Transition risk poses a significant near-term threat to the economy. This is one of the findings released today in the latest set of three UNEP Finance Initiative reports on climate risk management tools for financial institutions.
The latest guidance is the result of a
leading-edge project that convened 39 banks to pilot the recommendations
of the Task Force on Climate-related Financial Disclosures (TCFD)
building on previous UNEP Finance Initiative work. The package of
reports also includes guidance on understanding how the impacts of
climate change and the low-energy transition may impact our society and
economy and an overview of the various tools and analytics available, as
well as the potential technological and regulatory developments that
may shape climate risk tools in the future.
Climate scenario analysis is a key tool in measuring and managing
climate risks. Climate scenarios produced by Integrated Assessment
Models (IAMs) are increasingly being used by financial institutions to
identify and assess climate risks. UNEP FI’s report, ‘Pathways to Paris’
is a practical guide for financial practitioners looking to understand
and apply climate scenarios. Co-authored with the Center for
International Climate Research (CICERO), a world-renowned research
institution on climate and climate finance, the report examines the
driving assumptions and sectoral coverage of the models used to produce
climate scenarios, as well as the benefits and limitations of using
these pathways. As the report argues, deeper collaboration and dialogue
between financial institutions and scenario developers is essential to
linking climate-related risk drivers to financial impacts. Over the
course of the past year, UNEP FI has piloted its transition risk
methodology with 39 banks. This paper outlines the lessons learned and a
series of recommendations for enhancing the development and application
of IAMs by financial institutions. Reflecting these views, a North
American bank explained that greater granularity, additional
consideration of sectoral dynamics, and shorter time-horizons would help
financial institutions more effectively use these scenarios. In
CaixaBank’s case study, they highlighted a need for greater transparency
in the models’ “underlying assumptions” and the treatment of
“reputational risks” and “stranded assets,” within the scenarios.
‘Decarbonisation and Disruption’ highlights the ways in
which many sectors are exposed to transition risk. If not properly
managed, a disorderly transition could have major ramifications for
financial stability. Financial institutions need to not only prepare for
the transition along with their counterparties but must have the right
tools for risk assessment. Insert example from case study here if poss.
This paper was supported with analysis from Oliver Wyman, a leading
global management consultancy with deep risk expertise. The paper
includes bank case studies that affirm greater economic risks associated
with disorderly transition scenarios compared with orderly transition
scenarios. Banco Bradesco’s case study highlighted the usefulness of the
assessment exercise, stating that “transition risk analysis tools are
important allies to identify subsectors that are most resilient to
policies aimed at a low carbon economy, as well as those that are most
exposed to these risks.”
There is a burgeoning market for physical and transition risk tools which may be difficult to navigate. UNEP FI’s report, ‘The Climate Risk Landscape’
provides an overview of the various tools and analytics available,
including an assessment of their key characteristics. The report also
looks at the potential technological and regulatory developments that
will shape climate risk tools over the coming years. In comparing the
methodologies and coverage across tools, UNEP FI offers financial users a
view of the relative benefits and limitations of each approach.
Reflecting on the guidance and experiences showcased in the two reports,
UNEP FI Head, Eric Usher said, “as these scenario reports indicate,
deeper collaboration and dialogue between scenario developers and
financial practitioners is essential for linking climate-related risk
drivers to financial impacts. Over the past year, UNEP FI has repeatedly
brought together these parties (along with regulators and supervisors)
to support the adoption of climate scenarios in financial
decision-making.”
These three reports on climate risk analysis complement previous guidance
on this topic which also covered climate risk disclosure practices as
well as high-level transition-risk heatmapping and sectoral analysis.
In 2021, UNEP FI launched its latest TCFD programmes for banks and
investors, building on the key learnings and achievements of prior
pilots. These new programmes will bring new joiners up to speed on the
fundamentals of climate risk assessment, while exploring such topics as
climate scenario analysis, integrating physical and transition risk
analysis and road-testing some of the commercially available climate
risk tools identified in ‘The Climate Risk Landscape’. By leveraging the
convening power of the United Nations, UNEP FI’s TCFD programme will
engage regulators, climate experts, and financial practitioners to
empower the financial sector to manage its climate risks and play a
positive role in the low-carbon transition.
UNEFI
© UNEP
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