With the financial industry turning its attention to climate change, the demand for climate tools and analytics has skyrocketed. Financial institutions are deploying climate tools to improve climate-related financial disclosures, conduct climate stress tests, assess strategic decisions and align portfolios for net-zero emissions. A robust marketplace of tool providers has been developed to support these institutions, with new solutions, data and methodologies available almost daily. The speed of development can be overwhelming, but financial actors can become more informed consumers of climate tools by understanding current and emerging trends.
Partnerships and acquisitions
Professional service providers have sought to improve their customer-centric offerings through partnerships with data providers and acquisitions of climate-specialized companies. The creation of Climate Credit Analytics by Oliver Wyman and S&P is an example of such a partnership. Acquisitions of specialist climate consultancy firms or tool suppliers are also a way for larger companies to strengthen their climate capabilities, as evidenced by the acquisition of Acclimatise by Willis Towers Watson.
Combined approaches to transition and physical risks
Data and methods for assessing transitional and physical risks differ significantly, so most providers have developed tools to assess one of these two major risk types. While both transition and physical risk analyzes provide useful insights, when evaluating a company’s overall climate risk, both types of risk must be considered. While most underlying models for physical and transition risk remain separate, more instruments accumulate losses to provide an “all-in” perspective on climate risk. To date, however, few providers have integrated the potentially complex interaction effects between physical and transition risks into their tools.
Tools to comply with legal requirements
Climate regulatory requirements are increasing around the world, as evidenced by the proposed climate-related financial disclosure mandate from the US Securities and Exchange Commission (SEC) and the ongoing climate stress tests from the European Central Bank and the Bank of England. Financial institutions respond to regulatory pressures by engaging consultants and other third-party tool providers. Regulators try to compare the performance of their supervisees, which means there is more demand for comparable methods and output formats. These developments have presented an opportunity for tool providers, some of whom have developed dedicated tools or services for TCFD disclosures and climate stress test exams.
New and Improved Physical Risk Data
While the insurance industry has a long history of evaluating detailed physical risk data, many other financial institutions are only now acquainting themselves with specific physical hazards and methods of quantifying them. Even for insurers, climate change poses the difficulty of shifting baselines as physical impacts become more frequent and severe in a warming world. Physical risk assessment requires detailed data on asset resilience and local vulnerabilities, as similar assets and nearby locations can face vastly different physical impacts. As a result, tool developers have worked to provide financial users with granularity at the asset and address level.
Growing interest in advanced analytics
Many financial institutions and tool providers are showing an interest in advanced analytical techniques such as machine learning and artificial intelligence. Advanced approaches to physical risk assessment include data mining to identify potentially vulnerable assets and remote sensing to obtain early warnings of extreme events. For transition risks, some providers have included insights from behavioral economics to model the decisions of economic actors under different transition scenarios. New data sets and methodologies have also improved emissions tracking, including the use of satellite data to identify methane leaks.
Transition scenarios aimed at net zero
The global consensus to limit global warming to 1.5C above pre-industrial levels has impacted the types of transition scenarios financial institutions should use. Governments and businesses commit to achieving net-zero targets by 2050 to meet this 1.5˚C target. Stakeholders are increasingly asking for more details about how companies will achieve their net-zero liabilities. In addition, regulators are making stress tests with different 1.5 C scenarios to assess transition risks. With the mainstreaming of the 1.5°C ambition, most tool developers have enabled users to assess portfolios against one or more 1.5°C scenarios.
Rising expectations of financial institutions
In recent years, financial institutions have become more sophisticated in their understanding of climate risks and the tools to assess them. With increasing regulation, reputation and business incentives to understand climate change and the low-carbon transition, financial institutions are looking for tools beyond exploratory analysis. Tool providers have responded by expanding their offerings to ensure they are fit for uses such as TCFD disclosure, climate stress testing, and net-zero portfolio alignment. Another trend among financial institutions is the desire to develop analytical capabilities themselves. This has pushed tool developers to create more custom solutions that integrate well with existing risk and business infrastructure.
The landscape of tools
The climate tool space will continue to evolve to improve output and accommodate emerging use cases. To help financial institutions understand the range of tools, methodologies and providers, the United Nations Environment Program’s Finance Initiative (UNEP FI) released The Climate Risk Landscape in 2021. That report examined transition and physical risk tools from nearly 40 different providers.
In 2022, UNEP FI inventoried the latest developments in climate tools in their 2022 Supplement to The Climate Risk Landscape. That report includes more detail on some of the key trends noted above and extensive research into areas for future tool development. It also catalogs the actual experiences of a dozen financial institutions that have tested various third-party tools. These case studies provide the financial industry with detailed information about the processes, outcomes, lessons and challenges institutions have identified when using tools.