5.1. Transmission channels

Institutions should identify, through observation and judgement, the most relevant transmission channels through which environmental risks may affect their exposures. To do so, they should adopt a structured, well-documented and regularly reviewed process.

Institutions should identify reliable data sources, apply transparent methodologies, and clearly articulated assumptions. In accordance with Section 4.2 of the Guidelines on the management of ESG risks, institutions should gather the necessary data based on their materiality assessment.

To identify environmental transmission channels, institutions should identify relevant risk drivers by considering both transition and physical risks. A non-exhaustive list of potential transmission channels, both micro and macro, is presented in the Annex.

Institutions should assess the extent to which their counterparties may be indirectly exposed to environmental risks through their value chain or through potential spillover effects on the local economy, starting with their largest or most concentrated counterparties. Where such indirect impacts are assessed to be material, institutions should consider reflecting them in the relevant transmission channels.

According to the time horizon of the analysis, institutions should consider potential risk mitigation or amplification factors. These may include:

• a. private and public insurance coverage - while considering the existing and potential future insurance protection gaps;
• b. counterparties’ ongoing efforts and forward-looking strategies related to climate change mitigation and/or adaptation (e.g. transition plans where available), including the risks stemming from a potential failure or delay in effectively undertaking such a transition/adaptation; and
• c. relevant local or governmental adaptation measures, while being cautious not to rely on overly optimistic government actions or State-led financial support schemes.

Institutions should assess how transition and physical environmental risks propagate through relevant transmission channels, and materialise in established risk categories, including:

• a. business model and strategic risk (e.g. higher cost of risk and lower profitability); FINAL REPORT ON GUIDELINES ON ENVIRONMENTAL SCENARIO ANALYSIS
• b. credit risk (e.g. counterparties default or increased probability of default, impact on collateral values);
• c. market risk (e.g. loss of value of financial assets, increased volatility, widening of credit spreads on certain assets);
• d. liquidity risk (e.g. difficulties in accessing financing or liquidating assets, increased liquidity needs of customers); and
• e. operational risk (e.g. sudden or gradual disruptions to processes, including absence of staff and IT outages).