Charting aNew ClimateState-of-the-art tools and data for banks to assess credit risksand opportunities from physical climate change impactsTCFD Banking Pilot Project Phase IISeptember 2020Charting a New Climate 1

DisclaimerAcclimatise Group Ltd (“Acclimatise”) was commissioned bythe UN Environment Programme Finance Initiative (“UNEP FI”)Working Group, which includes the following thirty-nine banks:ABN-AMRO, ABSA, Access Bank, Bank of Ireland, Barclays, BMO,Bradesco, Caixa Bank, CIBC, CIMB, Citibanamex, Credit Suisse,Danske Bank, Deutsche Bank, DNB, EBRD, FirstRand, ING,Intesa Sanpaolo, Itau, KBC, Lloyds, Mizuho, MUFG, NAB, NatWest, Nedbank, NIB, Nomura, Nordea, Rabobank, Santander,Scotia Bank, Shinhan, Standard Bank, Standard Chartered, TDBank, TSKB, UBS (the “Working Group”), to develop a blueprintfor assessing the climate-related physical risks and opportunities for banks’ corporate credit portfolios. This report extendsthe work completed by Acclimatise, UNEP FI, and the participating banks in Phase I of UNEP FI’s TCFD banking program.Acclimatise, UNEP FI, and the Working Group shall not have anyliability to any third party in respect of this report or any actionstaken or decisions made as a consequence of the results,advice or recommendations set forth herein. This report doesnot represent investment advice or provide an opinion regarding the fairness of any transaction to any and all parties. Theopinions expressed herein are valid only for the purpose statedherein and as of the date hereof. Information furnished byothers, upon which all or portions of this report are based, isbelieved to be reliable but has not been verified. No warranty isgiven as to the accuracy of such information. Public information and industry and statistical data are from sources Acclimatise, UNEP FI, and the Working Group deem to be reliable;however, Acclimatise, UNEP FI, and the Working Group makeno representation as to the accuracy or completeness of suchinformation and has accepted the information without furtherverification. No responsibility is taken for changes in marketconditions or laws or regulations and no obligation is assumedto revise this report to reflect changes, events or conditions,which occur subsequent to the date hereof. This documentmay contain predictions, forecasts, or hypothetical outcomesbased on current data and historical trends and hypotheticalscenarios. Any such predictions, forecasts, or hypotheticaloutcomes are subject to inherent risks and uncertainties. Inparticular, actual results could be impacted by future eventswhich cannot be predicted or controlled, including, withoutlimitation, changes in business strategies, the development offuture products and services, changes in market and industryconditions, the outcome of contingencies, changes in management, changes in law or regulations, as well as other externalfactors outside of our control. Acclimatise, UNEP FI, and theWorking Group accept no responsibility for actual results orfuture events. Acclimatise, UNEP FI, and the Working Groupshall have no responsibility for any modifications to, or derivative works based upon, the methodology made by any thirdparty. This publication may be reproduced in whole or in partfor educational or non-profit purposes, provided acknowledgment of the source is made. The designations employed andthe presentation of the material in this publication do not implythe expression of any opinion whatsoever on the part of UNEnvironment Programme concerning the legal status of anycountry, territory, city or area or of its authorities, or concerningdelimitation of its frontiers or boundaries. Moreover, the viewsexpressed do not necessarily represent the decision or thestated policy of UN Environment Programme, nor does citing oftrade names or commercial processes constitute endorsement.CopyrightCopyright UN Environment Programme, September 2020This publication may be reproduced in whole or in part and inany form for educational or non-profit purposes without specialpermission from the copyright holder, provided acknowledgement of the source is made. UN Environment Programmewould appreciate receiving a copy of any publication that usesthis publication as a source. No use of this publication may bemade for resale or for any other commercial purpose whatsoever without prior permission in writing from the UN Environment Programme.

