Rationale and Design of a Scope 3 Capital Charge

Abstract

[Abstract] Climate change is caused by greenhouse gas emissions, and governments have introduced over seventy carbon pricing instruments (CPIs). Banks finance a significant fraction of global emissions, and many have committed to reduce their facilitated, or Scope 3, emissions to (net) zero by 2050. However, it is possible that governments will introduce a CPI impacting banks on their Scope 3 emissions earlier. Here we design a Scope 3 capital charge to make banks resilient against the possibility, albeit not certainty, that governments could introduce such a Scope 3 CPI. Based on interest rate swaps, our numerical examples are financially significant for counterparties with significant emissions. The contribution of this work is to provide a technical basis for banks to be sufficiently resilient