Goldman Sachs is working to hardwire controls into its risk management framework to help it guard against the risk of loss from climate change, a process it expects to complete by the end of this year.

“It’s one of our top risk priorities, not just [for] Goldman, but for the industry,” says David Wildermuth, deputy chief risk officer at Goldman Sachs. “We spend a lot of time talking to our peers, and people are approaching it from the same perspective—but, obviously, there are a lot of nuances.”

The bank is gauging where to set control thresholds for transition-related climate risks—for instance, an otherwise healthy borrower’s business model becoming challenged by emissions targets or divestment from shareholders—via integrated assessment modeling and scenario analyses.

This approach allows the firm to understand the sorts of impacts that various routes that the transition to a low-carbon economy could have on its clients, says Wildermuth, as well as on the firm itself, including the value of Goldman’s debt and equity portfolios, held-to-maturity securities, or ratings downgrades that might affect Current Expected Credit Loss reserves, allowances held against credit losses.

Once the potential impacts are evaluated, the bank’s risk teams will set tolerances for key business areas such as lending and financing. Right now, Wildermuth says, Goldman has the capability to conduct company- and sector-level assessments, adding that the modeling will improve with time, as more firms begin to disclose relevant information. Regional working groups then assess transactions on an individual basis, flagging them and escalating to higher-ups for attention where necessary.

Regulators are also seeing the importance of relevant internal control frameworks as part of a rapidly evolving supervisory framework on climate risk. The European Banking Authority highlighted the topic in its recent report on management and supervision of environmental, social and governance (ESG) risks.

In our client base, we were seeing a lot of pockets of climate- and, in some cases, ESG-related controls

Paul Ford, Acin

The watchdog suggested supervisors could consider whether a bank’s strategies, policies and procedures for combating climate risk were compatible with existing control frameworks, adding: “Particular ESG aspects could be considered when evaluating the ‘lines of defence’ model, in regard to consistency in the implementation of ESG risk-related objectives and/or limits in the risk-taking, risk management and internal audit function.”

The direction of travel has become so clear, says Paul Ford, chief executive of Acin—a firm that maintains an aggregated library of operational risks and controls, and counts JP Morgan among its clients—that his company has moved to integrate climate-related controls, verging into the world of financial risk, away from its operational risk origins.

“In our client base, we were seeing a lot of pockets of climate- and, in some cases, ESG-related controls,” says Ford of Acin’s decision to begin work on climate risk.

While all firms are devoting serious attention to the topic, he adds, some are going further than others: some companies are “reinventing the wheel”, and creating entirely new climate risk and control frameworks from the ground up, rather than using existing systems.

At one European bank, according to WatersTechnology’s sibling publication, Risk.net, work on climate risk controls has not so far entailed the creation of new controls or metrics. That firm’s stance is that the risk associated with climate change, while complex and diverse, can still be broken down into discrete units that slot into the firm’s current risk appetite framework.

Like Goldman, the European bank has spent the last two years building bespoke modeling capability and quantitative assessments for climate-related risk. It has also reviewed its lending thresholds to factor into formal portfolio lending limits the data gleaned from climate-scenario exercises and stress-test results.

This involves assessing individual transactions for carbon intensity and reviewing this against portfolio- and sub-sector-level commitments, according to a senior climate risk executive at the bank, before control officers examine new lending to ensure that policies aren’t contravened, and escalate decisions to the firm’s executive committee if need be. It will have 30 full-time staff dedicated to climate risk by the end of 2021, he adds.

It is rare for any exceptions to be made to these thresholds, the firm says.

Bank staff are undergoing extensive retraining to deal with new climate mandates, sources say. At one major bank, 600 credit risk officers have taken in-house classes in the scientific principles of climate change, its economic impacts, and the nature of physical and transition risks, involving lively discussions about the timeframe of climate change and global policy responses.

Goldman’s Wildermuth says his firm has benefited from enthusiastic quant staff members who had been researching climate modeling as a matter of personal interest for some time: the development of the firm’s physical and transition modeling capability, he says, was rapid as a result. Credit risk staff are receiving some tool-specific training, Wildermuth adds, to ensure that they properly understand the framework developed by the quant teams.