Adapting to climate change in central clearing: risks, environmental footprint and enabling transition

What are the responsibilities of CCPs in the transition? 

(FMIs) in general may not be as advanced as banks, which have been looking at climate and transition for years. However, FMIs are increasingly becoming more alert to the topic and as backbone infrastructures, it is important that they look at both the physical and transition risks associated with climate change.  

In terms of the physical risk, as with all FMIs, CCPs need to consider climate hazards such as weather events and other factors associated with climate change. In terms of the transition itself, CCPs can take a lead to provide products and clearing services that will ease the green transition, also including service offerings that allow for better hedging against climate risk.  

CCPs need to consider their responsibilities both in terms of the risks facing their business and also the facilitation that they provide for financial markets, acting as enablers of the green transition.  

Are the CPMI-IOSCO Principles for Financial Market Infrastructures (PFMI) sufficient to provide guidance to CCPs on how to consider climate change?  

At the ECB, we definitely think that the key considerations of the CPMI-IOSCO PFMI are as relevant for climate as they are for cyber security and other risks. Governance is one of the crucial ones. It is important to have a top-level board focus on the challenges and opportunities driven by climate change and all the dimensions associated with it. Other factors include general business risk from the perspective of the changing environment. Furthermore, financial and operational risk management, transparency and disclosures are all relevant with respect to climate risk.  

So, at a high level the principles seem to capture the traditional types of risks (e.g. credit, liquidity, operational, business) which would still be the main channels for materialization of climate related threats. At the same time, of course, the language is high level and was aimed at other areas. We are therefore working with the global regulatory community to ask whether the current level of text gives enough direction and to look at whether CCPs (and other FMIs) are actually incorporating climate into their risk frameworks.  

If it emerges that there is a need for more direction on how FMIs should consider climate risks, we will work with regulators to provide that. Our approach could be similar to how we worked on cyber resilience or stablecoin arrangements. There we started with the CPMI-IOSCO PFMI as this provided the basics, but there was also a need to go further so additional guidance was developed, initially for cyber resilience and more recently for stablecoin arrangements.  

In the case of cyber resilience, getting the attention from boardrooms on the cyber threat was a challenge when we started. Clearly that isn’t the case now, and I would expect that the evolution on climate governance will progress more swiftly.  

Are there any areas that are unique to climate risk that you have identified already? 

The physical risk is very specific. Floods and extreme storms, for example, are unique to climate and represent a new theatre of threats for many firms. FMIs have business continuity and disaster recovery plans already but they also need to give specific consideration to where and how they operate from a geolocational perspective in the context of the climate threat.  

In this respect, they have to map climate hazards and look at projections in the areas they operate. They will especially need to consider what climate risk mitigation is available in the relevant geolocations. Such aspects will need to be explored across the entire range of CCPs’ operations, including with respect to their third-party service providers. CCPs may already have frameworks but new climate change-related features will have to be considered. 

Another one for CCPs is the market shock scenarios. Do methodologies and historical calculations truly reflect the potential market disruption that could be triggered by climate scenarios? CCPs need to explore this and ensure that all their methodologies incorporate and accurately reflect plausible future tail risk scenarios triggered by climate change.  

This may not be an easy task as such tail risk scenarios need to be grounded in various climate change pathways, and they may oftentimes need to be modelled knowing that historic market moves may not be representative or indicative. Therefore, traditional modelling approaches may need to be adapted as well.  

Regarding stress tests, it is crucial that this topic is being explored not only at individual CCP level but also holistically in the clearing ecosystem. For the latter, the ongoing ESMA CCP supervisory stress exercise is a good example. 

What actions could be taken to reduce the environmental footprint of CCPs? 

The environmental footprint aspect is an important one. Firstly, CCPs need to understand where they are today and that is not easily calculated. There are methodological issues to be addressed but the industry is advancing in that respect.  

It is acknowledged that an FMI’s environmental footprint across its operations may be hard to construct. Value chains are very complex, and the FMI needs to consider all its suppliers and service providers as well. However, there are already disclosures around things like water use, waste management and sources of electricity to support operations.  

With respect to CCPs specifically, there could be another issue considered, namely the footprint of the products that they clear. For instance, responsible or sustainable production or sourcing could be an important feature of those cleared products. Hence, it is important that CCPs understand and quantify the environmental impact of their clearing offerings and how they could reduce it.  

What else does 2024 have in store with regards to CCPs for the ECB?  

Turning to the ECB - and in our work with the national central banks of the euro area - we also started to consider how climate risks could be incorporated into our FMI oversight activities, and we will provide further guidance in due course if needed.  

Let me mention that the Dutch central bank has just recently issued best practices for FMIs in the Netherlands with respect to incorporation of climate and environmental risk management into their processes and procedures.  

I consider both the previously mentioned ESMA stress test and the Dutch good practices as very useful tools to provide thought leadership and a sound basis for discussions regarding FMI climate risks. I hope to see more of such initiatives in the future.  

The good news on climate is that we are not starting with a blank page and can base our analysis and guidance also on the work done for banks, asset managers and elsewhere. The ECB is ready to contribute to this important work.