New report of scenario analysis tools and methodologies assists to improve climate risk modelling.
The UN Environment Programme Finance Initiative (UNEP FI) has published an overview of scenario analysis tools and methodologies to allow investors to make better choices when modelling climate risk.
The report, titled ‘The Climate Risk Landscape’, covers both transition and physical risk assessment tools and presents some of the key strengths and differences in approaches.
The presented transition risk tools cover numerous asset classes, such as equity, bonds, loans, mortgages and real assets.
As output they deliver results including financial and non-financial metrics, quantitative results and temperature alignment.
Methodology providers such as Baringa Partners, South Pole and Ortec Finance have indicated their ability to develop a range of financial output metrics, the report said.
Bespoke approaches are used by companies such as Carbon Delta, in collaboration with the Potsdam Institute for Climate Impact Research (PIK), Carbone 4 and Verisk Analytics.
Ortec Finance has developed three transition pathways similar to the Network for Greening the Financial System (NGFS) scenario set, including orderly and disorderly, Paris-aligned transitions and a business-as-usual scenario, equivalent to a ‘hothouse’ world.
Vivid Economics and Planetrics adopted the Forecast Policy Scenario by the Principles for Responsible Investment’s (PRI) Inevitable Policy Response.
Climate risk scenarios have resulted in a large number of methodologies and tools available to financial institutions, as they are based on numerous assumptions, baselines, inputs and modelling choices, and have a forward-looking nature.
The report explains that since 2019, the scenario analysis tools for climate-related risk assessments and disclosures have developed rapidly.
It highlights that the release of the NGFS reference scenarios have set a standard for climate scenarios in the finance sector.
“These integrate both emissions pathways and shared socioeconomic pathways and thus provide a common set of scenarios for assessing both transition and physical risks,” it writes.
Among the challenges that financial institutions will face in 2021 are that policy makers and regulators are increasingly highlighting the threats from climate change and are pointing the way towards mandatory climate risk through guidelines and standards.
Central banks and regulators will pilot and impose more climate stress testing on banks.
At the same time, the report expects in 2021 rising standardisation and mainstreaming of industry reporting standards, which are moving to align over the coming year and integrate the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).
A wider uptake of NGFS reference scenarios is highly likely, the report predicts.
All methodologies should also take into account carbon lock-in or expected greenhouse gas emissions.