Climate risks, both physical risks from extreme weather events and transition risks associated with shifting to a low-carbon economy, can significantly affect company valuations and investment strategies. Failure to account for these risks threatens not only the long-term viability of green loans or bonds in a rapidly evolving market landscape, but also results in missed opportunities in rightly identifying transition financing needs. Moreover, if not properly accounted for, these risks also invite risks related to reputational damage and activism. As a result, investment banks and sustainable finance advisory firms must integrate climate risk into their analytical frameworks. As investors increasingly prioritize sustainability, understanding the financial implications of climate-related factors becomes crucial.

One investment bank - a Japanese bank with a global presence -  has successfully integrated climate risk into the valuation and risk pricing criteria through its newly established Sustainability Solutions Department, positioning itself as a global leader in sustainable finance, thus attracting a growing base of conscious investors.

The newly established Sustainability Solutions Department recognized the urgent need to quantify climate-related impacts to advise their clients effectively. Understanding the financial implications of climate change is crucial for sound guidance; employing robust methodologies to assess and simulate climate risk effects on corporate financial statements, builds confidence in strategic recommendations for clients with corporate finance advisory and sustainability-linked issuances in capital markets. Equipped with reliable financial projections that include climate-related considerations, the department positions clients advantageously in a rapidly evolving landscape.

Pain Points

The staff of the newly created department was composed of existing bank staff who were generally new to the topic of climate risk and had minimal experience quantifying the impact of climate change. This lack of experience. Their ability to provide comprehensive, climate impact-related advisory services to their global clients was hindered by the following:

• Lack of Expertise in Quantifying Climate Risk: The department required a granular quantitative framework for assessing the projected impact of climate risks to the financial profile of a corporate.
• Inability to Identify Transition Financing Opportunities: Without established methodologies for quantifying climate change, the department struggled to provide actionable insights on transition financing gaps that needed to be fulfilled.
• Lack of Industry-Specific Analysis: Without sector-specific nuances within climate scenario analysis, the industry research team was unable to conduct the appropriate research on the impact of climate change on specific industries for its recommendation to clients.

These pain points collectively underscored the need for the department to adopt a robust climate risk assessment framework. By addressing these challenges, the firm knew it could enhance its advisory capabilities, ensuring that clients receive well-informed guidance in navigating the complexities of climate change and its financial implications. Adopting a proactive approach also both strengthened client and positioned the firm as a leader in sustainable finance.

The Solution

The award-winning Climate Credit Analytics is a climate scenario analysis model suite, which was launched in 2021. Climate Credit Analytics makes the critical link between climate change and credit risk by translating climate scenarios into drivers of financial performance (e.g., production volumes, fuel costs and capex spending) tailored to specific industries. These drivers are then used to condition and forecast complete financial statements of corporates under various climate scenarios, including those published by the NGFS, a group of over 160 central banks, financial authorities, and observers [1].

Developed through a collaboration between S&P Global Market Intelligence and Oliver Wyman,[2] Climate Credit Analytics includes an automated capability to evaluate more than 2.2 million public and private companies in over 145 sectors [3], as well as the ability for users to input proprietary information to expand this analysis. The solution covers five carbon-intensive sectors (Airlines, Automotive, Metal & Mining, Oil & Gas and Power Generation) and provides an Emissions-based approach for all other sectors to complete the portfolio analysis. Climate Credit Analytics leverages S&P Global Market Intelligence’s proprietary datasets and capabilities, including financial and industry-specific data, sophisticated quantitative credit scoring methodologies and the company-level environmental and physical risk datasets that powers many of S&P Global’s sustainability solutions.

Key Features

• Industry leading methodology based on a framework developed in collaboration with the United Nations Environment Programme Finance Initiative, tailored to provide comprehensive sector coverage.

• Road tested solution with broad market adoption, including use by major financial Institutions participating in regulatory climate scenario analysis and stress testing exercises in multiple jurisdictions spanning Europe, Asia, and the Americas. Also leveraged and referenced in industry research.
• Flexible scenario analysis with pre-loaded scenarios from the Network for Greening the Financial System (NGFS) and major regulators globally. In addition, users have the option to run customized scenarios or assess near-term exposure to climate transition risks, such as the implementation of a global carbon tax.
• Comprehensive portfolio analysis via six bottom-up models which cover 140+ industries under the GICS (Global Industry Classification Standard) code via a product specific approach for high carbon emitting sectors, such as oil and gas, power generation, metals and mining, automotive and airlines, plus an emissions-based approach for the remaining non-financial sectors, and a top-down approach for name-based extrapolation.
• Coverage of private and public companies utilizing S&P Global Market Intelligence’s company fundamental information and a waterfall approach to data enabling full portfolio analysis, even in cases where granular data is not readily available. The offering enables automated bottom-up analysis for 2.2 million companies. Where users have the requisite information, a proprietary analysis capability is also available.
• Differentiated datasets including industry and asset-specific data, emissions data, and physical risk data from Sustainable1, all of which enrich the analysis and provide granularity to the approach.
• Validated model suite supported by a detailed methodology guide (200+ pages), that has been successfully accepted and approved for use by Model Risk Management teams at multiple banks.
• High degree of flexibility enabling users to perform sensitivity analysis on many parameters and tailor key assumptions (e.g., counterparty transition planning) for decision-useful insights.
• Easy Implementation via a selection of delivery methods (e.g., Excel and API) to enable smooth integration into existing processes and workflows.
• Sophisticated quantitative credit scoring methodologies that translate the risk into credit scores and default probabilities, using either CreditModel™ or Probability of Default Model Fundamentals model (“Credit Analytics models”), a statistical suite of credit models by S&P Global Market Intelligence [4].

Key Benefits

Implementing a comprehensive climate risk quantification solution offers several key benefits for the Sustainability Solutions Department, enabling the investment bank to enhance its advisory services significantly:

• Enhanced Risk Assessment: By utilizing advanced analytical tools and reliable data, the department can help assess and quantify climate-related risks for their clients. This capability allows for a more nuanced understanding of how environmental factors may impact corporate financials, leading to more informed decision-making.
• Informed Client Advisory: With the ability to project climate conditioned financials, the department can provide clients with tailored insights on potential climate impacts on corporate finance transactions and capital requirements.
• Competitive Advantage: By integrating climate risk assessments into their advisory framework, the firm positions itself as a leader in sustainable finance. This proactive approach not only meets the growing demand for environmentally responsible investment strategies but also differentiates the firm in a competitive market, attracting a broader base of environmentally conscious clients.

Overall, these benefits not only enhance the department's operational efficiency but also contribute to the firm's long-term sustainability and success in a rapidly evolving financial landscape. By adopting this solution, the firm Is well-equipped to navigate the complexities of climate change, ensuring that it remains at the forefront of sustainable finance.

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^{[1] NGFS, as of August 20, 2024, https://www.ngfs.net/en/about-us/membership}

^{[2] Oliver Wyman is a third-party consulting firm and is not affiliated with S&P Global or any of its divisions.}

^{[3] All coverage numbers as of August 2024.}

^{[4] S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence PD credit model scores from the credit ratings issued by S&P Global Ratings.}