The Depository Trust & Clearing Corporation (DTCC), the principal US securities clearing house, has issued the first-ever analysis that examines how climate-related financial risk, namely physical and transition risks, may impact financial market infrastructures (FMIs).

FMIs can have direct exposure to climate-related physical risk, acknowledges the white paper, Climate-Related Financial Risk: An FMI’s Perspective, published by the DTCC. While FMIs’ existing business continuity programmes have proven to be sufficiently robust to withstand the impact of extreme weather events, these programmes should continue to be enhanced to prepare for potentially more frequent and more damaging climate-related events in the future.

And, while financial institutions face direct exposure to physical risk and indirect exposure to transition risk through their financing activities, FMI exposure to these risks via financial institutions is even more ancillary. Additionally, given the specific nature of its activities, the duration of an FMI’s exposure to risk is considerably shorter than the risk horizon of other financial service entities.

In response to FMIs’ unique risk exposure, the paper recommends that existing regulatory frameworks and standards be applied to FMIs to effectively mitigate future climate-related financial risk challenges. More specifically, the principles for FMIs (PFMIs) that were created by CPMI-IOSCO contain effective and adaptative guidance that could be applied for this purpose.

While green bonds can play a significant role in contributing to the funding required to address the global challenges of climate change, the paper also highlights that these instruments should not be given preferential treatment around how they are risk managed, including in the collateral management process.

As part of the DTCC’s approach to mitigating its exposure to climate-related risk, its business continuity team is adding climate-related trending metrics to its existing programmes to improve the company’s risk management capabilities. Additionally, its counterparty credit risk team is looking to incorporate climate-related risk monitoring as part of its overall approach to assessing counterparty exposure, compliance, controls and governance.

“Climate change is no longer being considered exclusively an environmental issue, but a multifaceted source of economic and financial risks that could threaten the stability of the financial ecosystem,” says Michael Leibrock, DTCC chief systemic risk officer. “As such, the DTCC includes climate-related financial risk as one of the many potential systemic threats that it actively analyzes and monitors.

"The overarching message is that existing PFMI guidance was appropriately designed by global policymakers to cover FMIs’ unique exposure to climate-related financial risk.”