AcknowledgmentsAuthorsThe Phase II pilot project wasled by a Working Group of thirtynine banks convened by theUN Environment ProgrammeFinance Initiative:AcclimatiseABN-AMROABSAAccess BankBank of IrelandBarclaysBMOBradescoCaixa BankCIBCCIMBCitibanamexCredit SuisseDanske BankDeutsche BankDNBEBRDFirstRandINGIntesa NordeaRabobankRBSSantanderScotia BankShinhanStandard BankStandard CharteredTD BankTSKBUBSRobin Hamaker-TaylorConsultant, Financial a ConnellChief Technical Officer and [email protected] KhosaTechnical Director, [email protected] FirthChief Executive Officer and [email protected] RycerzManagement [email protected] TurnerRisk Analyst and GIS [email protected] OwainRisk [email protected] [email protected] BaterRisk [email protected] HaworthSenior Risk [email protected] SteevesSenior [email protected] BagleeTechnical [email protected] LinaresData [email protected] UniversityRobert WilbyProfessor of Hydroclimatic [email protected] ManagementThe project was set up, managed, and coordinated by the UN Environment ProgrammeFinance Initiative, specifically:Remco FischerProgramme Officer, Climate Change [email protected] CarlinTCFD Programme [email protected] Environment Programme Finance Initiative and Acclimatise Group Ltd would liketo express their gratitude to the following individuals and organizations who contributed to the Phase II program:Lorenzo AlfieriEuropean Commission JointResearch CentreLisa AlexanderUniversity of New South WalesYochanan KushnirColumbia UniversityLorenzo MentaschiEuropean Commission JointResearch CentreRobert NichollsUniversity of East AngliaJosh ThompsonLoughborough UniversityCarbon Delta / MSCICarbone 4Climate CentralCLIMAFINFour Twenty SevenJBA Risk ManagementOasis HubOasis Loss Modelling FrameworkPrinceton Climate AnalyticsRhodium GroupWorld Resources Institute

ContentsExecutive Summary.11. Introduction. UNEP FI Phase II banking pilot forphysical climate risks and opportunities. 72. Extreme events data and portals. for review.12Extreme event types.12Review of extreme events data and portals.13Additional data sources andscientific programs on extreme events.233. Physical climate risk heatmappingof bank portfolios. 313. Banking for resilience: Analysis of opportunitiesdriven by physical climate risk.866. is meant by ‘opportunities’in the context of physical risk?. 87Drivers of physical climate risk-relatedopportunities.88A framework for assessing opportunitiesassociated with physical climate risks.93Bank case studies.957. Future directions.1007.1.7.2Charting the way forward.100Building the climate risk andopportunity ecosystem. 101Appendix A: Correlation analysisstudies for real estate.104Objectives. 31Heatmapping concept and methodology. 31Heatmapping exercise by Phase II banks. 37Appendix B: Correlation analysisstudies for agriculture. 1094. Tools and analytics for physical climate riskassessment of financial risk.42Appendix C: Acronyms and Abbreviations. 1124. of physical climate risk assessment toolsand analytics.43Summary of gaps and areasfor improvement.53Bank case studies.535. Physical risk correlation analysis ofFI s.66Correlation analysis. 67Modes of climate variability withimpacts on real estate and agriculture.70Worked example of correlation analysis.73Summary.79Pilot study.80Advanced analysis.84References.114

Executive SummaryContextThree years on from the publication of the Task Force on Climate-related Financial Disclosures(TCFD) recommendations, the financial sector’s attention is firmly focused on climate-relatedrisks and opportunities. The TCFD recommendations aimed to promote forward-looking scenario-based assessments of climate change by financial institutions and corporates, and for the findings to be incorporated into their strategic decisions. Since then, the Network for Greening theFinancial System (NGFS), a grouping of central banks and supervisors, has been established andits membership has grown at a fast pace. The NGFS aims to contribute to the development of environment and climate risk management in the financial sector, and to mobilize mainstream financeto support the transition toward a sustainable economy. Its members have collectively pledgedsupport for the TCFD recommendations. In another major development, the Principles for Responsible Banking (PRB) were established by UNEP FI and member banks in 2019. Signatory banks tothe PRB (more than 180 by August 2020), have committed to align their strategy and practice withthe vision that society has set out for its future in the Sustainable Development Goals and the ParisClimate Agreement. UNEP FI has run pilot projects on implementing the TCFD recommendationsfor over 90 banks, investors, and insurers. Many other processes and organizations aim to tackleclimate risk and opportunity in the financial sector.This new focus on climate-related risks and opportunities sits within a context of intensifying climate change impacts. The Intergovernmental Panel on Climate Change (IPCC) SpecialReport on global warming of 1.5 C estimates that human activities have already caused about1 C of global warming above pre-industrial levels.1 If global GHG emissions continue to increaseat the current rate, warming is likely to reach 1.5 C by around 2040 and up to 4 C by the end of thecentury. Yet the world will face severe climate impacts even with 1.5 C of warming. Physical risks– which result from climate variability, extreme events and longer-term shifts in climate patterns –are already being experienced and are set to intensify in the future.This report describes the outputs of the UN Environment Programme Finance Initiative (UNEPFI) Phase II banking pilot which lays out state-of-the-art tools and data for assessment ofphysical climate-related risks and opportunities by banks. The Phase II pilot, involving 39 UNEPFI member banks from six continents, focused on addressing key methodological challenges highlighted in its predecessor Phase I report, ‘Navigating a New Climate’.2 As the climate policy contextevolves, banks are more focused on meeting the emerging expectations of financial industry regulators. While the emphasis at present is on assessing risks, banks have a key role to play – and anenormous business opportunity to realize – in providing finance for governments, businesses andconsumers to invest in adaptation measures.This Phase II report provides rich technical guidance and information on the resources available to support forward-looking scenario-based assessments of physical risks and opportunities. The tools and data to support banks’ physical risk and opportunity assessments must begrounded in robust scientific evidence, be usable within the context of banks’ other data, toolsand systems, and facilitate comparability between banks. While these needs are not yet fully met,significant advances have been made.Charting a New Climate Executive Summary 1

