Emissions Impossible: Quantifying financial risks associated with the net zero transition

The risks that climate change poses to the financial system are subject to increasing scrutiny from market participants, financial authorities and civil society. There is widespread recognition that financial institutions and authorities need to develop data and tools with which to measure and manage climate-related risks.¹

Such risks include climate transition risk: that is, the potential negative impact on organisations or asset values associated with the transition to a lower-carbon economy.²

Transition risks can arise due to changes in policy or regulation, technology and consumer preferences, as well as potential legal risk.³ Despite the development of multiple frameworks to assess, categorise and disclose financial institutions’ exposures to climate transition risk, there remains little formal consensus as to the most suitable and relevant data and metrics through which to do so.

This paper examines some of the metrics which have emerged to quantify climate transition risks to financial institutions. It evaluates metrics according to their informational content and attributes, including their degree of risk sensitivity, as well as the degree to which they are objective and verifiable.

Download the whitepaper below to read the full version.

The research takeaways are that:

• Quantifying transition risks to financial institutions is inherently complex. Multiple metrics may be needed to provide a comprehensive view of a financial institution’s exposure to transition risk.
• More complex and risk-sensitive metrics may be better suited to financial institutions’ internal measurement and management of transition risk. Metrics that are more verifiable and objective have the benefit of enabling comparison across firms; they may, therefore, be better suited to use in financial institutions’ disclosures.
• Financial institutions and authorities should be mindful of the relative strengths of different metrics (e.g. risk sensitivity versus objectivity/verifiability), and use metrics for purposes to which they are suited. For example, were the safety and soundness of financial institutions to be assessed using metrics based on their emissions, this could give a misleading representation of risk. It could also disincentivize financial institutions engagement in financing activities that are currently high emitting, yet critical in supporting economy-wide transition.

How WTW can help

WTW provides data-driven, insight-led solutions in the areas of people, risk and capital. Leveraging the global view and local expertise of our colleagues serving 140 countries and markets, we help businesses sharpen their strategy, enhance organisational resilience, motivate their workforce and maximise performance.

WTW helps its clients identify climate-related risks and turn them into opportunities. In particular, its Climate Quantified^TM data and analytical tools provide cutting-edge measurement of physical, transition and liability risks across a range of financial institutions and markets.

About the IIF

The Institute of International Finance (IIF) is the global association of the financial industry, with about 400 members from over 60 countries, including commercial and investment banks, asset managers, insurance companies, professional services firms, exchanges, sovereign wealth funds, hedge funds, central banks and development banks. The IIF’s mission is to support the financial industry in the prudent management of risks, to develop sound industry practices, and to advocate for regulatory, financial and economic policies that are in the broad interests of its members, and foster global financial stability and sustainable economic growth.

For more information about the IIF, please visit: Institute of International Finance

Footnotes

¹ See, for example, Financial Stability Board (FSB) (July 2021), The availability of data with which to monitor and assess climate-related risks to financial stability, thereafter referred to as FSB (2021).

² See Task Force on Climate-related Financial Disclosures (TCFD), Glossary and Abbreviations.

³ Drivers of transition risk set out in the Recommendations of the TCFD (June 2017).

Transparency disclaimer

The IIF and WTW have collaborated to produce this analytical paper, which is not intended to promote any specific metrics or providers. WTW is a provider of climate-related data and metrics one of which, Climate Transition Value at Risk (CTVaR), is used and profiled in this paper. The paper is not an exhaustive overview of all available metrics, nor is it an endorsement of CTVaR or any other metric. Other firms, including other IIF members, provide alternative metrics.