Transcript provided by Kensho.  

Lindsey Hall: Hi. I'm Lindsey Hall, Head of Thought Leadership at S&P Global Sustainable1.  

Esther Whieldon: And I'm Esther Whieldon, a Senior Writer on the Sustainable1 Thought Leadership  Team.  

Lindsey Hall: Welcome to ESG Insider, a podcast hosted by S&P Global, where we explore  environmental, social and governance issues that are shaping investor activity and company strategy.  

COP27 kicks off in just over a week. This climate conference takes place in Sharm el-Sheikh this year  during 2 weeks in November. And although this is a United Nations event, we're hearing that 2022 will  bring many representatives from the private sector as well as the public sector.  

How do we adapt to a changing climate amid increasing extreme weather events around the globe?  That question will be an important part of the talks. We'll bring you more details about what to expect in  our episode next week previewing COP27.  

Esther Whieldon: We've talked a lot on this podcast about how the sense of urgency around climate has  increased. Most of the world's regions have suffered extreme weather conditions at some point this  year. Major flooding has devastated Pakistan while several European countries have been hit by  sweltering temperatures, and both China and North America experienced their warmest August on  record.  

Lindsey Hall: Scientists are increasingly making the connection between extreme weather conditions  and climate change and have devised climate risk models to better understand the impacts of a change  in climate. This can be used to predict how climate change will affect the economy, companies and  communities.  

As we'll hear later in this episode, continuing the current trajectory will impact nearly everyone. 92% of  S&P Global 1200 companies will have at least one asset highly exposed to physical hazards by the 2050s.  That's according to S&P Global Sustainable1 data under a business-as-usual high-emission scenario.  

Esther Whieldon: To learn more about how climate models work, our colleague and regular podcast  contributor, Jennifer Laidlaw, spoke to David Carlin. David works at the United Nations Environment  Programme's Financial Initiative, where he leads the TCFD and climate risk program. The TCFD or the  Task Force on Climate-Related Financial Disclosures has provided companies with a voluntary climate disclosure framework since 2017. Jennifer started by asking David why climate models were so  important.  

David Carlin: So it's a great question. Climate models are so important because in a lot of ways, climate  itself is a complex phenomenon and one that is inherently about the things that we don't know. It's  about the future not looking like the past, and so much of our current forecasts and models that exist  for other types of risks are in need of upgrade or amendment when thinking about climate.  

And because of the multiple interlinked systems of the economy, of societal choices and of the physical  realities of climate change, sometimes insights can be generated not only from a single approach, but also from a more integrated approach. And that's really where models come in to give us some of those  insights to help us also deal with those uncertainties that I mentioned.  

Jennifer Laidlaw: So what are some of the different climate models that exist? Could you give us some  examples?  

David Carlin: Yes. So I would start probably by breaking them up into models that look at the physical  systems of climate change. These are the more traditional models. And in the general public when you  hear the phrase climate models, this is typically what is being referred to these are models looking at  how an increase in carbon dioxide and other greenhouse gases will increase the temperature and the  knock-on effects that will have on both local and global climates. And so that's kind of the seed from  which all other climate models, whether they be for financial institutions, whether they be for  policymakers, where they all flow.  

So in addition to the physical hazard models, we also have models that look at as we transition away  from a high-carbon society. How that transition may create disruption and thereby risks of the  traditional type, the physical risks also show these as well, but credit risks, market risks, operational and  reputational risks.  

And so typically, models begin with that kind of element of the physical system, but then begin looking  into hazards to say, given these changes, what are the considerations that are likely to take place, what  are the impacts that are likely to befall us.  

And then as I said, on the transition side, a similar question is as we are moving to that world that we  need to get to that is sustainable and low carbon, what kind of disruptions can we expect along the  way?  

Jennifer Laidlaw: And what are these models showing us? What are the disruptions that we could face  as time goes on?  

