks, this policy document sets out theprinciples and specific requirements on the management of climate-related risks byfinancial institutions, with the aim to enhance the resilience of the financial sector againstclimate-related risks. The principles are tabulated in Appendix 1.1.4The Bank expects financial institutions to have an effective risk management frameworkthat integrates all material risks, which extends to climate-related risks, including theinteractions with other risk types. In this regard, the specific requirements in relation toclimate-related risks complement the Bank’s existing requirements for financialinstitutions to manage material risks and provide further insights on the consideration ofclimate-related risks as an integral part of financial institutions’ governance, riskmanagement, ICAAP, stress testing and disclosure practices.1.5Financial institutions also play a pivotal role in driving an orderly transition towards a lowcarbon economy. This in turn contributes to longer-term climate resilience of financialinstitutions and the financial sector. During the transition process, the Bank expectsfinancial institutions to have due regard to actions that they should take to –(a) mitigate risks surrounding economic dislocation that may arise from the abruptwithdrawal of financing from economic sectors or activities that are vulnerable toclimate-related risks, which may have potential adverse feedback loops to thewider economy and financial stability;1In view of the intensifying pace of climate change that is markedly narrowing the finite window for limiting globalwarming (IPCC).2 For additional information, refer to CCPT as well as the reference list in Part E of this policy document.3 A diverse set of global and domestic stakeholders including households, firms, governments, regulators, thefinancial sector, civil society, investors, multilateral institutions, standard-setting bodies, industry associations andscientific communities.4 Industry-wide platforms can foster sharing of information and a range of practices, collecting data and developingcommon models. An example is the CCPT Implementation Group.Issued on: 27 December 2021
Climate Risk Management and Scenario Analysis(b)(c)(d)Page 4 of 48support transition5 by customers towards more sustainable practices;expand the financing of climate-related opportunities and sustainable economicactivities, including offering new solutions, markets and products to support a lowcarbon economy; andbetter align business strategies and climate-related targets in supporting globaland national commitments6 to address climate change.2.Applicability2.1This policy document is applicable to financial institutions as defined in paragraph 5.2.3.Legal Provisions3.1This policy document is issued pursuant to –(a) sections 47, 143 and 266 of the Financial Services Act 2013 (FSA);(b) sections 57, 155 and 277 of the Islamic Financial Services Act 2013 (IFSA); and(c) sections 41, 116 and 126 of the Development Financial Institutions Act 2002(DFIA).4.Effective Date4.1This policy document comes into effect on 1 June 2022 subject to the followingtransitional specifications:(a) paragraphs 7, 8, 9, 10 and 11, with respect to governance, strategy, risk appetiteand risk management shall come into effect on 31 December 2023; and(b) paragraphs 9, 10, 11, 12 and 13, with respect to scenario analysis, metrics andtargets and disclosure shall come into effect on 31 December 2024.Question ED-1Would your institution face any specific challenges to comply with the effective dates inparagraph 4.1? Please indicate a reasonable timeline and elaborate on the specificchallenges as well as provide suggestions that could be considered for your institution tocomply with the requirements. Please indicate any additional aspects that the Bank shouldconsider when setting transitional arrangements.Additional questions for Development Financial Institutions (DFIs)Question ED-DFIs-1Are there specific challenges in meeting requirements of certain paragraphs of this policydocument (e.g., climate-related risks impact on ability to discharge mandate, challenges indeveloping strategies to integrate climate-related factors into business operations such asproduct design, staff performance and customer onboarding)? If yes, please provide moreinformation on the challenges and corresponding mitigation measures, as well as thetransition strategy, including a proposed transition period.5 Inthe CCPT, classification of Categories ‘C2’ and ‘C3’ represent progressive stages of transitioning as customerstake remedial measures under Guiding Principle 4 (GP4) to transition towards a low-carbon and climate-resilienteconomy by adopting sustainable practices. These remedial efforts should contribute towards the outcomes inwhich unacceptable risks to the climate and/or environment can be eliminated or significantly reduced.6 For example, the Paris Agreement and the 12th Malaysia Plan.Issued on: 27 December 2021
