7 Major Developments in the Climate Tools Market
As the financial industry has turned to climate change, demand for climate tools and analytics has exploded. Financial institutions are deploying climate tools to improve climate-related financial disclosures, conduct regulatory climate stress tests, assess strategic decisions, and align portfolios to net zero emissions. A robust market of tool providers has grown to support these institutions, with new solutions, data and methodologies appearing almost daily. The speed of development may seem overwhelming, but financial actors can become more informed consumers of climate tools by understanding current and emerging trends.
Partnerships and acquisitions
Professional services firms have sought to improve their offerings to clients through partnerships with data providers and acquisitions of climate-focused companies. The creation of Climate Credit Analytics by Oliver Wyman and S&P illustrates such a partnership. Acquisitions of consulting firms or providers of specialized climate tools are also a way for large companies to strengthen their climate capabilities, as evidenced by the acquisition of Acclimatise by Willis Towers Watson.
Combined approaches to transition and physical risks
Data and methodologies for assessing transitional and physical risks differ significantly, so most providers have developed tools to assess one of these two main types of risk. Although transition risk and physical risk analyzes provide useful information, assessing a company’s overall climate risk should consider both types of risk. Although most of the underlying models of physical risk and transition risk remain distinct, more and more tools are aggregating losses to provide a “big picture” perspective on climate risk. However, at present, few providers have integrated the potentially complex interaction effects between physical risks and transition risks into their tools.
Tools to meet regulatory requirements
Around the world, climate-related regulatory requirements are increasing, as evidenced by the climate-related financial disclosure mandate proposed by the United States Securities and Exchange Commission (SEC) and the Bank’s ongoing climate stress tests. European Central and the Bank of England. Financial institutions are responding to pressure from supervisors by engaging consultants and other third-party tool providers. Regulators seek to benchmark the performance of their supervisees, which means there is greater demand for comparable methodologies and output formats. These developments have presented an opportunity for tool vendors, some of whom have created dedicated tools or services for TCFD disclosures and climate stress test reviews.
New and improved physical risk data
While the insurance industry has a long history of assessing detailed physical risk data, many other financial institutions are just beginning to learn about specific physical risks and methodologies for quantifying them. Even for insurers, climate change presents the difficulty of changing baselines, as physical impacts become more frequent and severe in a warming world. Assessing physical risks requires detailed data on asset resilience and local vulnerabilities because similar assets and nearby locations can face very different physical impacts. As a result, tool developers have been working to provide asset and address level granularity to financial users.
Growing interest in advanced analytics
Many financial institutions and tool providers are interested in advanced analytical techniques such as machine learning and artificial intelligence. State-of-the-art approaches to physical risk assessment have included data mining to identify potentially vulnerable assets and remote sensing to gain early warning of extreme events. For transition risks, some providers have incorporated insights from behavioral economics to model the decisions of economic actors in various transition scenarios. New datasets and methodologies have also improved emissions tracking, including the use of satellite data to identify methane leaks.
Net Zero Focused Transition Scenarios
The global consensus to limit global warming to 1.5C above pre-industrial levels has influenced the types of transition scenarios that financial institutions must use. Governments and businesses are committing to net zero emissions by 2050 to align with this 1.5°C target. Stakeholders are increasingly demanding more detail on how companies will achieve their net zero commitments. Additionally, supervisors create stress tests with a variety of 1.5°C scenarios to assess transition risks. With the integration of the 1.5°C ambition, most tool developers have enabled users to assess portfolios against one or more 1.5°C scenarios.
Growing expectations of financial institutions
In recent years, financial institutions have become more sophisticated in their understanding of climate risks and the tools to assess them. With growing regulatory, reputational and business incentives to understand climate change and the low carbon transition, financial institutions are looking for tools that go beyond exploratory analyses. Tool providers have responded by expanding their offerings to ensure they are suitable for uses such as TCFD disclosure, climate stress testing and net zero portfolio alignment. Another trend among financial institutions is the desire to develop analytical capabilities in-house. This has driven tool developers to create more bespoke solutions that integrate well into existing risk and business infrastructure.
The landscape of tools
The climate tools space will continue to evolve to improve outcomes and address emerging use cases. To help financial institutions understand the range of tools, methodologies and providers, the United Nations Environment Program Finance Initiative (UNEP FI) published The Climate Risk Landscape in 2021. This report explored the transition and physical risk tools from nearly forty different vendors.
In 2022, UNEP FI provided an update on the latest developments in climate tools in its 2022 supplement to the Climate Risk Landscape. This report features more details on some of the key trends noted above and in-depth research into areas for future development of the tool. It also lists real-world experiences from a dozen financial institutions that have piloted different third-party tools. These case studies provide the financial sector with detailed information on the processes, results, learnings and challenges that institutions have identified when using the tools.