David Carlin: So I think we really see 2 major types of disruptions. In physical systems, we see significant  disruptions from a worsening and increasingly severe climate regime. So that means that on the  scientific side, what we see from these models are stronger storms. We see heavier patterns of rainfall,  and at the same time, in certain places, more acute droughts and desertification because that rainfall,  while it's heavier, may fall in different places. We see extended and worsening heat waves. We also see  ice caps melting resulting in sea level rise. We also see biodiversity under threat as well as other  ecosystems. And we see the spread of endemic pests and other types of impacts that will negatively  affect regions maybe that previously haven't experienced them.  

So if those are kind of the physical consequences, we also see the potential for societal and economic  disruptions and these can be both conflicts over resources. So water is a critical resource that is one that  will be made more tenuous by changes in the climate. Also, we see challenges in terms of economic  resiliency.  

So we're in the most globalized era we've ever been in and supply chain disruptions, whether it's due to  pandemics, whether it's due to conflicts, we've seen just over the last 2 years those 2 examples of how  global supply chains have been very much disrupted. So we see that kind of disruption. 

And then we also see the potential for impacts on the financial system that can spread more widely. So  potential challenges in one sector, maybe it's due to a major shift in preferences as we move toward  decarbonization or due to large-scale asset stranding of fossil assets, these things are leading to  contagion effects in our economic systems, in our financial systems.  

And so from climate, we have both the very physical and the very tangible stronger effects of a more  hostile climate regime, but we also see potential for those disruptions to filter into the economy, into  societies and into global communities overall in ways that can affect our well-being, in ways that can  affect our economic prospects and in ways that can affect overall prosperity.  

Lindsey Hall: Now Jen, climate models have played an important role helping central banks develop  climate stress tests to estimate the potential cost of climate change on the financial system and the  broader economy. You've spoken about that a lot on this podcast in the past, and we'll provide links to  those episodes in our show notes. Now how do climate models measure risks to the financial system?  

Jennifer Laidlaw: Well, I've recently attended an event hosted by S&P Global Sustainable1 in London  where climate risks and modeling were amongst the topics of discussion. I asked one of the panelists,  Alban Pyanet, about the role of climate models in determining climate risks and their impact on the  financial system. Alban is as a Partner at consultancy, Oliver Wyman in New York, and he works with  financial institutions on integrating climate risk into their financial management.  

Alban Pyanet: Well, first, I want to clarify what we mean by climate risk and climate risk can take several  definitions depending on the who you ask. And here, we're really talking about the financial impact  associated with climate change or really the climate financial risk.  

So in terms of models that are being developed by financial institutions, I think of them as grouped into  2 categories. One, what -- that's we call the scenario model. So those are the models that are used or  developed -- to develop scenarios, meaning that they paint a picture of what the economy will look like  under a specific evolution of climate.  

Those are models that are largely, but not exclusively developed by research institutes. And they are  used by financial institutions as an input into their processes. So they give a sense of what the economy  will look like under given climate scenarios and can be used to inform decisions down the line.  

And the second group of models are more related to the financial performance associated with climate  change. This is really taking the climate scenarios and the information coming from the climate  scenarios and translating that into a view of the financial performance of an institution or of their  counterparties. So that includes things like rating or valuation or financial performance, et cetera.  

And there are several flavors of those. I talked about the climate scenario analysis, but there are also  views that are more adjusting the current models of the institutions. So what do they think will happen  regardless of the scenarios? And how can this be captured into the decision-making?  

Esther Whieldon: It's interesting to hear Alban mention the importance of climate models for financial  institutions. So Jen, did you hear about any other sectors? 

Jennifer Laidlaw: Climate models produce information and data that can help companies and investors  measure future risks to their businesses or investments. Now at S&P Global Sustainable1, we've just  published a physical risk data set that was created with the help of climate models.  

So I spoke to Steven Bullock, Global Head of ESG Innovation and Solutions at S&P Global Sustainable1.  His team helped create the new data set. The data measures the exposure of an asset or a company to 8  climate hazards. So that includes things like extreme heat, wildfires and drought. It also quantifies the  future financial costs of those hazards. I asked him, what's driving demand for this kind of data?  

Steven Bullock: We're now seeing more and more investors integrating climate and other ESG  considerations into the investment process. And we're even seeing central banks and supervisors  recognizing that climate could affect the stability of the global economy.  

