Climate Risk Methodologies

David Carlin

Head of Climate Risk

In this video, David Carlin gives an overview of some of the current climate risk methodologies used by climate risk tool providers and he explores some of the approaches and general workflow for assessing both transition and physical climate risk.

Climate & Biodiversity

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Climate Risk Methodologies

5 mins 17 secs

Key learning objectives:

Understand the general process workflow and approach to transition risk assessment
Understand how physical risk assessment is conducted

Overview:

It is clear that there are a lot of factors for financial institutions to consider when carrying out a climate risk assessment. Transition risk assessment generally involves backward and forward-looking data, while physical risk assessment considers hazards, vulnerability, and exposure. The best way to approach this is through a comprehensive and multidimensional approach that covers both physical and transition risks.

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Summary

How can we approach transition risk assessment?

Transition risk assessment uses two sets of data:

Backward looking dataset - Reflects the status quo (eg: current emissions)
Forward looking dataset - Projected for scenarios of different possible futures

Then different metrics are used to assess different types of risks, impact assessment, alignment strategy and target setting. Most of the tools that perform transition risk assessment use a general analysis structure. When users provide data inputs, climate risks can be identified through transition risk scenarios. Depending on the different channels, these risks can then transmit into financial risks as well as producing financial opportunities. The results or analysis output are often shown as some kind of climate-adjusted financial risk indicator.

What is the general workflow used in transition risk assessment?

It begins with selecting a target temperature alignment or warming limit that the client company or institution wants to align with, often following a specific scenario or pathway. Next, socio-economic parameters, such as the level of technology development and economic development, will be identified. Then, those assumptions are then fed into a climate model that experts will use to generate analysis on what the pathway will look like to that particular temperature outcome.

How is physical risk expressed?

Physical risk is generally expressed as:

Risk =Hazard x Vulnerability x Exposure

Hazards refer to potentially damaging physical events or human activities that harm the environment, human health, or cause economic disruption.
Exposure relates to the risk faced by assets in climate events.
Vulnerability refers to the susceptibility to those hazards when thinking about physical, social, and economic factors.

How are physical climate risks assessed?

The 6-step process as outlined by the World Bank:

Define needs and objectives
Identify available data and resources
Define the scope and approach
Generate relevant scenarios
Estimate the impacts
Present and interpret the final results.

Tool vendors can measure hazard, exposure, and vulnerability at different levels like: country, regional, sectoral, company, or portfolio level. Then considering various variables that impact supply chain disruptions, productivity loss, and overall financials. Physical risk assessment outputs can then be expressed in metrics such as climate value-at-risk, physical risk score amongst others

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David Carlin

David Carlin is the Head of Climate Risk and TCFD Programme at UNEP FI where he has worked with over 100 financial institutions to explore the risks and opportunities presented by climate change and the transition to net zero. He also conducts research at the intersection of climate, nature, and finance at Cambridge’s Institute for Sustainability Leadership. David is also an advisor to governments, firms, and solutions providers as he helps them to explore how they can integrate sustainability and climate-readiness into their strategies and operations.

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