10 November 2022

How can we enable the financial sector to deliver on its climate commitments?


By Cervest

How can we enable the financial sector to deliver on its climate commitments?

To mark COP27’s finance day on 9th November, we turned our attention to the financial sector, looking at the progress that has been made, why understanding climate risk is so crucial for the industry, and how business leaders can drive action with climate intelligence.

Climate change is almost unanimously recognized as the key emerging risk across the financial sector. Most financial organizations have publicly committed to climate action, and climate-related risk is a regular item on board agendas. While taking these first steps is crucial, we are still a long way from turning these commitments into actions.

It’s inevitable that large-scale systemic change across the financial sector will take time, but time is precisely what we don’t have. According to the IPCC’s latest report, we need to halve global emissions by 2030 to limit warming to 1.5°C. That deadline is now 8 years away. What the sector is struggling with is not what it needs to do, it’s the how. The question is, how can we enable the sector to bridge the gap between commitment and action?

We need a better understanding of climate-related risk across the financial sector

When it comes to climate change, delivering on climate action across the financial sector is no easy task. Especially when there is so much riding on getting this right. Action across the sector needs to address multiple intersecting challenges; quantifying the impacts of climate change on its own operations and getting visibility of the extent of exposure to climate risk, supporting customers and clients to navigate and manage their risk and make the right funding and investment decisions to drive the implementation of global mitigation and adaptation.

Climate risk is not easy to quantify, partly because climate risk analysis needs to be based on projections of future climate scenarios, and partly because climate-related data is fragmented and complex, and companies do not have the climate science expertise in-house to help quantify their climate risk directly from climate-related data. Intelligence solutions that facilitate the measurement of physical and transitional climate risk analysis are highly necessary - and they are also currently available. EarthScan™, for example, equips companies with meaningful risk insights about fundamental material climate impacts.

Facilitating action for the financial sector

The scale and speed of progress depends on overcoming two significant obstacles - lack of asset-level granular data and access to standardized, comparable and shareable climate risk data. A recent study from the European Central Bank found that when it came to identifying climate-related risks, 96% of banks had blind spots and this was a barrier to comprehensive understanding of the magnitude of risk they face. The study attributed this large number of blind spots to a lack of asset-level, granular data. Without asset-level data, the sector can’t gauge the full extent of their exposure to climate risk and how its climate risk will develop over time. This information is essential for financial organizations to make climate-informed decisions about the level of climate-related risk they can accept and the actions they need to take.

Cervest’s climate intelligence product, EarthScan, has been designed to unlock precisely these two challenges. Recently, we launched Cervest Ratings™, which evaluate the potential for climate-related risks to cause physical damage to individual assets, portfolios, companies and financial securities so everyone can interpret and understand their climate-related risks. We know our customers and partners need transparent, easily explainable ratings to quickly prioritize assets across their portfolio so we have designed Cervest Ratings to enable them to report their risk to different stakeholders, strengthen pre-acquisition due diligence and investment strategies and inform adaptation planning on their most vulnerable assets.

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Fit-for-purpose metrics

The financial system doesn't yet have universally accepted metrics to incorporate all the many dimensions of climate risk into decision-making. In particular, the financial sector needs metrics that assess the potential damage and financial impact of climate events. However, drawing a straight line between climate change and real-world financial outcomes is complex.

The drivers of physical climate risk are not economic, which presents three key challenges for businesses wanting to identify their material climate-related risks; discovering your exposure to climate hazards across geographically distributed assets, translating that exposure into impacts such as physical damage to assets and translating climate hazard impacts into a meaningful financial metric. The best candidate to address this metric gap is Climate Value-at-Risk (CVaR), a metric that translates climate hazard exposure metrics into estimates of potential physical damage that can be translated into financial losses.

Economic security is key for a resilient future and it’s clear that the opportunities exist to get these essential items in place and support the financial sector to extend its capabilities when it comes to climate-related risk. The European Central Bank is clear that swift progress is possible. They have set an active expectation for the banking sector to map out the data they need and get access to asset-level intelligence in place, to be fully able to manage their climate-related risk by 2024.

EarthScan™ has been created to help everyone navigate the complexities of climate change, make decisions about how to allocate resources and capital to protect existing investments and assets from the impacts of climate change, finance new climate-resilient projects and support the decision-making capabilities of their customers and clients.

To stay up-to-date with the latest news and COP27 insights from Cervest, read our COP27 daily journal, or to discover more about your asset-level climate risk, sign up to EarthScan™.

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