Phase II pilot project activities and outputsThe Phase II pilot activities were structured as a set of five modules: Module 1: Extreme events data and portals – reviewed examples of climate andclimate-related extreme events data and portals from both public (free to use) andcommercial data providers. While there are many portals providing data on projected futureincremental changes in temperature and precipitation, the Phase I pilot identified a lack ofdata on future changes in extreme events. The examples included in the review were purposefully selected to cover a wide range of extreme event types of relevance to banks’ loan portfolios. The review applied an analytical framework which covered: whether the provider givesobserved and/or future data; spatial resolution and spatial coverage of the datasets; theoutput formats; and data accessibility.Piloting banks also provided their views on how the data and portals can be strengthened tobetter meet their needs for undertaking portfolio physical risk assessments. The banks identified trade-offs between ‘one stop shop’ data portals which bring together multiple hazardtypes and thus facilitate comparison between hazards at the same location, versus providerswho specialize in one or two hazards at high quality (e.g. high spatial resolution, wide range ofreturn period statistics). Banks were enthusiastic about using data portals which allowed forhazard data to be downloaded and integrated into their own systems, as client data confidentiality can constrain them from uploading data to external analytics platforms. Module 2: Portfolio physical risk heatmapping – recognized the benefits of examining totalportfolio exposure and identifying where higher physical risks may lie before moving onto ‘deep-dive’ assessments of at-risk portfolio segments. The module explained the widerange of impact channels through which physical risks can affect counterparties’ performanceacross their entire value chains, encompassing operations, physical assets, supply chainsand markets. It described the three components of risk that can be evaluated in heatmapping,using the IPCC’s risk definition – vulnerability, hazards and exposure.The module also summarized a collective activity by Phase II pilot banks who worked towardsreaching a shared view on key areas of vulnerability and relevant hazards for six sectors ofinterest. While banks’ views differed, their key sector-based findings on vulnerabilities were: Agriculture, forestry and fisheries are highly vulnerable due to their reliance onclimate-sensitive natural resources (water, land) and labor health and productivity, whereoutdoor workers can be exposed to extreme events. Metals and mining activities depend on water availability, while competition with otherwater users are often key issues for mining operations. More frequent heatwaves can alsoimpact labor productivity and operating hours at mine sites. Power and energy sector vulnerabilities vary between sub-sectors. Hydropower and thermal power generation are highly dependent on water for operation. In comparison, solarand wind generation were considered less vulnerable to climate-related factors. Within oil and gas, extraction of crude petroleum and natural gas are vulnerable due totheir dependence on natural resources and outdoor workers (who are also often workingin extreme environments). Further, changes in seasonal demand for fuels for heating andcooling can be expected. Manufacturing needs large quantities of water and land for operation of the sector’s fixedassets. Real estate is vulnerable to changes in market demand driven by physical risk, as experience of extreme events, particularly when coupled with insurance concerns could makesome real estate locations less desirable, while opening up investment opportunities inothers.2 Charting a New Climate Executive Summary

