Physical Climate Risk and the Financial Sector – Investors’ Climate Information Needs

By | July 28, 2020

This post is the latest in our special issue: “Climate Change and Financial Markets – Risk, Regulation, and Innovation.” To learn more about the special issue and the work of the Global Financial Markets Center around climate change and financial markets, please read the special issue’s introduction here. And to review all The FinReg Blog posts that touch on climate change, go here.


As financial markets are paying more attention to climate change and the financial cost of climate hazards increase, investors are looking for more transparency and precision in physical climate risk assessment tools to support their financial decisions.

Climate-related risks for investors entail two main facets: (1) transition risk, or changes in climate policy and regulations, which can result in an explicit or implied price on carbon emissions, potentially ‘stranding’ assets supporting fossil fuel infrastructure, and (2) physical climate change, e.g. changes in temperature, precipitation patterns, and extreme events. The impacts of physical climate change can place a severe strain on company facilities, employees, and the communities on which companies depend. Indirectly, it may also cause transportation, communication, and supply chain disruptions. Ultimately, these can affect equity, debt, and real estate assets in investors’ portfolios.

Under the current climate, which is approximately 1°C above pre-industrial temperatures, we already experience the impacts of physical climate change. This includes extreme weather, floods, drought, heat stress, and sea level rise (). There are risks and associated costs of direct physical impacts of weather-related events (Morel et al. 2015). Sustained high temperatures have resulted in decreased worker productivity (Kjellstrom et al. 2018), and changing rainfall patterns have affected agricultural markets (Sullivan 2014). Financial regulators are raising concerns about investors’ exposure to physical risks (BoE 2018; DNB 2017). Analyses show increasing losses— both insured or not—in assets due to natural catastrophes and extreme weather events of dozens of billions USD a year (EC 2013; Swiss Re 2018)

Over the last five years, service providers have developed tools intended to help financial decision makers identify, manage, and disclose physical climate risk. The tools available vary in scope and focus and only a few provide a transparent look at data sources or methodology, making it difficult for investors to tailor approaches to their investment portfolios.

While one line of research has focused on stranded assets that could come about via changes in climate policy (transition risks), there is a lack of concentrated study on financial impacts of climate change via production and supply chain disruptions, physical damage, and changes in resource pricing and demand.

Further, there is a plethora of climate scenarios and modelling at global and regional levels, but it is difficult for investors to translate the results to actual risks on their assets in specific sectors or locations, and the appropriate times’ scales, i.e. 1–5 years versus 20+ years.

Specific assessments and guidance interpreting physical climate risk linkages to financial implications are emerging. In 2017, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) published recommendations on improving the reporting standards for climate-related risks and opportunities (TCFD 2017).  Moreover, the European Union’s regulation on the establishment of a framework to facilitate sustainable investment (EU Taxonomy) is in the pipeline.

Climate services can provide improved indicators and metrics to help investors better manage physical climate risks and make better investment decisions in a changing climate. In our chapter, Physical Climate Risks and the Financial Sector—Synthesis of Investors’ Climate Information Needs, we provide an overview of investors’ needs and information gaps regarding the physical impact of climate change and identify what information sources financial actors rely on and the challenges they face in decision-making based on available climate change information.

The chapter presents results from the ERA4CS-JPI Climate research project ClimINVEST, coordinated by CICERO Center for International Climate Research and including Wageningen Environmental Research, I4CE Institute for Climate Economics, Carbone4, Climate Adaptation Services and Météo France. ClimINVEST aims to provide transparency on methodologies for physical climate risk assessment and develop guidance tools that inform investors’ risk management processes.

To develop tailored climate services for the financial sector, we argue that it is essential to convene climate change researchers and financial decision-makers to facilitate investor’s decision-making on climate-proof investments and build public understanding of climate-related risks. The user needs identified in our synthesis further underscore the importance of collaborative efforts between scientific research and finance on improving climate-related risk information, connecting climate hazards and financial impact, and facilitating disclosure of climate risk in investment portfolios in line with the recommendations from the Task Force on Climate-related Financial Disclosures (TCFD).

Comparison of physical climate risk service providers

Financial institutions are beginning to explore physical risk with service providers that use diverse approaches. Comparing across service provider approaches, there is a range of climate hazards covered but limited transparency on the underlying methodologies, and a limited scope of scenarios employed.

Nevertheless, they all try to answer the same type of question: how climate change can potentially affect investments, projects, companies, governments?  For more details on the review from 2018, see I4CE (2018)

To investigate potential impacts, the approaches combine information on four broad categories: climate hazards; the counterparty’s exposure to these hazards; the sensitivity of the counterparty to this exposure; and its capacity to address these potential impacts.

The approaches reviewed build on public data sources for climate hazards which are further processed by service providers internally. Further, they provided scores or quantitative estimates with different details. The information provided to end users also differed through the type of detail (e.g. per type of hazard, climate scenario, time horizon, category of impact, counterparty) and the level of detail (e.g. counterparty or sectorial level analysis) they provide.

