Introducing Climate Factors into Collateral Framework
The European Central Bank (ECB) introduces climate factors into collateral framework to address climate-related financial risks.
The European Central Bank believes that the new collateral framework can protect collateral in refinancing operations and avoid a decrease in collateral value caused by the impact of climate transition.
Related Post: ECB Releases Climate and Nature Plan 2024-2025
Introduction to Collateral Framework Incorporating Climate Factors
The European Central Bank’s climate stress test on the balance sheet of the euro system suggests that the value of financial assets may be affected by climate change. Climate change may have an impact on the value of collateral in the refinancing business, and climate factors will play a buffer role to reduce the value of these asset mortgages by adjusting the value of collateral assets in advance. Climate factors will include two parts, namely:
- Assets issued by non-financial institutions and their affiliated companies.
- The uncertainty of low-carbon economic transition.
The European Central Bank introduces an Uncertainty Score in the process of adjusting collateral values, which consists of the following components:
- Sector-specific stress: Industry climate risk measured based on stress testing.
- Issuer-specific exposure: Climate transition risk faced by asset issuers.
- Asset-specific vulnerability: Sensitivity of asset prices to future climate shocks.
The European Central Bank assigns a climate factor to each asset (currently the main refinancing asset is corporate bonds issued by non-financial institutions) based on the uncertainty score and adjusts the collateral value. Climate factors will also be included in scenario analysis to supplement existing risk management tools.
Impact of Climate Factors on Collateral Framework
The European Central Bank plans to officially implement a new collateral framework in the second half of 2026 and develop specific rules based on climate data in the first quarter. When uncertainty score is high, the value of collateral will be lower, which will have a negative impact on the liquidity of refinancing. The European Central Bank plans to regularly review climate factors and consider the development of data availability, regulatory policies, and risk assessment capabilities.
Reference:
ECB to Adapt Collateral Framework to Address Climate-related Transition Risks
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