Climate Risk Scenario Analysis for the Trading Book

As climate-related events continue to occur with increasing frequency and severity, environmental risks need to be considered in the trading book given the value of financial instruments that may be affected by environmental factors.

As a result, potential financial risks arising from climate change remain a key area of focus, particularly for investors and regulators. As part of a May 2022 discussion paper, the European Banking Authority noted that environmental risks can materialize through market risk and the trading book via multiple channels. For instance, the transition to a low carbon economy can impact commodity markets (eg, fossil fuels), and physical risks emerging from climate change can cause market price fluctuations, such as more frequent and severe extreme weather events causing losses in equities due to the destruction of firms’ assets or capacity to produce.

Scenario analysis is a core tool to help inform strategy and business decision-making by assessing the scope and severity of these risks. However, much of the focus from regulators and banks has so far been on credit risk impacts in the banking book. How these risks affect the trading book has received less attention and research, and inclusion in regulatory exploratory exercises has been limited (eg, a carbon price shock in the European Central Bank’s (ECB) short-term disorderly transition risk scenario).

In the third quarter of 2022, ISDA and EY conducted a survey of ISDA members to provide a better understanding of the maturity of firms’ approaches to climate risk and scenario analysis in the trading book. The survey also sought to explore bank target states and the key challenges affecting their ability to achieve this.

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Documents (1) for Climate Risk Scenario Analysis for the Trading Book

Joint Paper on UK EMIR Reform

On July 1, ISDA and UK Finance published a paper, which recommended a set of reforms for the UK European Market Infrastructure Regulation (UK EMIR), carefully considering each EU EMIR 3.0 reform and asking whether we would wish to adopt...

Response to FCA on UK EMIR Reporting

On June 30, ISDA submitted a response to chapter 5 of the UK Financial Conduct Authority’s (FCA) quarterly consultation CP25/16 on trade repository reporting requirements under the UK European Market Infrastructure Regulation (UK EMIR). Chapter 5 proposes ‘Amendments to the...

CDS Trading Activity in EU, UK and US Markets

This report analyzes credit derivatives trading activity reported in Europe. The analysis shows European credit derivatives transactions based on the location of reporting venues (EU versus UK) and product type. The report also compares European-reported credit derivatives trading activity to...