The scope of hazards covered by each approach varied. Most of the reviewed approaches at the time of study addressed acute climate-related phenomena (e.g. hurricanes, heat waves, drought and floods) while coverage of chronic phenomena was emerging (for example some approaches focus specifically on water availability). Some methodologies showed differences in the indicators that describe a given hazard (for example water stress can be studied through either the mean yearly water supply or intra-year variability of water supply), but several approaches offered limited transparency about the chosen indicators.

In addition, the existing methodologies covered by this analysis addressed different climate-related impacts on corporate counterparties. They focused on different scopes of the counterparty’s exposure; for instance, some methodologies cover the upstream and downstream value chain and the logistics, whereas others covered operations only. In the same vein, only a few covered capital, labor, natural resources, and the macro context.

At the time of the review, forward-looking analyses were starting to be integrated into physical climate risk analyses. Service providers often included forward-looking scenario-based analyses for climate hazards with variable time horizons (from 15-years up to 2100) and typically used a single scenario, which is not sufficient to reflect the range of potential long-term risks.

Case studies from France, the Netherlands and Norway

In order to provide insights into physical climate risk and investor needs, our chapter presents three geographical case studies that offer unique perspectives. France, the Netherlands, and Norway have all been at the forefront of understanding physical climate-related risk in their respective financial and regulatory environments. Their efforts complement the activities of the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD), which developed recommendations at a broad level for company disclosure of climate-related risks.

In France, the 2015 Energy Transition for Green Growth Act (Article 173-VI and V) requires institutional investors to report on their integration of climate-related risks in their investment policies. This triggered a dialogue between banks, insurers, and financial regulators on how to integrate climate-related risks in risk management tools.

In the Netherlands, the changing climate is challenging the Dutch Central Bank and financial institutions to deal with potential flood risks from more frequent and heavier precipitation and sea level rise.

In Norway, actors such as Finance Norway and the Norwegian government are assessing the risks from physical impacts of climate change on the Norwegian economy. The sovereign wealth fund manager (Norges Bank Investment Management NBIM) is a leader in working on climate-related risks.

Investors’ key information needs on physical climate risk

Although the country-specific contexts of France, the Netherlands, and Norway are unique and the case studies present differences, we have identified some common key needs of investors regarding physical climate risk across the three countries. This reflects the needs of a range of different investor types, e.g. pension funds, asset managers, insurance, and banks, and is categorized as risk awareness, risk analysis, and risk management. The synthesis focuses on the investors information needs for developing and improving understanding of physical impacts of climate change, for qualitative and/or quantitative estimation of physical climate risk and for identifying and implementing plans, actions, or strategies to reduce the implications of these risks.

First, there is a need for in-house capacity building and training within financial institutions on physical climate impacts to increase risk awareness. This should target both sustainability and risk managers and include training on available and reliable information and how to use it. There is also a need for clearer communication on the value creation of climate change opportunities in reducing risks.

Secondly, financial institutions need better tools and metrics for risk analysis, to assess how climate change, including increases in flooding and extreme weather events, and associated physical impacts affect assets in specific sectors, markets, and locations.

Thirdly, investors are asking for consistent, granular data on climate-related risks and there is a need for forward-looking scenario-based analysis.

Finally, with regards to risk management, our chapter identifies a need for guidance and information to better engage with companies on climate-related risks as well as clear information from researchers on uncertainty related to the probability of physical impacts of climate change.

Financial institutions need to prepare for physical climate risks now, but they face a lack of science-based information relevant for their decisions. The investor needs identified in our chapter underscore the importance of collaboration between research and finance on improving climate-related risk information.


Acknowledgements: The ClimINVEST project, that provided funding for the chapter that is the basis for this article, is part of ERA4CS, an ERA-NET initiated by JPI Climate, and funded by RCN (NO), ANR (FR), NWO (NL) with co-funding by the European Union (Grant 690462).


Karianne de Bruin is an environmental economist at Wageningen University & Research. She specializes in the field of adaptation economics, decision-making under uncertainty and climate services.

Romain Hubert is a project manager at I4CE. Romain works on integrating climate-related risks in the analysis and management of financial risks.

Julie Evain is a research fellow at I4CE’s Finance, Investment and Climate Division, addressing climate risk analysis topics.

Christa Clapp is the leader of the Climate Finance group at CICERO. She has over 20 years of experience with climate policy and economic analysis topics.

Miriam Stackpole Dahl is a senior communications advisor at CICERO, specialized in communication and international relations. She has experience with strategic communication, media relations and stakeholder outreach at the national and European level.

Jaclyn Bolt is a business innovator at Wageningen University & Research, with expertise in development and implementations of sustainable business models and financial mechanisms.

Jana Sillmann is the leader of the Climate Impacts group at CICERO. She is a geo-ecologist, specialized in analysis of climate extremes in climate models.

This post is adapted from the book chapter “Physical Climate Risks and the Financial Sector—Synthesis of Investors’ Climate Information Needs” in W. Leal Filho and D. Jacob (eds.), Handbook of Climate Services, Climate Change Management, available here.

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