Climate risk assessments: understanding and mapping climate risk scenarios

March 20, 2023
The ESG App
UNEP published its latest Climate Risk Landscape report in March 2023. This is a continuation of reports published in 2020 and 2021, which provided an initial overview of the various publicly available climate risk assessment tools, and reflected on the use experience of the financial institutions.

UNEP published its latest Climate Risk Landscape report in March 2023. This is a continuation of reports published in 2020 and 2021, which provided an initial overview of the various publicly available climate risk assessment tools, and reflected on the use experience of the financial institutions. The objective of the latest report is to help financial institutions better understand the variety and limitations of climate risk tools and frameworks.

This report highlights three types of risks related to climate that financial institutions should monitor as part of their climate risk assessment program. Two of these, physical and transition risks, are already being incorporated to some extent by financial institutions in their current climate risk management approaches.  Physical risks refer to risks resulting from environmental events such as floods, wildfires, and landslides, among many others. Transition risks are associated with policies, technologies, laws, and similar actions designed to shift the economy toward lower fossil-fuel consumption. This report introduces a third potential risk, those related to legal liability (i.e. litigation). These can include people or businesses seeking compensation for losses associated with physical or transition risks, for example.

Physical risk scenarios continue to be underpinned by assumptions of the IPCC RCPs, primarily through a moderate emissions pathway (RCP 4.5) and a high emissions scenario (RCP 8.5). The IPCC (Inter-governmental Panel on Climate Change) established the Representative Concentration Pathway (RCP) scenarios for atmospheric GHG concentrations which measure the amount of warming that could occur by the end of this century. The RCPs are labelled after a possible range of radiative forcing values in the year 2100 (values commonly used include: 2.6, 4.5, 6.0, and 8.5 Watts per square meter). These values indicate the level of warming that is likely to occur, with 2.6 representing a mild scenario, and 8.5 representing an extreme case. The IPCC working groups use these scenarios to contrast a world with extreme climate change with a world in which emissions remain low.  

Some physical risks mentioned in the report, including their secondary effects, are

* (Acute) Hurricanes and typhoons, where coastal regions and islands are the most vulnerable since they are affected not only by the direct impact of a storm but also by secondary hazards, such as storm surges and pounding waves.

* (Acute) Floods, which may cause disruption of services, health impacts such as famine and disease, and tertiary effects could change the position of river channels, leading to landslides.

* (Acute) Wildfire risks whose secondary effects include erosion, landslides, impaired water quality, and smoke damage, often accompanying fire events.

* (Chronic) Rising sea levels lead to multiple adverse effects like coastal erosion, inundations, storm floods, tidal waters encroachment into estuaries and river systems, and contamination of freshwater reserves.

* (Chronic) Heat stress, in which the health impacts of rising air temperature are compounded by increased atmospheric water vapor, which reduces humans’ ability to dissipate heat.

* (Chronic) Drought stress, where increasing temperature, in addition to changes in precipitation patterns, can cause drier weather conditions and more intense and frequent drought events, which can have severe economic, environmental, and social impacts.

* (Chronic) Precipitation stress including frequent flooding. Heavy rainfall effects in urban areas can be especially catastrophic, endangering lives and damaging infrastructure.

Transition risks are related to the process of adjustment toward a low-carbon economy. The drivers of these risks are generally global, even though the specific nature of these drivers can vary in different countries. Transition risk assessments require access to detailed understanding and views about the development and deployment of future technology, a well-grounded set of emissions data, and a range of climate and macroeconomic models. Many transition scenarios make use of complex Integrated Assessment Models (IAMs), which provides directional insights on the effect of a particular event (e.g., market, technology, policy) on the future climate or economic outlook.

Some transition risks include

* Policy and legal risks such as enhanced emissions reporting obligations, mandates on and regulation of existing products and services

* Technology risks such as unsuccessful investments in new technologies and high upfront costs to transition to low-emission technologies

* Market risks such as uncertainties in market signals and shifts in consumer preferences

* Reputation risks such as the stigmatisation of sectors and increased stakeholder concern

As net-zero goes mainstream within the financial sector, climate finance is being increasingly recognised for its critical role in supporting the actions needed to combat climate change. To fill financing gaps under the Paris Agreement for both mitigation and adaptation, developed countries need to provide at least US$100 billion a year in climate capital. For their part, developing countries are facing adaptation costs of up to US$340 billion per year by 2030, increasing to US$565 billion per year by 2050 (source). The global gap is large and continues to widen and the pressing need to scale up commitments around climate finance is one of the reasons why climate risk assessment tools are crucial for financial institutions. It must be recognized, however, that there are certain challenges and limitations that these tools might never be able to overcome because of the uncertainty of climate change or because of the limitations of modelling and data. For instance, climate change does not necessarily follow a linear trajectory. Furthermore, its shocks do not follow a normal distribution, with tail-end catastrophes and tipping points as real possibilities .

The world is witnessing an increase in migration as individuals seek to relocate in hopes of escaping poverty, disease, and malnutrition resulting from changing ecosystems. The rapid activity witnessed in the private sector reflects the urgency to push for an immediate and all-encompassing transition toward decarbonisation. The international scientific community agrees that the global average temperature must be kept below 1.5°C above pre-industrial levels in order to avoid the worst possible climate outcomes. This is heavily influenced by the IPCC’s Special Report on Global Warming of 1.5°C report, which showed that the harmful effects of 2°C of warming are much more significant than those of 1.5°C. Increasingly, governments are either proposing firm net-zero goals or considering doing so. At present, over 91% of global GDP (representing 83% of global GHG emissions) is captured by government net-zero targets (source). A global consensus on the need to limit warming to 1.5°C and reach net-zero CO2 emissions by 2050 is in motion.

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