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 Crisis

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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 an acknowledged authority on climate change and its implications for the financial system. He is the founder of D. A. Carlin and Company, an advisor to governments, corporates, and financial institutions on climate and ESG topics. He has authored numerous reports that provide practical tools for financial actors looking to address climate change and has run capacity-building programs for financial institutions and supervisors around the world. David led the creation of UN Environment Programme’s- Finance Initiative (UNEP FI)’s Risk Centre as the head of Risk. Over the past years, he has worked with over 100 global banks, investors, and insurers on climate scenarios, climate risk assessments, and climate governance. He has been an advisor to UNEP FI’s TNFD pilot program on nature and biodiversity related risks, the Net-Zero Banking Alliance (NZBA), and the Glasgow Financial Alliances for Net Zero (GFANZ). David is also a contributor to Forbes and a senior associate at Cambridge’s Institute for Sustainability Leadership (CISL) as well as a visiting fellow at King’s College London. David has worked as a Principal in Finance, Risk, and Public Policy for Oliver Wyman and in Model Risk Management for PNC Bank. His background is in quantitative modeling and decision science.

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