Climate Risk Management and Scenario AnalysisPage 5 of 485.Interpretation5.1The terms and expressions used in this policy document shall have the same meaningsassigned to them in the FSA, IFSA or DFIA, as the case may be, unless otherwisedefined in this policy document.5.2For the purposes of this policy document –“S” denotes a standard, an obligation, a requirement, specification, direction, conditionand any interpretative, supplemental and transitional provisions that must be compliedwith. Non-compliance may result in enforcement action;“G” denotes guidance which may consist of statements or information intended topromote common understanding and advice or recommendations that are encouragedto be adopted;“financial institution” refers to –(a) a licensed bank, a licensed investment bank and a licensed insurer, including alicensed professional reinsurer under the FSA;(b) a licensed Islamic bank and a licensed takaful operator, including a licensedprofessional retakaful operator under the IFSA;(c) a prescribed development financial institution under the DFIA; and(d) a financial holding company approved under the FSA and IFSA.“climate-related risks” refers to financial risks from climate change, which includesphysical, transition and liability risks;“board” refers to the board of directors of a financial institution; and“senior management” refers to the chief executive officer (CEO) and senior officers ofa financial institution.5.3The glossary set out in Part D describes selected terms used in this policy document andthe reference list set out in Part E provides additional resources for financial institutions.6.Related Legal Instruments and Policy Documents6.1This policy document must be read together with other relevant legal instruments, policydocuments and guidelines that have been issued by the Bank, in particular –(a) Climate Change and Principle-based Taxonomy (CCPT);(b) Value-based Intermediation Financing and Investment Impact AssessmentFramework (VBIAF);(c) Corporate Governance;(d) Risk Governance;(e) Risk-Weighted CAF (Basel II) – ICAAP (Pillar 2);(f)CAF for Islamic Banks – ICAAP (Pillar 2);(g) Guidelines on ICAAP for Insurers;(h) ICAAP for Takaful Operators;(i)Risk-Weighted CAF (Basel II) – Disclosure Requirements (Pillar 3);(j)CAF for Islamic Banks – Disclosure Requirements (Pillar 3);(k) Stress Testing;(l)Credit Risk;(m) Operational Risk;(n) Liquidity Coverage Ratio;(o) Net Stable Funding Ratio;(p) Outsourcing; and(q) Guidelines on Business Continuity Management.Issued on: 27 December 2021
Climate Risk Management and Scenario AnalysisPage 6 of 48PART B REQUIREMENTS AND GUIDANCE7.Level of ApplicationS7.1Financial institutions (excluding financial holding companies) shall comply with therequirements in this policy document at the following levels:(a) entity level, which refers to the global operations of the financial institutions,including overseas branch operations; and(b) consolidated level, which includes all financial and non-financial subsidiaries.S7.2Financial holding companies shall comply with the requirements in this policy documenton a consolidated level basis.G7.3For the purpose of paragraph 7.1, locally incorporated foreign financial institutions andbranches of foreign financial institutions operating in Malaysia may leverage their groupor parent company’s climate-related policies and procedures to meet the requirementsof this policy document.S7.4For branches of foreign financial institutions operating in Malaysia, the requirements inthis policy document shall apply to the Malaysian operations of the branch with thefollowing modification:(a) any reference to the board in this policy document shall refer to the governing bodyof the branch of the foreign financial institution operating in Malaysia or any of itscommittees; and(b) any reference to senior management in this policy document shall include areference to the CEO of the branch and officers performing a senior managementfunction in respect of the branch operations.Question LA-1Please highlight areas in this policy document that may depart significantly from theregulations of –(a) home regulators or supervisors (for locally incorporated financial institutions andbranches of foreign financial institutions operating in Malaysia); or(b) host regulators or supervisors (for financial institution’s subsidiaries or branches inforeign jurisdictions).Issued on: 27 December 2021
Climate Risk Management and Scenario Analysis8.Page 7 of 48GovernanceSPrinciple 1: The board and senior management shall exercise effective oversight ofclimate-related risks to safeguard the financial institution’s resilience against the adverseimpacts of climate change. Financial institutions shall clearly identify the relevantresponsibilities for managing climate-related risks and assign these responsibilitiesthroughout the organisation structure. Financial institutions shall manage climaterelated risks proportionate to the materiality of climate-related risks, taking intoconsideration the size, nature and complexity of the financial institution’s businessmodel.S8.1The board shall have the overall responsibility and accountability to safeguard thefinancial institution’s resilience against the adverse impacts of climate change. In fulfillingthis role, the board shall evaluate the risks and opportunities arising from climate changeon a periodic basis and consider these risks and opportunities in assessing andapproving the financial institution’s strategies and business plan.S8.2The board shall clearly assign roles and responsibilities for the management of climaterelated risks to senior management and address interactions with existing governancearrangements to ensure an integrated view of risks. The board shall designate a seniormanagement officer to oversee the effective management of climate-related risks. Forexample, the board may appoint a chief sustainability officer (CSO) or expand the currentresponsibilities of an existing senior management officer for this purpose.G8.3A large financial institution 7 is encouraged to appoint a dedicated CSO to providenecessary focus on the management of climate-related risks, in view of the inherentcomplexity and scale of operations of large financial institutions.S8.4The senior management of a financial institution shall implement policies and proceduresto build and support climate resilience and shall be responsible for the day-to-daymanagement of climate-related risks and opportunities.S8.5The senior management shall review the effectiveness of the financial institution’sorganisational structure and appropriately define the roles and responsibilities of