ESG Risk and Compliance
Level 2 — NGFS Scenario Analysis · Climate Risk in Credit Underwriting · ISSB S2 and ESRS E1 Full Disclosure

This unit covers the NGFS scenario architecture and the extraction of the financial variables needed for banking portfolio stress testing from the NGFS Scenario Explorer. The three scenario families are reviewed in the context of banking risk: the Orderly Transition scenario (net zero by 2050, carbon prices rising to USD 250 per tonne by 2050, limited physical risk materialisation) implies high near-term transition risk and low long-term physical risk; the Disorderly Transition scenario (delayed policy followed by rapid transition, higher peak carbon prices, more economic disruption) implies higher short-term macroeconomic stress than Orderly; the Hot House World scenario (GDP growth 10 to 23 percent lower by 2100 due to physical impacts) implies low transition risk but high physical risk accumulating over multi-decade horizons. The NGFS Scenario Explorer extraction covers carbon price, renewable energy share, fossil fuel demand indices, GDP growth rates, unemployment rates, and real estate price indices at the 2030, 2040, and 2050 time horizons.

This unit covers the translation of NGFS scenario macroeconomic variables into sector-level transition risk impacts for the corporate lending portfolio. The translation methodology uses sector-specific impact models: for oil and gas, the NGFS fossil fuel demand indices drive the revenue projection adjusted for the borrower's position on the supply cost curve (developed in Module 1.3); for utilities, the NGFS renewable energy share projection drives the displacement of thermal generation; for industrial sectors, the NGFS carbon price trajectory drives the carbon cost impact on EBITDA. Sector impact models are applied at the 2030 and 2040 time horizons, producing EBITDA margin and revenue projections that are then translated into credit quality migration estimates — the sector-level migration matrices that provide the transition risk component of the portfolio-level expected credit loss calculation in Unit 2.1.4.

This unit applies the NGFS Hot House World physical risk assumptions — a global average temperature increase of approximately 3 degrees Celsius above pre-industrial levels by 2100 — to the real estate and infrastructure lending portfolio using the location-based physical risk methodology from Module 1.2. The collateral value stress calculation applies the physical risk score uplift under the Hot House World scenario to the property value discount functions from Module 1.2, producing a scenario-specific collateral value stress for each high-risk asset location. Counterparty credit quality migration covers the agricultural lending portfolio (significant crop yield decline in water-stressed and heat-stressed regions) and the infrastructure lending portfolio (increased maintenance and repair costs and potential early asset retirement for coastal and flood-exposed infrastructure). The physical risk migration matrices produced here are the counterpart of the transition risk matrices from Unit 2.1.2.

This unit covers the quantification of the expected credit loss uplift attributable to climate risk under each scenario and the assessment of the capital adequacy implications. The ECL uplift — the difference between the climate-adjusted ECL and the base case ECL — is expressed as both an absolute amount (additional provision required) and as a basis point impact on the portfolio's total performing loan outstanding. The capital adequacy impact assessment converts the ECL uplift into a capital ratio impact: under the Basel III standardised approach, an increase in expected credit losses requires either an increase in loan loss provisions (which reduces CET1 capital directly) or an increase in risk-weighted assets if credit quality migration moves borrowers into higher risk weight categories. The capital ratio impact is expressed as basis points of CET1 ratio impact at the 2030 and 2050 time horizons — the precursor to the Pillar 2 capital quantification in Module 3.1.

This unit covers the preparation of the regulatory-grade scenario analysis disclosure table and accompanying narrative, which together form the TCFD scenario analysis disclosure and the ISSB S2 strategy and metrics sections. The disclosure table format covers: the three NGFS scenarios with brief descriptions and key assumptions (carbon price, temperature pathway, physical risk severity), the portfolio-level financial impact metrics under each scenario at three time horizons (expected credit loss uplift in basis points, capital ratio impact in basis points, and collateral value stress as a percentage of secured portfolio), and the sector-level breakdown of the transition and physical risk components — formatted to meet the ECB's TCFD reporting guidance and ISSB S2 quantitative disclosure requirements. The accompanying narrative covers the scenario selection rationale, methodology overview, key risk and opportunity findings, and strategic implications for the bank's risk appetite and lending strategy. The capstone deliverable is the complete scenario analysis disclosure table and narrative.

