ESMA Consults on Climate Risk Stress Testing Approach for Clearing

Proposed framework identified four elements of climate risk that may adversely impact clearing houses and intermediaries.

The European Securities and Markets Authority (ESMA) has published a paper calling for input from stakeholders on a proposed climate risk stress testing methodology for central counterparties (CCPs) or clearing houses.

While it has started developing a framework, ESMA notes that the assessment of climate risk within individual CCPs is still in its infancy, and that no cross-CCP climate stress test has been carried out to this date in any jurisdiction.

ESMA has identified four different elements of climate risk that may adversely impact CCPs.

  • Physical risk from weather-related hazards, which could affect CCPs’ physical premises, the premises of their clearing members, and/or those of their service providers – thereby impairing CCP functioning and operations as well as clearing member creditworthiness
  • Rapid transition risk, which could arise when investors shift portfolio allocations or divest from certain assets, thereby causing volatility spikes and possible clearing member defaults, which would affect the CCP
  • Business risk, which could impact a CCP if its clearing activities are linked in part or in full to “brown” assets or activities (e.g. a specific commodity or type of energy contract) and the volumes of transactions (and hence earnings) decline over time
  • Collateral replacement risk, which could play out when the assets used as collateral degrade in value due to a transition away from environmentally damaging issuers, resulting in the CCP requiring additional collateral to be posted

In the paper, ESMA presents its approach to CCP climate risk stress testing to seek stakeholders’ views on the following:

  • a proposed classification of climate risks relevant to CCPs
  • the methodology to build an EU-wide climate risk stress testing framework for CCPs
  • how to best calibrate the stress tests
  • the current development of climate risk assessments by CCPs

The consultation is open for comment until 21 April 2022.

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