We're also seeing increased regulation and political pressure, the second key demand driver. So things  like the Task Force on Climate-Related Financial Disclosures, the TCFD, is a great example of this. And  more and more countries are starting to mandate climate risk reporting in line with those  recommendations.  

And then the third demand driver is what I would refer to as sort of changing market dynamics. It's this  growing recognition that ESG is a driver of corporate business value and financial risk, or in other words,  recognizing that climate risk is financial risk. And the bottom line is that businesses are now actively  competing for capital based on their performance on these types of issues.  

So the need for this robust and timely data on climate-related risks and opportunities is greater now  than ever before. And climate modeling has such an important role to play because it provides  companies and investors with a way of understanding their exposure to these types of risks under  different future climate scenarios so that they can start to manage these risks, but also report and be  transparent to their stakeholders.  

Jennifer Laidlaw: He also explained the methodology behind the data and how climate models play their  part.  

Steven Bullock: We firstly look at the climate hazard exposure, we then look at the financial impact of  that exposure and we apply it to assets and companies. And I'll just talk through a little bit on each of  those 3 steps.  

So in terms of the climate hazard exposure, what we are looking to do, what we're aiming to do is to  provide an assessment of the exposure to different types of climate hazard around the world. So things  like extreme heat, wildfires, water stress, droughts, sea level rise and so on and so forth. There are areas  of the world that are exposed to these issues in different ways.  

So we are using the latest and greatest climate models and science provided by the IPCC. And what  we're doing is we're looking at the map of the world and we're estimating how those climate hazards  will change through time under different scenarios.  

So just to give you an example, we look at extreme heat. And with that hazard, we look at how the  number of days in a year where locations are exposed to extreme heat how that changes through time  as temperatures increase out into the future. 

So looking at the map of the world, you can start to see where those hotspots are for different types of  climate hazard exposure.  

Jennifer Laidlaw: Steve then went on to tell me how the data quantifies the financial impact of climate  hazards.  

Steven Bullock: At the start of the year, we acquired a business called The Climate Service, who have a  lot of expertise in quantifying these financial impacts. And what we have to overlay across these hazards  are around about 1,200 impact functions developed for different types of assets.  

So just to give you another example of what that means in practice. Let's take an office building, for  example, that's exposed to extreme heat. Well, we know that as that extreme heat becomes more  pronounced in the future, that office building may need to increase its cooling costs, the operating expenses associated with cooling equipment and air-conditioning and so on and so forth. We also know  that those systems may go through what they require maintenance through time as they use more  frequently.  

We also know that extreme heat could also cause employee productivity losses, reduced employee  productivity because temperatures become sort of unbearable for the workforce. And in areas where  there isn't a reliable air-conditioning equipment and processes, then that exposure is more pronounced.  

So what we've done is we've identified these different types of impacts and then we put a financial  figure on those, on the costs and the losses. And then we can equate that as a percentage of the value  of the asset, and that's a really useful tool to help our clients who are companies but also investors start  to understand what are the financial implications of these climate hazards through time?  

And then very quickly, that the final piece is then applying that to assets around the world. So right now,  we're able to look at almost 1 million asset locations that are linked to companies or to large listed and  private companies around the world. So the location-specific data allows us to have financial impact  assessments at the asset level and then rolled up to the company level.  

So right now, 20,000 companies in our database have these types of metrics available and the close to 1  million assets that those companies own as well.  

Jennifer Laidlaw: I wondered whether a business could use the data to predict what its potential losses  might be 40 years, say, down the road.  

Steven Bullock: We looked at the 1,200 largest companies globally, and we determined that over 1/3 of  those 1,200 companies would have at least one asset where the physical risks of climate change are  equivalent to 20% or more than the asset's value by the 2050s, which would rise to almost 50% of those  companies by the end of the century.  

So what this is telling us is that there is quite significant financial risk today across the largest companies  in the world. And we can be very specific about the percent of the value of those assets that are at risk.  

