By David Carlin, TCFD Programme Lead, UNEP FI (this article was originally published on Forbes)

As the financial sector has turned its attention to climate change, the demand for climate tools and analytics has skyrocketed. Financial institutions are deploying climate tools to enhance climate-related financial disclosures, complete regulatory climate stress tests, assess strategic decisions, and align portfolios to net-zero emissions. A robust marketplace of tool providers has developed to support these institutions, with new solutions, data, and methodologies appearing almost daily. The rapidity of development can feel overwhelming, but financial actors can become more informed consumers of climate tools by understanding the current and emerging trends.

Partnerships and acquisitions

Professional services firms have looked to enhance their client-facing offerings through partnerships with data providers and acquisitions of climate specialty firms. The creation of Climate Credit Analytics by Oliver Wyman and S&P exemplifies such a partnership. Acquisitions of specialist climate consultancies or tool providers also represents a way for larger firms to bolster their climate capabilities, as demonstrated by the acquisition of Acclimatise by Willis Towers Watson.

Combined approaches to transition and physical risks

Data and methodologies for assessing transition and physical risks differ significantly, so most providers have built tools to assess one of these two major risk types. While both transition and physical risk analyses provide useful insights, evaluating a firm’s overall climate risk must consider both risk types. Although most underlying models for physical and transition risk remain separate, more tools are aggregating losses to provide an “all-in” perspective on climate risk. However, at present, few providers have integrated the potentially complex interaction effects between physical and transition risks into their tools.

Tools to meet regulatory requirements

Across the world, regulatory requirements on climate are rising, evidenced by the proposed climate-related financial disclosure mandate from U.S. Securities and Exchange Commission (SEC) and the ongoing climate stress tests of the European Central Bank and the Bank of England. Financial institutions are responding to supervisory pressure by engaging consultants and other third-party tool providers. Regulators seek to compare performance across their supervisees, meaning that there is greater demand for comparable methodologies and output formats. These developments have presented an opportunity for tool providers, some of whom have created dedicated tools or services for TCFD disclosures and climate stress testing exams.

New and improved physical risk data

While the insurance sector has a long history evaluating detailed physical risk data, many other financial institutions are just becoming acquainted with specific physical hazards and methodologies to quantify them. Even for insurers, climate change presents the difficulty of shifting baselines, as physical impacts become more frequent and severe in a warming world. Physical risk assessment demands detailed data on asset resilience and local vulnerabilities as similar assets and nearby locations may face vastly 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 showing interest in advanced analytical techniques such as machine learning and artificial intelligence. Cutting edge approaches for physical risk assessment have included data mining to identify potentially vulnerable assets and remote sensing to obtain early warning of extreme events. For transition risks, some providers have incorporated insights from behavioral economics to model the decisions of economic actors under various transition scenarios. New datasets and methodologies have also improved emissions tracking, including the use of satellite data to identify methane leaks.

Transition scenarios focused on net zero

The global consensus to limit global warming to 1.5 C above pre-industrial levels has influenced the types of transition scenarios financial institutions must use. Governments and companies are committing to net-zero by 2050 targets to align to this 1.5˚ C goal. Stakeholders are increasingly calling for more details on how companies will achieve their net-zero commitments. In addition, supervisors are creating stress tests with a variety of 1.5˚ C scenarios to assess transition risks. With the mainstreaming of 1.5˚ C ambition, most tool developers have enabled users to assess portfolios against one or more 1.5˚ C scenarios.

Rising expectations from 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 seek tools that go beyond exploratory analyses. Tool providers have responded by expanding their offerings to ensure they are fit for uses such as TCFD disclosure, climate stress testing, and net-zero portfolio alignment. Another trend among financial institutions is a desire to develop analytical capabilities in-house. This has pushed tool developers to create more bespoke solutions that integrate well into existing risk and business infrastructure.

The landscape of tools

The climate tool space will continue to evolve to enhance outputs and meet emerging use cases. To support financial institutions in understanding the range of tools, methodologies, and providers, UNEP FI released The Climate Risk Landscape in 2021. That report explored transition and physical risk tools from almost forty different providers.

In 2022, UNEP FI took stock of the latest developments in climate tools in their 2022 Supplement to The Climate Risk Landscape. That report features greater detail on some of the key trends noted above and extensive research into areas for future tool development. It also catalogues the actual experiences over a dozen financial institutions who piloted different third-party tools. These case studies provide the financial industry with detailed information about the processes, outputs, learnings, and challenges that institutions have identified when using tools.