On May 4, 2021, the Autorité de contrôle prudentiel et de résolution (“ACPR” – the French Prudential Supervision and Resolution Authority) published a first assessment of financial risks stemming from climate change and the main results of a climate pilot exercise (which many have referred to as a climate risk “stress” test) conducted between July 2020 and April 2021 and covering 9 banking groups and 15 insurance groups (including several public sector financial institutions), together representing 85% of French banks’ total assets and 75% of French insurers’ technical provisions and assets, respectively.
Objectives of the Pilot Exercise
The ACPR stated that the main objectives were to:
- Assess the risks and vulnerabilities to which French banks and insurers could be exposed and their strategic reaction function in the face of these risks (under the dynamic balance sheet assumption), under different scenarios including orderly and disorderly transitions and a physical risk scenario, illustrating a laissez-faire policy and based on the IPCC’s worst-case scenario. This scenario was assessed with the assistance of CCR regarding the exposures of French insurance and re-insurance undertakings.
- Mobilize and raise financial institutions’ awareness of climate change risks by contributing to improving their ability to anticipate and manage these risks, the materialization of which may exceed their normal decision-making and exposure horizon. Beyond this, the exercise aimed to identify current gaps in terms of data and resources (staff numbers, training needs, analytical capabilities, etc.).
Features of the Pilot Exercise
The ACPR stated that the main features were:
- A 30-year horizon covering the 2020-2050 period, which is sufficiently long to integrate the effects of climate change, in contrast to the usual duration considered for stress-tests (3 to 5 years);
- A bottom-up exercise covering banks and insurers aiming to analyze the interactions between the two sectors, in particular the impact of insurance coverage on banks’ risk parameters;
- An international dimension, designed to take account of the global nature of climate change and its differentiated impact across different regions of the world as well as of the international scope of the major French banking and insurance groups;
- A sector-specific, granular approach encompassing 55 sectors of activity, for each scenario and each geographical area considered, to capture the very contrasting effects of transition policies depending on the business sectors considered;
- The combination of two assumptions:
- first a "static balance sheet" assumption up to 2025, the traditional framework for supervisory stress-testing,
- then a "dynamic balance sheet" assumption, from 2025 to 2050, in order to analyze the strategies of financial institutions and the actions implemented to mitigate the effects of climate change; this assumption also aims to analyze the coherence of the strategies implemented by these institutions and their climate commitments;
- The exercise also includes the consideration of "second-round effects" to measure banks’ indirect exposure to physical risk, under the hypothesis of an increase in the insurance protection gap for certain assets due to the increase in the cost and frequency of extreme weather events; [and]
- Lastly, participation in the pilot exercise was voluntary and was carried out by institutions without any specific regulatory purpose.
Additional Work Required
While the report includes detailed findings (and is certainly worth reading to those interested therein), importantly, it also concludes that even though the pilot exercise provided insightful lessons, it also raised a number of methodological issues on which additional work will be required. Of course, this conclusion is consistent with related research and findings of the BCBS and the Federal Reserve.