Extreme weather events in 2021 shattered records around the globe. Hundreds died in storms and heatwaves, farmers struggled with drought and wildfires set new records for carbon emissions. Scientists say there is more to come as the Earth's atmosphere continues to warm through the next decade and beyond.
Given the increase and intensity of these major hazards, members of the sustainability team at this large pension fund wanted to put in place a more sophisticated framework to evaluate potential risks to the firm’s investment portfolios. In particular, they wanted to better understand the possible financial impacts of seven climate hazards: extreme temperatures, drought, coastal flooding, fluvial flooding, water stress, tropical cyclones and wildfires.
Members of the team began to review specialists in this area and selected The Climate Service (TCS) as their analytics provider. Based in North Carolina, TCS has received multiple awards for its innovative approach to analyzing climate risks. The firm was acquired by S&P Global early in 2022 and became part of its Sustainable1 business group that serves as the company’s single source of essential sustainability intelligence. Sustainable1 is combining TCS’s climate modeling expertise with its unrivalled data and risk analysis capabilities to provide expansive climate risk data intelligence for financial institutions, corporations and governments.
Pain Points
Members of the sustainability team wanted to evaluate physical risks to the firm’s real estate and infrastructure assets. These assets are held for long periods of time, making them susceptible to climate-related hazards should adequate steps not be taken to move to a green economy. The team wanted to understand:
- The probability that different physical risks could occur across regions of the world over time.
- How these physical risks could financially impact the assets.
These insights would help the pension fund factor climate-related risks into ongoing investment strategies for real estate and infrastructure. Following this, the team wanted to apply the same methodology to measure climate risk across a more diverse portfolio of assets.
Climate- and weather-related disasters continue to surge around the world calling for a more in-depth look at possible physical risks and the financial impact on different types of assets
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The Solution
A Look at Real Assets
For real estate and infrastructure assets, Sustainable1’s newly acquired capabilities would enable the team to:
- Identify a range of physical risks in different locations throughout the world, including extreme temperatures, drought, coastal flooding, fluvial flooding, water stress, tropical cyclones and wildfires.
- Evaluate how these risks could financially impact real assets by increasing operational costs, causing damages needing repair and/or resulting in a loss of revenue.
At the center is the use of the S&P Global Climanomics platform that measures physical risks in financial terms under different climate-warming scenarios. Members of the sustainability team saw how the solution set could uncover actionable climate risk intelligence to inform their decision-making and subscribed to the offering
The sustainability team provided three information sources for each asset under consideration: (1) the specific type of asset, (2) the location, and (3) the value of the property. The Climanomics platform then determined the impact of the major physical hazards on each asset, accounting for the asset’s specific vulnerabilities to each hazard.
To quantify the financial risk, Climanomics analytics identified losses from specific asset vulnerabilities to business impacts. For example, how would an increase in temperature impact cooling costs at a datacenter or a flood impact clean-up and repair costs at a merchandise warehouse?
Hazards and assessments of vulnerabilities are considered for each asset to model the average annual loss, which calculates the cost of damage and/or lost revenue over time as a percentage of the asset’s value. The total average annual loss is the sum of the financial impact of all hazards. This can be disaggregated by type of hazard and, within each hazard, by type of expense. The loss data is available for each decade out to 2100 and for four greenhouse gas (GHG) concentration scenarios that align with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).
A Look at Equities
The pension fund wanted a consistent methodology applied across the diverse set of asset classes in which it invests. To achieve this, Sustainable1 took its industry-leading corporate asset dataset and ran it through Climanomics to create market-first, bottom-up climate risk analytics with a financial impacts product for equities. The Sustainable1 Physical Risk Exposure Scores and Financial Impact Dataset were launched on September 15, 2022 and include information on 20,000+ companies and 870,000+ asset locations across four RCP scenarios. The exposure scores describe the exposure of an asset or company to climate change hazards. The financial impact metrics reflect the projected future financial costs of changing hazard exposure, expressed as a percentage of the value of the exposed assets.
The Climanomics platform and support from Sustainable1 specialists offered the sustainability team:
A deep analysis of physical risks
Sustainable1 utilizes publicly available raw climate data from sources such as NASA, the Intergovernmental Panel on Climate Change (IPCC), the National Oceanic and Atmospheric Administration, the World Wildlife Fund HydroBASINS and much more. The data may include information on temperatures and precipitation, which expert Sustainable1 scientists use to build and refine their own climate models. For example, while precipitation is important for flooding, so is topography, land use and basin area, variables that are included in the hazard models.
Sustainable1 has a growing library of proprietary impact functions that model the vulnerability of 270+ individual asset types to climate-related hazards based on a wide range of factors specific to each asset type.
Scenario analysis to test alternative futures
Scenario analysis provides actionable insights about potential future outcomes. Climanomics incorporates four climate scenarios based on the Representative Concentration Pathways (RCPs), a greenhouse gas (GHG) concentration trajectory adopted by the Intergovernmental Panel on Climate Change (IPCC). The pathways describe different climate futures, all of which are considered possible depending on the volume of GHGs emitted in the years to come.
A price on climate change
The Climanomics platform quantifies physical risks in financial terms (average annual loss) that are aligned with the recommendations of TCFD.
Assessments of different asset classes
The Physical Risk Exposure Scores and Financial Impact database measure the exposure of stock portfolios to climate change and estimates the financial costs of hazards.
Transparency into the assumptions
Detailed white papers outline all the assumptions that are used to calculate the probability of a physical risk occurring.
Management reports
The Climanomics platform delivers simple charts, graphs, narrative and data for export that provide insights into the location, severity and timing of climate-related risks.
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Key Benefits
The sustainability team is benefiting from:
- Vulnerability analysis from the asset level up, paired with best-in-class climate modeling.
- An estimate of the average annual financial loss for each real asset in the portfolio, alongside portfolio-level results, to enable meaningful mitigation and adaptation planning.
- A transparent methodology with a detailed explanation of the assumptions behind the risk analysis.
- An easy and secure platform for running scenario analysis and stress testing portfolios hosted on scalable, enterprise-grade AWS cloud infrastructure.
- A unified methodological approach applied across asset classes for important consistency.
- A unique bottom-up approach to equity analysis that captures different geographies and asset types.
- Access to experienced and highly responsive professionals at Sustainable1.
“We supply information to the investment group that thinks in financial terms. We need to speak the same language and provide relevant climate-related insights that are backed by a sound explanation of the assumptions to support their important work.”
The sustainability team
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1Oil and gas industry needs to step up climate efforts now", International Energy Agency, January 2020, www.iea.org/news/oil-and-gas-industry-needs-to-step-up-climate-efforts-now.