Module 3: Tools for physical risk assessment of financial risk – aimed to improve banks’understanding of commercially-available tools and analytics, as well as training the PhaseII banks to utilize the Phase I Excel-based methodologies.a The module examined commercial tools and analytics using a framework which considers their coverage of climate scenarios,time horizons and hazards; their approach to analyzing physical risks; the required user inputs;and the outputs provided. The tools and analytics are differentiated according to their level ofanalysis (ranging from portfolio-wide assessments through to analysis of individual assets);the impact channels covered; and their methodologies for impact assessment.Several piloting banks provided case studies on their experience of applying and further developing the Phase I methodologies to provide initial physical risk assessments for specificsectors, whereas others engaged in direct discussions with commercial providers to evaluate their tools and analytics. Some piloting banks identified parts of their real estate portfolios which could experience future depreciation in property values due to extreme events,and potential increases in the probability of default (PD) for energy and oil & gas companies.The banks highlighted some benefits from trialing the physical risk tools, including bringingtogether teams of experts from across the bank to look at climate change risk, and developingtheir understanding of potential risks to segments of their portfolios. They also identified challenges faced during the piloting process, including collation and processing of bank-held dataand insufficient granularity or lack of data on counterparties. Module 4: Physical risk correlation analysis of FI portfolios – was developed as banksrecognized the value of having a deeper understanding of observed relationships betweenloan performance metrics and climate-related events. Some banks have reported thatborrowers are already being affected by climate and weather events, and these effectsprovide early signals of a changing climate, and empirical evidence which may help to calibrate forward-looking physical climate risk assessments. The module provided a step-bystep process for banks to undertake correlation analysis with a worked example using actualproperty values for an anonymized coastal city and its neighborhoods in the US. The resultsrevealed neighborhoods and types of house experiencing ‘climate gentrification’ – a termused to describe increases in real estate values in neighborhoods that are more resilient toclimate-related threats.3 The module also summarized recent developments in scientificresearch on correlation analysis and more sophisticated statistical techniques, based on areview of more than 50 studies investigating flood, drought and wildfire risks within the realestate and agriculture sectors. A pilot bank applied correlation analysis to begin to evaluatehow a major wildfire in South Africa may have affected the value of nearby properties. Theirresults showed a deceleration in price increases after a major fire event for properties locatedclose to the wildfire. Module 5: Analysis of opportunities driven by physical climate risk – aimed to provideinsights into the climatic, business, policy and market-led drivers of physical risk-related opportunities. The scale of investment needed for adaptation over the next 10 years isenormous and cannot be met by public budgets alone – both public and private finance areneeded to meet this challenge. Opportunities for banks to support the adaptation needs oftheir clients were found to vary depending on the region, market and industry in which a bankoperates. Understanding the changes taking place in business sectors and with clients as theyare impacted by a changing climate, being aware of the adaptation responses they need tomake, and recognizing the challenges presented by the Paris Agreement and a green recoveryfrom COVID-19 were found to be critical. The module reiterated the opportunities frameworkdeveloped in the Phase I pilot, which helps banks identify where to focus their adaptation andresilience financing efforts. The framework was designed to provide a strategic market assessment within the context of a bank’s institutional capacity and market positioning. Applicationof the framework can show where a bank is best-placed to assist its clients. Piloting bankssummarized actions they were taking and planning, to help clients adapt and build resilienceto physical climate risk. In turn, these actions provide business opportunities to the bank insectors including agriculture, water-intensive industries, real estate, urban development andinfrastructure.aThe methodologies are detailed in the Phase I report, ‘Navigating a New Climate’.Charting a New Climate Executive Summary 3

The five modules are shown in the numbered rings in Figure 1, mapped on to the cause-effectchains linking climate hazards to risks and opportunities for banks. Some of the modules targetseveral elements in the cause-effect chains, e.g. Module 5 supports analysis of client adaptationneeds, solution provider opportunities, and associated opportunities for banks. Furthermore, analysisof some elements in the cause-effect chains is supported by more than one module, e.g. Modules 2,3 and 4 all help with assessment of risk to banks’ loan portfolios.Figure 1: The Phase II pilot modules map on to the cause-effect chains linking climate hazardsto risks and opportunities for banksLooking forwardThe imperatives for banks to assess and act on physical climate-related risks and opportunities have never been greater – nor have their needs for robust tools and data to support theirassessments. The modules developed through the Phase II pilot have charted out state-of-the-arttools and data to help them on this journey. Nevertheless, challenges remain, and the Phase II pilothas shed light on the very real practical constraints that banks face in making strides forward.Evaluating physical climate-related risks and opportunities in loan portfolios requires datawhich translate climate science into impacts on clients and the wider economy, and onwards tofinancial metrics used by banks. It requires knowledge of how physical risk can affect the entirevalue chains of banks’ counterparties – not only their physical assets and operations, but also theirsupply chains and markets, and their environmental and social performance. It requires an understanding of how well-prepared counterparties are for the risks that lie ahead, of their adaptation4 Charting a New Climate Executive Summary

