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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A firm's enterprise risk management (ERM) team identifies climate change as a risk affecting several of its businesses. A risk manager distinguishes between physical risk and transition risk. Which example is a transition risk?

A new carbon tax raising costs for coal-dependent plants is a transition risk because it stems from policy change in moving to a low-carbon economy. Flooding, drought and heatwaves are physical risks, arising directly from climate events rather than from the economic adjustment.

  1. AA coastal warehouse is damaged by a more frequent flooding event
  2. BA new carbon tax sharply raises operating costs for the firm's coal-dependent power plantsCorrect
  3. CA drought reduces crop yields for an agricultural borrower
  4. DA heatwave interrupts supply from a key factory

Explanation

Transition risk arises from the shift to a low-carbon economy through policy, technology or market changes. A carbon tax is a policy change. Flooding, drought and heatwave are physical risks from climate events themselves.

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