By Rajul Mittal, Head of Sustainable Finance & ESG, Synechron, The Netherlands & Parul Vyas, Sr. Associate Research & Strategy, Sustainable Finance & ESG Team, NYC
World leaders have been busy negotiating how we can best mitigate the worst effects of climate change at COP27, but as we have already seen this year with record breaking temperatures and droughts, climate change is happening now. The reality is that even with drastic action, we need to expect and be prepared for more extreme weather events and the financial risks associated with them.
I challenge anyone to think of an investment that will be immune to climate risk. Big businesses have complex supply chains, relying on natural resources, cheap energy and productive agriculture. As the war in Ukraine has shown, stress on a major grain exporter and disruption to energy supply has major ramifications across the globe. And with climate change, the potential impact on our global economy will be much greater.
The uncertainty of climate change makes factoring in the risk extremely challenging for any investor, but fund managers and fund selectors must question their exposure to it. The answer lies with ‘Climate Data.’
The need for climate data
Climate data focuses on long-term patterns and provides information about a particular location’s atmospheric conditions, temperature, precipitation, seasonal weather trends, and the probability of an inevitable climate-related disaster happening soon. It allows you to check the intensity and frequency of a climate-related event, probability of damage, price of insurance, and potential resale value of homes. As such, this data is of great importance to banks and portfolio managers.
Climate data also helps boost growth in many sectors, so access to it can not only help increase resilience but also open up opportunities. For example, the agricultural sector is hugely affected by extremes of weather in terms of crop yields and livestock health. Through climate data, farmers can better plan which crops to grow when faced with an environmental calamity.
Not only this, but climate data is also critical in gauging national government creditworthiness. The global economy is impacted by how the financial sector generates, analyses, and uses the forecasted climate risk data. According to Moody’s, the heat waves are “credit negative” for a country like India, where the long-term credit exposure to physical climate risks is making the economic growth more volatile and more likely to experience economic shocks. Investment banks, with the help of climate data, can save millions of dollars in investments by analysing macroeconomic factors like company performance and product sales which can be severely affected by climate change.
There is also a regulatory imperative. Regulatory frameworks are increasingly emphasising the need for better quality and more transparent climate data. In the UK the Task Force on Climate-related Financial Disclosures (TCFD) has developed a framework to help public companies and other organisations disclose climate-related risks and opportunities. Reporting against this framework became compulsory for the UK’s largest businesses in Spring this year. And in the US, the proposed U.S. Securities and Exchange Commission (SEC) climate risk rules state that all publicly traded companies in the United States will be required to disclose how they are impacted by the physical risks of climate change.
Challenges with Climate Data
But despite the clear need for climate data in analysing investments, acquiring good quality and reliable information presents certain challenges.
Complexity and expertise
Private and public sector users need climate data that has been as fine-tuned as possible and is available in understandable, workable formats. Most of the time, there is a glaring gap between what climate data is currently available and what the companies need. Even if reliable access is possible, the information is often too complex, and there can be a lack of expertise in assessing and interpreting the most viable climate model.
Additionally, climate data comes with a heavy price tag. The cost of researching, gathering, and monitoring data for climate scenario analyses often exceeds a given company’s budget, leaving them unprepared for extreme climate events. Sometimes, the climate model is downscaled to such a level that it misses the crucial data points that would lead to useful discussions of relevance and response.
Lack of universal data
Another significant roadblock is the lack of universal access to climate data. The rising demand for customized climate data has been a profit-making opportunity for data providers. Rather than focusing broadly on regional, national, or global climate risk data, climate data providers create data tailored to specific blue-chip companies or decision-makers. The ongoing pursuit of profit has shifted the motivation for climate science and research away from the public interest.
Like the ESG data landscape, a lot of focus is on the large cap companies when it comes to climate data. This is true both for what the market has in terms of climate data on companies and what the companies themselves disclose in terms of climate impact.
Open access to reliable climate data is still a work in process. Without open access more affluent sectors of society, or wealthier nations, will be better protected from extreme climate events since they are able to pay for such data. Experts suggest that governments should defer the responsibilities to the private sector and allow a more innovative and technology-dependent path to gather climate data. Others suggest that the responsibility should remain exclusively with the government. It remains to be seen how this unfolds.
However, the most practical approach seems to be a public-private partnership where the climate data is shared via an open governance system. In September 2022, the Climate Data Steering Committee (in the U.S.) recommended the design of a newly available data utility, the Net-Zero Data Public Utility, to address the data gaps, uncertainty, and inaccessibility that slow climate action. The committee will advise how to capture, create, and maintain an open, centralised climate data system to accelerate the transition towards a net zero global economy.
The simple fact is that without reliable data access, the nature and scale of the problem cannot be accurately assessed and in turn, investments can’t be thoroughly analysed. We’ll need to watch for progress on this, but in the meantime, wealth managers need to seek climate risk assessments wherever possible, and mine the data presently available.