Climate Change Valuation Adjustment (CCVA) using parameterized climate change impacts

TL;DR

This paper introduces Climate Change Valuation Adjustment (CCVA), a flexible framework to quantify climate change impacts on CVA+FVA, revealing significant effects on long-term interest rate swaps and the importance of business model transformations.

Contribution

It presents a novel parameterized approach to model climate change impacts on CVA+FVA, capturing transient effects and stakeholder discussions.

Findings

Significant CVA+FVA impacts on 20-year interest rate swaps due to climate change.

Impact magnitude depends on timing and duration of business model transformations.

Even slow climate impact scenarios can cause notable financial adjustments.

Abstract

We introduce Climate Change Valuation Adjustment (CCVA) to capture climate change impacts on CVA+FVA that are currently invisible assuming typical market practice. To discuss such impacts on CVA+FVA from changes to instantaneous hazard rates we introduce a flexible and expressive parameterization to capture the path of this impact to climate change endpoints, and transient transition effects. Finally we provide quantification of examples of typical interest where there is risk of economic stress from sea level change up to 2101, and from transformations of business models. We find that even with the slowest possible uniform approach to a climate change impact in 2101 there can still be significant CVA+FVA impacts on interest rate swaps of 20 years or more maturity. Transformation effects on CVA+FVA are strongly dependent on timing and duration of business model transformation. Using a parameterized approach enables discussion with stakeholders of economic impacts on CVA+FVA, whatever the details behind the climate impact.