keybusiness and risk functions in supporting the financial institution’s strategies to buildclimate resilience and manage climate-related risks. For example, as part of the processof integrating climate risk considerations in the management of material risks, financialinstitutions may consider establishing dedicated committees or sub-committees in theearly stages to ensure sufficient consideration and oversight are given to themanagement of climate-related risks and opportunities.SPrinciple 2: The board and senior management shall ensure that they have a soundunderstanding of climate-related risks to inform the financial institution’s business andrisk management strategies.S8.67The board shall actively discuss and remain up to date on climate-related developments.This includes developing a clear understanding of the distinctive elements andtransmission channels of climate-related risks.Large financial institution means –(a) a financial institution with one or more business lines that are significant in terms of market share in therelevant industry; or(b) a financial institution with a large network of offices within or outside the country through operations ofbranches and subsidiaries.Issued on: 27 December 2021
Climate Risk Management and Scenario AnalysisPage 8 of 48S8.7Senior management shall provide regular and timely updates to the board with materialinformation on climate-related risks and opportunities to facilitate the board in carryingout its oversight activities.S8.8Financial institutions shall strengthen their capabilities in managing climate-related risksand implementing the strategies to build climate resilience. This is supported byappropriate capacity building and training plans for the board, senior management andall relevant staff.SPrinciple 3: Financial institutions shall embed climate-related risks into their internalcontrol frameworks across the three lines of defence to ensure the robust managementof material climate-related risks.S8.9Financial institutions shall ensure that the roles, responsibilities and accountabilities inmanaging climate-related risks shall be clearly allocated across the three lines ofdefence. Appendix 2 describes the examples on incorporating climate-related risksacross the three lines of defence.The rest of this page has been intentionally left blank.Issued on: 27 December 2021
Climate Risk Management and Scenario Analysis9.Page 9 of 48StrategySPrinciple 4: Financial institutions shall incorporate the potential impact of materialclimate-related risks into their business strategies to strengthen resilience againstclimate-related risks and support orderly transitions.S9.1Financial institutions shall appropriately identify and assess the potential impact ofclimate-related risks and opportunities when developing the business strategies in orderto make informed forward-looking decisions when navigating structural changes in thebusiness environment during the transition towards a low-carbon economy.S9.2In addressing climate resilience over the long term, financial institutions shall usescenario analysis to assess the impact of climate-related factors on the businessstrategies under a range of time horizons and plausible climate pathways. The scenarioanalysis is useful in the context of climate-related risks given the uncertainty andcomplexity associated with the future outcomes of climate change and challenges to thefinancial sector that have not yet materialised. Paragraph 12 provides details on theexpectations for financial institutions when using scenario analysis.G9.3Given the uncertainty surrounding the timing of the impact of climate-related risks andthe dependency on short-term actions, a strategic and prudent approach is for financialinstitutions to embed relevant time horizons in relation to the requirements in this policydocument, where appropriate. Financial institutions may consider the following timehorizons:(a) short-term horizon (1 to 3 years) to capture impacts over the ordinary businessplan horizon; and(b) medium-term horizon (4 to 10 years) and long-term horizon (beyond 10 years andreaching at least 30 years) to provide insights on impacts from the evolution anddirection of climate-related risks as they materialise over time.S9.4To ensure alignment in the consideration of climate-related risks within financialinstitutions’ business strategies, financial institutions shall identify and monitorappropriate internal climate-related targets8. Financial institutions’ progress against itsclimate-related targets serves to inform and validate the financial institution’s assessmentof climate-related risks.G9.5Climate-related targets are important to steer financial institutions into taking earlyactions in managing transition risks, including proactive and continuous efforts to managethe risk of economic dislocation. This may include developing transition strategies forcustomers over the long term, including the use of scenario analysis to assess thepathways of future emissions that would be financed by financial institutions.G9.6For example, as the transition towards a low-carbon economy impacts structural changessurrounding the business environment, a forward-looking financial institution wouldconsider how climate-related factors would impact the strategies of key business linesand portfolios, including the products and services it is currently offering or planning tooffer and develop appropriate climate-related targets and action plans to manage therelevant risks. Significant deviations from the targets would prompt a review of theassumptions underpinning a financial institution’s assessment of climate-related risks.See Appendix 3 for an illustrative example of setting climate-related targets.8A climate-related target refers to a specific level or metric such as temperature limits or reduction in GHGemissions to avoid dangerous interference with the climate system and achieve climate-related goals andstrategies of the financial institution. For example, financial institutions can target to reduce emissions of ownoperations and financed emissions to achieve net-zero emissions by 2050.Issued on: 27 December 2021