This unit covers the conceptual framework for integrating climate risk into loan origination credit assessment and the regulatory backdrop driving this integration. The ECB's supervisory expectations on climate risk (published in 2020 and updated in 2022) require banks to integrate climate risk into their credit risk framework by 2024, including in loan origination standards, internal credit ratings, and sector risk appetite; the Bank of England's expectations under SS3/19 and the Basel Committee's climate risk principles provide the global supervisory context. The integration framework design covers three approaches: an overlay approach (climate risk assessed separately and used to override the standard credit scorecard output), an embedded approach (climate risk factors incorporated directly into the standard scorecard), and a hybrid approach (standard scorecard criteria supplemented with climate-specific criteria for high-exposure sectors). The unit covers the trade-offs between approaches, noting that the ECB expects banks to move toward the embedded approach over time.

This unit covers the PD adjustment methodology for agricultural loans based on the physical climate risk assessment from Module 1.2. The PD adjustment covers two physical risk drivers: water stress (chronic reduction in water availability affecting irrigated agriculture) and heat stress (increasing temperature affecting crop yields and livestock productivity in non-irrigated agriculture). The PD adjustment matrix maps the water stress and heat stress scores from the WRI Aqueduct assessment to a PD uplift percentage, based on published research on the relationship between climate hazard exposure and agricultural loan default rates, with matrix entries reflecting both hazard severity and the borrower's adaptive capacity (irrigation infrastructure, drought-resistant crops, and crop insurance). The unit works through the PD adjustment calculation for three agricultural borrowers with different physical risk profiles and adaptive capacity levels, producing adjusted PD estimates under the current climate baseline and the 2030 and 2050 NGFS Hot House World scenario.

This unit covers the LGD adjustment for commercial real estate secured loans based on the collateral physical risk assessment. Physical climate risk reduces the recoverable value of collateral in two ways: direct damage (extreme weather events cause physical damage that reduces property value) and chronic impairment (chronic hazards such as flooding risk or heat stress reduce property market value even without a specific damage event, as buyers discount for climate exposure). The collateral value discount function maps the physical risk score from Module 1.2 to a percentage discount on the current market value, based on hedonic pricing research on the relationship between flood risk exposure and property transaction prices. The unit covers the research evidence for the discount function, the uncertainty in the estimates (which is high for novel hazards such as coastal sea level rise in locations without established market pricing of climate risk), and how to present LGD adjustments with uncertainty ranges. Three commercial real estate properties with different physical risk profiles are worked through, producing adjusted LGD estimates under the current climate and the NGFS Hot House World 2050 scenario.

This unit covers the PD adjustment methodology for energy sector loans based on the transition risk modelling from Module 1.3. The adjustment reflects the increase in borrower default probability attributable to the financial impact of carbon pricing, fossil fuel demand decline, and regulatory requirements on borrower debt service capacity, calculated by mapping the DSCR projection under each carbon price scenario to a PD migration using the standard relationship between DSCR and credit rating. The unit covers the PD adjustment for two energy sector borrowers: an oil field operator (facing revenue decline from oil demand reduction under the IEA NZE scenario) and a coal-fired power plant operator (facing both carbon cost increase and revenue decline from renewable energy displacement). The unit also covers the counterintuitive result that Disorderly Transition can imply higher credit risk than Orderly Transition for some borrowers, because the rapid policy shift creates a more severe short-term financial shock.

This unit covers the integration of the physical risk and transition risk PD and LGD adjustments into a loan origination scorecard and the design of the climate risk due diligence requirements for new lending in high-climate-risk sectors. The scorecard integrates the standard credit assessment criteria (financial performance, management quality, market position, and collateral quality) with climate risk criteria (physical risk score, transition risk exposure, and borrower climate adaptation or mitigation capability) scored on a five-point scale added to the standard scorecard with a specified weight. The due diligence requirements specify the additional information borrowers in high-climate-risk sectors must provide at origination: for agricultural borrowers, farm location details, crop type and irrigation infrastructure details, and evidence of crop insurance; for commercial real estate borrowers, detailed property specification and evidence of flood insurance or flood protection infrastructure; for energy sector borrowers, the audited GHG inventory, the transition plan (if available), and the latest capital expenditure plan. The capstone deliverable is the completed climate-adjusted loan scorecard for the three case sectors and the climate risk due diligence requirements document.

This unit covers the assembly of the complete ISSB S2 disclosure from the component parts developed in Modules 1.1 through 2.2 and the internal consistency review that ensures the disclosure is coherent as a whole. The assembly covers the governance section (board oversight and management accountability from Module 1.1), the strategy section (strategic resilience and financial planning integration from Module 1.1, updated with the quantitative scenario analysis results from Module 2.1), the risk management section (physical risk assessment methodology and heat map findings from Module 1.2, transition risk modelling methodology and counterparty findings from Module 1.3, and portfolio-level scenario analysis from Module 2.1), and the metrics and targets section. The internal consistency review covers the three most common consistency failures: narrative-quantitative consistency (e.g. describing transition risk as a medium concern but reporting a 200 basis point ECL uplift is inconsistent), cross-section consistency (scenario assumptions must match across strategy and risk management sections), and temporal consistency (time horizons must be consistently defined). The unit provides a consistency checklist applied to the draft disclosure before finalisation.

