As the financial sector has turned its attention to climate change, the demand for climate tools and analysis has skyrocketed. Financial institutions use climate tools to improve climate-related financial disclosures, conduct regulatory climate stress tests, evaluate strategic decisions and align portfolios to net-zero emissions. A robust marketplace of tool providers has developed to support these institutions, with new solutions, data and methods appearing almost daily. The speed of development can feel overwhelming, but financial stakeholders can become more informed consumers of climate tools by understanding current and emerging trends.
partnerships and acquisitions
Professional services firms have attempted to enhance their customer-facing offerings through partnerships with data providers and acquisitions of climate specialists. The formation of Climate Credit Analytics by Oliver Wyman and S&P is an example of such a partnership. Acquisitions of specialist climate consulting firms or tool providers also represent an opportunity for larger companies to strengthen their climate capabilities, as illustrated by Willis Towers Watson’s acquisition of Acclimatise.
Combined approaches to transition and physical risks
Data and methodologies for assessing transition and physical risk differ significantly, so most vendors have developed tools to assess one of these two main types of risk. While both transition and physical risk analyzes provide useful insights, when assessing an organization’s overall climate risk, both types of risk must be considered. Although most underlying models for physical risk and transition risk remain separate, more tools aggregate losses to provide an “all-in” perspective of climate risk. However, few vendors currently have the potentially complex interaction effects between physical and transition risks built into their tools.
Tools to meet legal requirements
Around the world, climate regulatory requirements are increasing, as evidenced by the US Securities and Exchange Commission’s (SEC) proposed climate-related financial disclosure mandate and the ongoing climate stress tests by the European Central Bank and Bank of England. Financial institutions are responding to regulatory pressures by hiring consultants and other third-party tools. Regulators try to compare the performance of their regulators, which means there is a greater demand for comparable methods and output formats. These developments have presented an opportunity for tool providers, some of which have developed dedicated tools or services for TCFD disclosures and climate stress test testing.
New and improved physical risk data
While the insurance sector has a long history of evaluating detailed physical risk data, many other financial institutions are just beginning to become familiar with specific physical risks and methods for quantifying them. Even for insurers, climate change presents the challenge 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 experience very different physical impacts. As a result, tool developers have worked to provide financial users with asset and address level granularity.
Growing interest in advanced analytics
Many financial institutions and tool providers are showing interest in advanced analytics techniques such as machine learning and artificial intelligence. Cutting-edge approaches to assessing physical risk include data mining to identify potentially at-risk assets and remote sensing to provide early warning of extreme events. For transition risks, some vendors have integrated insights from behavioral economics to model the decisions of economic agents under different transition scenarios. New datasets and methods have also improved emissions tracking, including using satellite data to identify methane leaks.
Transition scenarios with a focus on net zero
The global consensus to limit global warming to 1.5°C above pre-industrial levels has influenced the types of transition scenarios that financial institutions must use. Governments and businesses commit to net-zero targets by 2050 to align with this 1.5°C goal. Increasingly, stakeholders are demanding more detail on how companies will achieve their net-zero commitments. In addition, regulators are creating stress tests using a variety of 1.5°C scenarios to assess transition risks. With the mainstreaming of the 1.5 degree ambition, most tool developers have allowed users to assess portfolios against one or more 1.5 degree scenarios.
Rising expectations of financial institutions
In recent years, financial institutions have become increasingly sophisticated in their understanding of climate risks and the tools to assess them. With growing regulatory, reputational and business incentives to understand climate change and the transition to a low-carbon economy, financial institutions are looking for tools that go beyond exploratory analysis. Tool providers have responded by expanding their offerings to ensure they are suitable for applications such as TCFD disclosure, climate stress testing and net zero portfolio alignment. Another trend among financial institutions is the desire to develop analytical skills in-house. This has pushed the tool developers to develop more customized solutions that integrate well with the existing risk and business infrastructure.
The tool landscape
The field of climate instruments will continue to evolve to improve results and meet new use cases. To help financial institutions understand the range of tools, methodologies and providers, the United Nations Environment Program Finance Initiative (UNEP FI) published The Climate Risk Landscape in 2021. This report examined transition and physical risk tools from nearly forty different vendors.
In 2022, UNEP FI took stock of the latest developments in climate tools in its 2022 Supplement to The Climate Risk Landscape. This report provides more details on some of the key trends mentioned above and extensive research on areas for future tooling development. It also catalogs the actual experiences of over a dozen financial institutions that have piloted various third-party tools. These case studies provide the finance industry with detailed information about the processes, outcomes, insights and challenges that institutions have identified when using tools.