Malaysia consults on 2024 climate stress tests, launches sustainability-linked sukuk format

Malaysia’s first ever climate stress test will be tailored to the specific physical risks that the country is exposed to, according to a proposed framework issued by the central bank last week.

Bank Negara Malaysia (BNM) said the exercise will be conducted in 2024 and will feature climate variables that have been “downscaled and calibrated” to suit the national context, based on input from climate experts. While the test’s assessment horizon concludes in 2050, BNM has proposed incorporating the added impact of physical risks between 2050 and 2100 “to mitigate any significant underestimation”.

In addition, BNM may include variables such as floods and other “major perils” that could be experienced by the Southeast Asian economy.

Recent extreme weather patterns, such as a one-in-100-year flood event in December, “suggest that the physical impact of climate change in Malaysia is already materialising, with more physical risk events expected to occur later in the century”, said BNM. This follows a 2021 study from UK academics which found that Malaysia’s credit rating will be among the hardest hit by climate change by the end of the century.

The format of the exercise, along with technical elements such as scenarios selection, portfolio scope and granularity and other considerations, has been outlined in a BNM discussion paper, which is open for stakeholder feedback until the end of September.

The stress test will be underpinned by three climate scenarios developed by central banking body the Network for Greening the Financial System (NGFS), similar to tests that have carried out by other financial supervisors. The first will model the physical and transition effects of current government policies, the second will focus on the consequences of achieving the national climate targets under the Paris agreement, and the third will consider a delayed transition where climate measures are only introduced after 2030.

But BNM said the exercise should not be considered an assessment of domestic policy measures as future policy “will most likely extend beyond carbon pricing mechanisms (eg, emission caps and investments in technology) and include actions that are beyond the bank’s mandates”. It will not be used to calibrate capital requirements for financial institutions, the bank said.

Additionally, the test will exclude liability risks arising from environmental or climate-related litigation in order to simplify modelling, although BNM acknowledged their significance. Liability risks are not usually covered in climate risk stress tests, despite the NGFS including them among the physical and transition risks that should be taken into account by supervisors.

Malaysian financial institutions have been asked to put in place the necessary data infrastructure, and develop the modelling and resource capacity required to assess climate-related risks ahead of 2024.

Malaysia slightly lags regional neighbours Singapore, which will start incorporating thematic climate scenarios within its industry-wide stress test from this year, and the Philippines, which has given regulated banks until 2023 to do so. Hong Kong concluded its pilot climate stress test in 2021 and will make it a permanent feature of its supervisory stress testing framework by 2024.

Separately, Malaysia’s financial regulator, the Securities Commission (SC) has launched a framework for SRI-linked sukuk issuances – sukuk being the sharia-compliant version of conventional bonds.

Similar to sustainability-linked bonds, the new format will allow issuers to secure borrowing at preferential rates if they achieve certain sustainability KPIs and can be used for general purpose financing, unlike green or social bonds.

The framework requires borrowers to appoint an external reviewer prior to issuance and an independent verifier post-issuance to assess compliance with the framework, in line with ICMA’s SLB principles – however borrowers can choose not to publicly disclose their sustainability KPIs.

“The SRI-linked sukuk will enable companies in [high-emitting industries] as well as other industries to transition into a low-carbon or net-zero economy,” the SC said at the framework’s launch.