A framework to integrate climate transition plans into ICAAP/ORSA to co-manage green and financial targets

Abstract

Financial institutions (FIs) need to develop transition plans for the future low-greenhouse gas (GHG) economy. This is not only a regulatory requirement but also a critical task to best position the institution for future success. This transition will require significant alterations and adjustments to FIs’ asset mix and business activities. Many FIs have publicly committed to 2050 net zero targets. There is an obvious linkage among the FIs’ risk taking, financial performance and financed emissions. Transitioning from high-emitting sectors will moderate the climate risk impact and reduce financed emissions but also affect the financial performance of the FIs. This paper proposes a framework to integrate the measurement and tracking of financed emissions into the FIs’ existing internal capital adequacy assessment (ICAAP) and own risk and solvency assessment (ORSA) frameworks. The process involves capturing climate risks in terms of the key risk drivers, developing a transition plan and quantifying the joint effects in risk, financial and emission metrics. The paper discusses the components, linkages and interconnectedness of the extended ICAAP/ORSA framework, and the dynamic, iterative process to co-manage financial and green performance against their respective targets using the framework. The integrated process enables course corrections and can be extended to an optimisation framework subject to interim green targets. This article is also included in The Business & Management Collection which can be accessed at https://hstalks.com/business/.