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Reflecting climate reality in financial decision-making

Together with Cindy Coltman, Linda supported Carbon Tracker and the Sustainable Finance Lab in organising an event for financial sector practitioners. The event took place on the 6th of November 2024 at the Ortec Finance office in Rotterdam.

The event led to some key takeways, do’s and don’ts and key questions to ask for managing climate risks:

Flawed Economic Thinking on Climate

  • Outdated Damage Functions: Integrated assessment models misalign with climate science.
  • Underestimated Physical Damage: Models overestimate the time available to address issues.
  • NGFS Phase V Update: Key uncertainties like climate tipping points remain unaddressed.
  • Implications: Serious risks for financial markets.

Bridging Climate Science and Economics

  • Rapid Emission Reductions: Similar to COVID-19 levels, annually for 20 years.
  • Net Zero by 2030: Requires deep systems change, innovations, policies, and financial system overhaul.
  • Economists and Banks: Consider costs of inaction, higher default risks for carbon-intensive loans, and increased capital requirements.
  • Government Role: Set policies, regulatory signals, and support for developing economies and new technologies.
  • Public Institutions: Scale blended finance and decarbonisation pathways globally.
  • Climate Resilience: Support vulnerable regions to avoid “doom loops” between governments and local financial sectors.
  • Bank Engagement: Assess companies against sector averages and support decarbonisation efforts.

Overcoming Climate Scenario Analysis Limitations

  • IAMs and Neoclassical Models: Current models don’t consider financial systems.
  • Models as Delay Instruments: Underestimated impacts can create false security.
  • Breaking the Horizon Tragedy: Use credible narratives, quantitative models, and expert judgement.
  • Investor Actions: Set climate targets, engage with portfolio companies, and assess vulnerability to climate risks.
  • DNB Survey: Many pension funds lack ESG risk assessments, including climate risks.
  • Upcoming Guide: Updated climate and nature-related risks guide in early 2025.
  • CSDDD Directive: Requires climate transition plans from companies, excluding the financial sector for now.

Do’s in Climate Scenario Analysis

  • Use a wide range of scenarios, including stress scenarios for tail risks.
  • Understand the narratives and assumptions behind these scenarios.
  • Incorporate both short-term and long-term impacts in your analyses.
  • Clarify assumptions and uncertainties, including economic models and risk inclusions.
  • Present long-term physical risks clearly, not just annualised impacts.

Don’ts in Climate Scenario Analysis

  • Don’t base strategies on exact timings of shocks. Test resilience for immediate shocks.
  • Avoid assigning probabilities to specific scenarios. Explore a wide range.
  • Incorporate impacts from all scenarios into your baseline.
  • Don’t see scenarios as predictions. They explore possible pathways.
  • Avoid reporting long-term impacts only in cumulative annualised terms. This can distort the message.

Do’s in Climate Risk Mitigation

  • Adopt a sustainable investment strategy:
    • Engage with companies to align with a below 2-degree trajectory.
    • Divest from companies not decarbonizing.
    • Invest in climate solutions and adaptation.
  • Use scenario analysis for policy advocacy.
  • Implement a concentrated portfolio with long-term stewardship to understand company actions and climate risks.

Accompanying Resources

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