Climate Risk Management and Scenario AnalysisPage 10 of 48S9.7Financial institutions shall clearly communicate and cascade the strategy and internalclimate-related targets within the financial institution. This is important to promoteeffective understanding and coordination with appropriate levels of accountability andoversight across functions.S9.8Financial institutions must review its business strategy in a timely manner to take intoaccount material developments in its management of climate-related risks. For example,realised impacts of climate-related risks or controversies that give rise to reputational riskmay warrant a change in the long-term strategy of the financial institution. This is toensure that business strategies are responsive and resilient to the evolvingdevelopments of climate change and also commensurate with the financial institution’sinternal progressive understanding of and capability in managing the impact of climatechange.The rest of this page has been intentionally left blank.Issued on: 27 December 2021
Climate Risk Management and Scenario Analysis10.Page 11 of 48Risk AppetiteSPrinciple 5: Financial institutions shall embed climate-related risks into the risk appetiteframework, including the potential long-term impact of these risks as drivers of existingtypes of material risks. Financial institutions shall reflect these material risks in theinternal capital adequacy assessment process.S10.1Financial institutions shall manage climate-related risks in line with the risk appetiteapproved by the board.S10.2Financial institutions shall clearly address climate-related risks within the risk appetitestatement (RAS). When using the RAS to guide the implementation of ICAAP, financialinstitutions shall consider material climate-related risks when assessing the internalcapital adequacy over relevant time horizons.S10.3To support and monitor the RAS, financial institutions shall develop appropriate riskmetrics to manage climate-related risks, including risk limits and thresholds formanagement action.G10.4For example, the assessment of climate metrics such as GHG emissions under differentclimate scenarios and climate targets can be translated into financial impact using riskmetrics. Risk metrics in turn are used to set limits when managing the share of financialexposure to transition risks and the concentration to climate-related risks within the riskappetite of the financial institution.The rest of this page has been intentionally left blank.Issued on: 27 December 2021
Climate Risk Management and Scenario Analysis11.Page 12 of 48Risk ManagementGeneral RequirementsSPrinciple 6: Financial institutions shall integrate material climate-related riskconsiderations into their existing enterprise-wide risk management framework. Thismust be supported by a reliable approach to identifying, measuring, monitoring andcontrolling material risks.S11.1 Financial institutions shall –(a) develop a comprehensive understanding on climate change to enable the mappingof transmission channels and impact of climate-related risks to existing risk typessuch as credit, market, liquidity, operational, insurance/takaful underwriting andreserving, strategic, reputational and regulatory compliance risks;(b) enhance and update existing risk taxonomy 9 , risk management policies andprocedures, as well as risk functions and capabilities to reflect the distinctiveelements of climate change. For example, financial institutions shall ensure thatthe risk management practices cover the different time horizons reflected inparagraph 9.3; and(c) review risk management practices, including related data, metrics and tools, in atimely manner to reflect continuous improvements in internal risk managementcapabilities and embed the latest global and domestic developments on climatechange. To ensure progress over time, financial institutions shall implement a longterm roadmap when developing the metrics and tools, which shall be a keycomponent of the implementation plan required in paragraph 14.S11.2 Financial institutions shall integrate climate-related risk considerations into the existingrisk management cycle through the following functions: risk identification, riskmeasurement, risk monitoring and risk controls. Appendix 4 illustrates the climate-relatedrisk management cycle.S11.3 Financial institutions shall have in place processes to ev
financial institutions, with the aim to enhance the resilience of the financial sector against climate-related risks. The principles are tabulated in Appendix 1. 1.4 The Bank expects financial institutions to have an effective risk management framework that integrates all material risks, which extends to climate-related risks, including the
This guidance is aimed at non-financial companies at the early stages of using scenario analysis to assess climate-related risks and opportunities. Scenario analysis is useful for assessing the business implications of climate change. Scenario analysis helps in making strategic and risk management decisions under complex
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potential exposure of the financial sector to climate transition risk. Furthermore, it has improved authorities' understanding of financial institutions' governance and risk management practices around climate-related risks and opportunities. Scenario analysis is a useful tool for identifying potential risks in an environment
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