Business risk and the emergence of climate analytics

The text discusses the increasing importance of climate change assessments in financial risk analysis and decision-making within global capital markets. Investment managers, advisors, corporate regulators, and standard-setting bodies are increasingly advocating for the integration of climate-related risks into investment strategies and financial reporting. Initiatives such as the Financial Stability Board's Taskforce on Climate-Related Financial Disclosures (TCFD) have established frameworks for reporting climate risks and opportunities, with some governments starting to mandate such disclosures. Additionally, central banks and supervisory authorities are recognizing the need to incorporate climate risk information into financial stability monitoring.

To accurately assess financial risks from climate change, particularly those associated with extreme weather events, there's a reliance on data from global and regional climate models, primarily sourced from the Coupled Model Intercomparison Project (CMIP). These models offer projections based on various scenarios, providing a range of possible climate futures. However, the text highlights significant challenges in using these models for financial risk analysis. Limitations include the models' ability to accurately represent climate phenomena and the difficulty in assessing the relative strengths of different models. Moreover, the models may not account for the 'skill' or independence of individual models, leading to potential inaccuracies in risk assessment.

Businesses demand climate risk information over various timescales, from short-term to several decades. However, the precise numerical outputs from climate models can lead to overconfidence in their reliability for financial decision-making. The article emphasizes the need for a nuanced approach to using climate data, integrating expert judgment and understanding the limitations of model predictions, especially for assessing risks from extreme weather events that disrupt business operations and asset values.

The emergence of Climate Service Providers (CSPs) is noted as a significant development. These entities utilize predictive climate analytics to assess an entity's risk profile, often employing proprietary methodologies. However, the rapid growth and sometimes opaque nature of these services raise concerns about the potential misuse of climate data, which can lead to maladaptation, overconfidence in risk assessments, and even the misrepresentation of risks in financial reports.

The article argues for a paradigm shift toward operationalizing climate modeling, akin to weather forecasting, to meet the detailed and specific demands of financial risk assessment. This entails a significant investment in climate science, including the development of high-resolution models capable of resolving weather-scale phenomena. Additionally, it calls for the establishment of climate translators, professionals trained to interpret complex climate data for business and financial decision-making. This new approach requires direct engagement between climate scientists and the business community to ensure that climate data is used appropriately and effectively.

In summary, while recognizing the critical role of climate change assessments in financial risk management, the text advocates for more robust, nuanced, and operationally-focused climate modeling. It highlights the need for better communication and understanding between the climate science community and financial sector to ensure that climate risk assessments are accurate, reliable, and ultimately beneficial for guiding business strategies and protecting financial stability in the face of climate change.