ECB Limiting Transparency About Its ‘Climate Factor,’ Bank Watchers Say

 

Ducoulombier Supports Scoring Transparency

Frédéric Ducoulombier, who heads the Climate Regulation and Policies programme at EDHEC Climate Institute, a French business university, sees the ECB’s climate factor system as limited in multiple ways, described in an article published Aug. 26 in The Banker.

“On issuer scores, my view is that the ECB should publish them or, at a minimum, publish the climate factor and its principal components for each marketable asset,” according to Ducoulombier.

“Disclosure would allow issuers and researchers to identify errors, assess consistency and understand why comparable assets receive different treatment,” he said.

Further:

It would also allow banks, investors and other institutions to use the scores. This is especially important if the factor is expected to create a wider sustainability pricing signal. An opaque score is unlikely to transmit far beyond the Eurosystem’s own operations.

The ECB’s position that disclosing individual scores or climate factors is “not necessary” for protecting the Eurosystem’s balance sheet “explains its policy choice, but does not establish that withholding them is legally required or that the degree of transparency is adequate,” commented Ducoulombier.

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Regarding the climate factor now in use, observers agreed that more transparency is needed.

Ducoulombier told EYE that both the model and scores can be disclosed. “Transparency does not require disclosing confidential raw data, but it does require publishing the conceptual framework, assumptions, scenarios, equations, calibration choices and sensitivity tests.”

More specifically in terms the methodology, Ducoulombier noted that the ECB says that the sectoral component of the climate factor is derived from the expected shortfall under “the adverse scenario” of its climate stress test. “But,” he said, “it has not specified which of these two scenarios it uses. Nor, to my knowledge, has it published the sectoral stress values entering the calculation.

“The first adverse scenario applies this “run-on-brown” shock, which affects corporate profitability and asset values differently across sectors,” Ducoulombier said. “The second adds broader macroeconomic and financial stresses to the same transition shock,” he said.

“The distinction matters,” Ducoulombier elaborated. He said: “In several sectors, the shock under the second scenario is more than twice as large as under the first. If the ECB uses the second scenario, some of the resulting adjustment may reflect an ordinary macro-financial downturn rather than climate transition risk specifically. Such risks may already be reflected in market prices, ratings and standard haircuts.”

And the transparency gap doesn’t end there,  Ducoulombier told EYE:

“There are several elements on which greater transparency would be useful:

• the precise scenario, sectoral shocks and sector classifications used;
• the methodology and data underlying the corporate climate score, including the treatment of missing information;
• the individual corporate scores and the mapping of issuers into score categories;
• the parameters used to transform the resulting “uncertainty score” into a collateral adjustment, including how the maximum 5% reduction was calibrated;
• sensitivity analyses showing how different scenarios, assumptions and functional forms affect the result;
• an explanation of what risk is believed not to be captured already by market prices, credit assessments and standard haircuts, and how double counting is avoided;
• validation showing how the measure relates to the additional loss that the Eurosystem could experience between a counterparty’s default and the liquidation of its collateral; and
• for the extension to credit claims, the data and proxies that will be used where debtor-level climate information is unavailable.”