plans, and of the risk mitigation that will be provided by insurers and governments. Evaluating allthese factors within loan portfolios is no mean feat, and the data collection and analysis effort canappear daunting.While more work lies ahead, the pilot has shown that the Phase II tools and data can providereal help to banks in charting their way forward:Heatmapping proved to be an efficient approach which helped to focus attention on portfoliosegments meriting deeper analysis. The collaborative sector vulnerability exercise by pilotingbanks identified many cause-effect chains through which climate change can affect indicatorsof investment performance. It demonstrated the richness and complexity of physical climaterisk, and also revealed differences of opinion among the banks on the degree of vulnerabilitiesfacing sectors and subsectors. The commercially-available tools and analytics for physical risk assessment enable banks tobegin evaluating credit impacts. The range of tools / analytics shows that providers have madesignificant advances in facilitating physical risk analysis across counterparties’ value chains.Yet they still lack depth and data on some key aspects of counterparty physical risk. Pilotingbanks also identified challenges in corralling together in-house datasets and in assessing risksfor SME clients. Correlation analysis and more advanced statistical techniques for analyzing relationshipsbetween loan performance metrics and climate-related events show great potential andshould be further explored. The pilot has identified a large body of research on these techniques applied to real estate and agriculture, which can be built upon by banks to develop theirown analyses, grounded in empirical data specific to their portfolios. Even this is not enough to fully grasp the systemic nature of climate change and its interactions with other risk factors. This report is published in the wake of the COVID-19 pandemicwhich has demonstrated the implications of failing to understand and manage systemic risks. LikeCOVID-19, climate change can lead to systemic risk, and requires models capable of appraisingmultiple hazards and system interdependencies. COVID-19 has demonstrated the limits to currentrisk management practices which are invariably focused on fragmented appraisal of risk. Management of systemic risk must improve if a robust response to climate change is to be achieved.Banks have not yet understood and realized their potential opportunities to support clients’investments in adaptation. The banking sector has a critical role to play in implementation of theParis Agreement by mobilizing financial flows to deliver adaptation and climate resilience. ThePrinciples for Responsible Banking provide a driver for banks to assess and report on their climateresilient investment/lending opportunities, as signatories to its framework are committed to aligning with the Paris Agreement and to conducting impact assessments and target setting aroundpositive impacts alongside negative impacts. Banks must recognize their pivotal role in financingeconomies and societies that are prepared for the unavoidable physical risks that lie ahead.Charting a New Climate Executive Summary 5

1. Introduction:Helping banks respond to anevolving climate landscape1.1.ContextThe publication of the voluntary recommendations of the FSB Task Force on Climate-relatedFinancial Disclosures (TCFD) in June 2017 proved to be a game-changer for focusing the financial sector’s attention on climate-related risks and opportunities. Just three years later around1,400 organizations have signed up as TCFD supporters, and a lot else has changed. December2017 saw the establishment of the Network of Central Banks and Supervisors for Greening theFinancial System (NGFS) by eight central banks and supervisors. Since then, NGFS membershiphas grown rapidly, reaching 69 members and 13 observers by July 2020. In 2018, the Intergovernmental Panel on Climate Change (IPCC) Special Report on global warming of 1.5 C4 showed thatthe world will face severe climate impacts even with 1.5 C of warming above pre-industrial levels,and the effects are significantly worse at 2 C. The Principles for Responsible Banking (PRB) wereestablished by UNEP FI in 2019. Signatory banks to the PRB, numbering more than 180 in August2020, have committed to aligning their strategy and practice with the vision that society has setout for its future in the Sustainable Development Goals and the Paris Climate Agreement.5 UNEPFI has run pilot projects on implementing the TCFD recommendations for over 90 banks, investors,and insurers.b Other financial sector initiatives are focused on mainstreaming frameworks for themanagement of climate-related risks and opportunities, developing new approaches and creatingnew guidance and tools.cRegardless of the success and rate at which global greenhouse gas (GHG) emissions arecontrolled, some anthropogenic climate change is already locked into the earth’s climatesystem over coming decades and centuries. According to the IPCC Special Report on globalwarming of 1.5 C, human activities are estimated to have already caused about 1 C of globalwarming above pre-industrial levels. If global GHG emissions continue to increase at the currentrate, global warming is likely to reach 1.5 C by around 2040 and up to 4 C by the end of the century.Physical risks—those risks resulting from climate variability, extreme events and longer-term shiftsin climate patterns—are already being experienced and are set to intensify in the future.A dramatic transformation across economies is required over the next 10 years to transfer toa sustainable development pathway, consistent with achieving net zero by 2050 at the latestand managing unavoidable physical risks. This will require radical actions by all stakeholders.Governments for example will have to effect change through enacting targeted policies and regulations to ensure public services, infrastructure and natural environments are resilient to climatechange. Business will need to direct more investment toward adaptive t

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