This unit covers the preparation of the ISSB S2 cross-industry metric disclosures for a financial institution: absolute gross Scope 1 and 2 GHG emissions (from the institution's own operations), absolute Scope 3 Category 15 financed emissions (calculated using the PCAF methodology for the lending and investment portfolio), climate-related transition risk exposure (the proportion of the loan and investment portfolio exposed to transition risk above a specified threshold), physical risk exposure (the proportion of the portfolio secured by assets in high or very high physical risk locations from Module 1.2), and capital deployment toward climate risks and opportunities. The financed emissions disclosure (Scope 3 Category 15) is the most complex and data-intensive element: for large universal banks, the disclosure must rely on estimated emissions for a significant portion of the portfolio and must disclose the coverage ratio (the proportion of portfolio exposure for which actual reported data is used). The unit covers the acceptable estimation methodologies and the PCAF data quality thresholds the ISSB S2 disclosure should target over a multi-year improvement trajectory.

This unit covers the ISSB S2 industry-based metric requirements for financial institutions in the banking sector, drawn from the SASB Commercial Banks and Investment Banking and Brokerage industry standards. SASB identifies the following climate-related metrics for commercial banks as industry-specific disclosures under ISSB S2: the percentage and amount of loans and investments by segment subject to climate risk (breaking down the portfolio by TCFD sector category), the description of the incorporation of environmental risk factors in credit analysis, and the total amount of loans and investments for renewable energy and fossil fuel-related projects. For investment banks, additional metrics cover climate-related advisory revenues and underwriting revenues by category. The portfolio segmentation by climate risk category is the most analytically demanding element, requiring the sector classification and carbon intensity screening from Module 1.3 to be applied to the full loan and investment portfolio. The unit provides a simplified portfolio segmentation methodology appropriate for a first-year disclosure, with guidance on how to improve data granularity and coverage in subsequent years.

This unit covers the ESRS E1 climate disclosure requirements as they apply to financial institutions subject to CSRD. ESRS E1 applies to financial institutions with the same mandatory disclosure requirements as non-financial companies (governance, strategy, targets, and metrics), with sector-specific adaptations reflected in the financial sector ESRS currently under development by EFRAG. The mandatory ESRS E1 disclosures covered — applicable regardless of materiality determination — are: the description of the governance structure for climate risk oversight, the disclosure of GHG emission reduction targets, and the disclosure of the institution's approach to climate risk in lending and investment. The sector-specific elements covered include the ESRS E1 disclosure requirements for financed emissions (referencing the PCAF methodology), the disclosure of climate risk policies applying to lending and investment decisions, and the disclosure of climate-related targets for financed emissions where the institution has committed to NZBA or NZAOA targets. Each ESRS E1 requirement is mapped to the ISSB S2 content prepared in earlier units, identifying where a single disclosure section satisfies both frameworks and where ESRS E1 requires additional disclosure.

This unit covers the ISSB S2 and ESRS E1 interoperability mapping for the financial institution context and the preparation of the assurance evidence pack. The interoperability mapping table identifies: disclosures identical in both frameworks (GHG emission methodology documentation, governance structure description, scenario analysis summary), those where ISSB S2 requires a format or data point not covered by ESRS E1 (ISSB S2 cross-industry metric table format, industry-based metrics), and those where ESRS E1 requires additional disclosures not required by ISSB S2 (ESRS E1 financed emissions policy disclosure, ESRS E1 climate target setting rationale with EFRAG format requirements). The mapping table is a practical reference for the Head of Sustainability Reporting at a financial institution preparing both disclosures simultaneously. The assurance evidence pack maps each quantitative and qualitative disclosure element to its underlying source: for financed emissions, the PCAF calculation workbook with data quality scores; for physical risk exposure metrics, the WRI Aqueduct dataset access records and the heat map calculation; for transition risk exposure metrics, the sector classification methodology and the carbon-related assets identification process; for the governance section, the board committee minutes and terms of reference. The capstone deliverable is the complete ISSB S2 disclosure draft, the ESRS E1 interoperability mapping table, and the assurance evidence pack outline.