The need to understand the interconnectedness of the climate risk has never been greater, according to a new report.
Climate Tango: Principles for integrating physical and transition climate risk assessment with sectoral examples, a joint report from the University of Cambridge Institute for Sustainability Leadership and the UN Environment Programme Finance Initiative, has taken a systemic approach to understanding and addressing sustainability.
The report found that such an approach is critical to the financial sector tackling the complex network of interconnected issues. It warned: “Despite growing awareness of the interrelation of challenges that face people, nature and climate, we must recognise that integrated assessments of sustainability issues remain at an infant stage. To address this will require significant attention in the coming years to bring disparate areas of research together in the same dance.”
The report proposes five principles for conducting a combined assessment of physical and transition risks (integrated climate-risk assessment). These principles are then unpacked in a step-by-step process to apply the ClimateWise physical and transition risk frameworks, to help financial institutions implement this approach and build understanding among staff.
Principles for integrated assessment of physical and transition risk include:
- Approach: Conduct transition and physical risk analysis simultaneously
- Level of analysis: Be sector-specific as well as location-specific
- Quantification: Capture climate risk impacts via forward-looking metrics
- Scenario-based analysis: Take into account feedback loops between physical and transition risk
- Relevance: Align to TCFD pillars. Conducting an integrated climate-risk assessment in line with the principles proposed above can then be translated into the following steps. Principles 1 and 2 to set the focus of the assessment are covered within Step 1, and Principles 3, 4 and 5 on the design and approach of assessment are captured in Steps 2 and 3 on the method of assessment.
It also provides step-by-step guidelines:
Step 1 – Identification: Choose the scope of risks and sector to be assessed
Step 2 – Illustration: Capture the interplay between transition and physical risks • Identify how transition risks impact physical risks • Identify how physical risks impact transition risks • Map out the interaction with a risk matrix
Step 3 – Materiality: Quantify the risk transmission channels • Apply climate scenarios suitable for integrated climate-risk assessment • Interpolate the climate-related risks to financial factors through transmission channel.