Incorporating Climate Risk in Prudential Frameworks

This technical report discusses the integration of climate risk into prudential frameworks for trading books, as highlighted in the ISDA report 'Climate Risk Scenario Analysis for the Trading Book'. It outlines the significance of climate risk for financial institutions, emphasizing the need for banks to assess both physical and transitional climate risks. The report details the recommendations from the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) and the European Banking Authority (EBA), which stress the importance of incorporating climate risk into risk management frameworks. The document explains the Climate Risk Scenario Analysis process and its relevance in modeling potential future scenarios based on climate outcomes. It also examines the implications of climate risk on capital requirements under the Fundamental Review of the Trading Book (FRTB) framework, discussing the Standardized Approach and Internal Model Approach for calculating capital requirements. The report concludes by addressing the challenges and potential changes in regulatory measures related to climate risk in trading books.