Climatewise launches transition risk modelling framework

Channels: SAA/ALM, Outsourcing, Risk, Governance

Companies: ClimateWise, Prudential Regulation Authority

People: Tom Herbstein, Mark Carney

The ClimateWise Insurance Advisory Council has launched an open-source framework designed to help investors and regulators assess how the transition to a low-carbon economy will impact the financial performance of infrastructure investments.

The modelling framework assesses the materiality of transition risk for infrastructure investment portfolios and can be used by asset managers on top of their own risk modelling.

Transition risk refers to the perils emerging from the transition to a low carbon economy, these can include policy changes, carbon taxes, reputational impacts and shifts in markets and technology.

Tom Herbstein, senior programme manager at ClimateWise, said: “We decided to use infrastructure as a focus for this project, as they are particularly vulnerable to transition risk from both a venue and cost perspective .”

The framework is an open-source tool for asset owners and managers to help them integrate the material financial drivers of transition risk into their own financial models. It also helps to quantify the breadth of asset types exposed to transition risk and opportunity as well as define the potential impact of that risk at asset level, Herbstein explained.  

The tool is aimed at decision makers and will be followed by a final report in the next month which will offer a step by step guide for practitioners on how to implement it.

Prior to its release the framework was tested on the portfolios of the asset manager arms of a large European insurer and of a large international bank. It was also tested on the portfolios of one of the largest direct investors in infrastructure and of a large third-party asset manager.

“The findings of the research is that although there is no immediate and dramatic threat from transition risk, for many asset classes a gradual increase in exposure, over time, will occur,” Herbstein said.

“The framework highlights how total divestment from the riskier assets is not necessarily the only option, as different geographies can introduce different levels of transition risk. This allows to think strategically on how best to manage their future risk exposure.”

Risk across different infrastructure assets is measured but risk across different geographies, namely Europe, the US and India is also taken into account.

“As an example, India, because of its carbon dependence will take longer to transition away from fossil fuels. Therefore, transition risk for gas energy generation over the next 20 years, is lower than in the US or Europe,” Herbstein explained.

“This means there are opportunities for asset managers to geographically diversify their portfolios, so it is not only about the risk but also identifying opportunities.”

The work is the first of two pieces commissioned by the ClimateWise Insurance Advisory Council. The second project, currently in development, is looking at the physical risk associated with geographic concentrations of risk within real estate lending portfolios.

The council was formed in 2016, on the back of Prudential Regulation Authority’s 2015 report on the impact of climate change on the UK insurance sector and Bank of England governor Mark Carney now famous speech Breaking the Tragedy of the Horizon. The insurance industry responded by setting up the The ClimateWise Insurance Advisory Council.

Formed of C-suite executives from the global insurance industry, the council is aimed at ensuring regulators and policy makers fully understand the nature of climate change risks. It is also tasked with identifying opportunities where regulators and the industry as whole can respond to such risks.

The ClimateWise Transition Risk Framework can be accessed here

Vincent Huck