Applying the FAS 157 classification methodology to ESG risks in an investment portfolio – a focus on climate change

Abstract

This paper proposes applying an asset categorization methodology to identify securities most at risk for ESG issues in an investment portfolio. To demonstrate the methodology, climate change risk (physical and transition risk) is used as an example of an ESG issue. The paper proposes using a categorization of assets based on FAS 157 that was developed in 2009 as a reaction to the global financial crisis. FAS 157 required that investment managers classify their assets under management into 3 categories (Level 1, Level 2 and Level 3) for reporting purposes. This paper applies the same line of thinking to the categorization of financial assets based on whether the investment manager had performed a climate change risk assessment, and if so, the type of assessment performed. This would enable greater transparency into the inherent climate change risks in a portfolio and identify if and how asset managers are assessing securities for climate change risks.