So that information, of course, is incredibly useful for the companies that are managing those assets to  identify the types of mitigation and adaptation initiatives that might be required to manage that risk.  But of course, it's also interesting for investors in those companies to see that type of intelligence because that would, of course, provide more transparency on the value of those businesses and the way  that they're managing climate risks.  

The other really interesting finding from the research was that -- and the previous statistic of over 1/3  was based on a BAU scenario, a business-as-usual scenario. But even under a 2-degree aligned scenario,  a scenario that's aligned with the goals of the Paris Agreement, by the end of the century 39% of those  companies would still have at least one asset exposed from a financial perspective. And I thought that  finding was actually really compelling because what it shows you is that there is inherent sort of residual  or baked in financial risk exposure even under the most optimistic climate scenarios. And that's a real  call to action for companies to take action now to manage and mitigate those impacts.  

Jennifer Laidlaw: So climate science is something that's constantly developing and scientists or  expanding their knowledge over changing climate. I wondered how that might impact climate models. I  asked Alban what improvements he expects to see.  

Alban Pyanet: I would identify a few avenues for improvements for those models. So if we talk about  the first category that I mentioned earlier around the scenario models, I think here it's important to  keep them up to speed with a little science. So areas like the modeling of tipping points, for instance,  when it comes to climate change is something that can be improved by the research institutes in the  future and they're working on this.  

And also there is another avenue, which is making those scenarios more useful to the financial  community, in particular. So that includes things like having a more granular view on how specific  industries can be impacted, having a narrative around what could happen to those industries and also  reflect the relevant risks. So for instance, at this point, some of the perils on the physical risk side are  reflected, but not all of them. So I think continued improvement on that topic will also be helpful.  

On the other type of models, the financial models I referenced earlier, one of the key areas of  development will really be around getting better data and leveraging those data in these models. So  that may include items like transition plans, for instance, so collecting data around transition plans of  counterparties are reflecting that in the financial analysis assessing their credibility and then make a  decision based on that.  

Jennifer Laidlaw: I also spoke to David about what climate modeling might look like in 2050 and beyond  when we'll know a lot more about the impacts of climate change.  

David Carlin: There's definitely a lot of ways in which things are likely to develop, I think the trend  toward increasing clarity about the local effects and about the complex and second and even third order  effects. So you're talking about an increasing salination of a water supply due to saltwater intrusion on  an island state and what is that going to do for agricultural productivity, what is that then going to do for  economic impacts. These are all things that people will increasingly be looking at these multifaceted  relationships.  

I think, likewise, the impact of adding energy to the global system and how that actually is felt in  different areas, so storms in the Atlantic fires in Australia, the prevalence of those. Right now, there's a  lot of noise. We have some signals and we have some clear evidence of strengthening effects, but we also have a lot of uncertainties. And I think in some ways, we're going to resolve a number of those  uncertainties.  

I would say the second area is on the tipping points. On those tipping points, I think we're also going to  get a lot better at understanding not only what the danger zone looks like, but what the periods by  which that danger zone is likely to manifest and how we might be able to avoid that also, I think, will  become a lot more clear. A lot of things that just the last 5-or-so years about changes in ocean  circulation patterns, changes in the breakdown of certain major air currents and others that could be  caused by changes in climate; impacts of clouds, this is another big area. So a lot of these big  uncertainties, which can really swing the needle from a negative consequence of climate change to a  potentially devastating one.  

Lindsey Hall: So we've heard today how climate models can help us understand future risks. And if you  can measure the impacts of climate change, you can begin to take action to mitigate and to adapt.  

Jennifer Laidlaw: Yes, and what's interesting is that we can drill down into potential losses and start  putting a price tag on climate change. That, as we heard, is really important for companies and  investors.  

Esther Whieldon: Well, thanks, Jen, for joining us and explaining what is a complex subject in plain  English. Going forward, we'll be watching how this plays out at COP27.  

Lindsey Hall: Thanks so much for listening to this episode of ESG Insider. And a special thanks to our  producer, Kyle Cangialosi. Please be sure to subscribe to our podcast and sign up for our weekly  newsletter, ESG Insider. See you next time.  

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