By Laura Canevari
Understanding the implications of physical climate
risk to financial institutions is a complex challenge. The ClimINVEST initiative
aims to facilitate improved financial decision-making in the face of climate
change by offering tailored indicators, tools and maps for financial
institutions. As part of the project, the Institute for Climate Economics
(I4CE) has undertaken a
useful review of existing tools and approaches, that can assist financial
actors assessing their own physical climate risks.
Physical climate impacts can increase risk for the financial sector and the economy in several ways. However, the translation from physical risk to financial impacts is not always straightforward. As noted in I4CE’s review, very few service providers have developed approaches to analyse how climate risks can impact counterparties’ financial statements (e.g. in their balance sheets and profit and loss calculations) and how they affect the operation of financial activities. The review therefore focusses on assessing the functions, target uses and outputs of the tools currently available in the market, including those developed by Acclimatise and other service providers. The review summarises several key differences.
target use and target users for each approach differ: from those designed
to be used as pre-screening tools by project managers to those carrying more
comprehensive assessments target to risk managers. Similarly, the level of
analysis also varies, from tools focusing on risks at the project level, to
those operating at counterparties level, upstream/downstream value chains, on
sovereign counterparties; or even incorporating the larger socio-economic
environment. Equally, the methodologies incorporated in the tools can tackle
the assessment of different types of impacts, with some focusing only on
economic impacts and others also incorporating an assessment of financial
Another important difference found between the tools is their use of climate change scenarios,
and the sources of information these scenarios build on. Some of the tools have
built their scenarios using trend analysis and thus are based on past and
observed weather records. Contrastingly, other tools use an exploratory
approach, based on either IPCC data or outputs from Integrated Assessment
Models (IAMs). Generally, the time horizon chosen determines the type of
climate scenario used: It is common, for example, to find the use of trend
analysis on short term horizons, whilst long term analyses tend to be more
exploratory in nature.
The tools reviewed in the report also differ in their mechanisms to deal with uncertainty. In
some cases, the approaches developed have dealt with uncertainty by considering
the worst-case future climate scenario (a conservative approach); others have
used multi-model approaches for climate projections. In the case of the Acclimatise Aware
tool, the Global Climate Model agreement was used as indicator for uncertainty;
this indicator is then integrated when weighting the exposure to location-
specific climate hazard data.
formats provided by the different tools
and approaches were also found to be very diverse, ranging
from qualitative analysis using scoring systems, to quantitative assessments
providing financial estimates. Results are also aggregated differently by each
instrument: they can be aggregated according, to
scenario, type of impact, time horizon, counterparty, or hazard type.
conclusions and remarks
Whilst service providers are developing sophisticated methodologies to
help financial actors assess physical climate risks, they still face barriers
to exploit their full potential. Data availability remains an important
challenge, especially access to data on corporate counterparties. Information is
still needed at macro and sectoral scales in order to better characterise
financial implications caused by changing business environments; but it is also
needed at the counterparty or asset scale in order to define exposure,
sensitivity and adaptive capacity to a diverse range of climate impacts.
There is no “one-size-fits all” approach, and financial actors will have
to choose what type of tool is better suited to their assessments needs and
which can be better integrated into their existing risk management approaches.
Existing tools can nonetheless be further refined to better fit user needs and
new approaches can also be developed to match emerging assessment and
disclosure demands. Close collaboration between financial actors and service
providers will be a key factor determining the successful refinement and application
of tools and approaches. Acclimatise, will continue to work closely with
financial institutions in order to keep advancing the development of suitable
tools and approaches able to support financial actors identifying and dealing
with physical climate risks.
Photo by Chris Liverani on Unsplash