IIF Authors

Status: Will be live at 05/24/2023 08:00

Emissions Impossible: Quantifying financial risks associated with the net zero transition

On Wednesday, May 24, the IIF and WTW published a joint research report which examines emerging metrics to quantify climate transition risk to financial institutions.

Financial institutions identify, measure and monitor transition risk using a variety of data and tools. Transition risks can arise due to changes in policy or regulation, technology and consumer preferences, as well as potential legal risk. Despite the development of multiple frameworks to assess, categorize and disclose financial institutions’ exposures to climate transition risk, there remains little formal consensus as to the most suitable and relevant data and metrics through which to do so.

This report examines some of the metrics which have emerged to quantify climate transition risks to financial institutions. It evaluates metrics according to their informational content and attributes, including their degree of risk sensitivity, as well as the degree to which they are objective and verifiable.

The research takeaways are that:

  • Many climate-related metrics are based on greenhouse gas (GHG) emissions, which may not be a comprehensive indicator of a firm’s exposure to transition risk. This is because measures of emissions suffer from systematic reporting biases, tend to be backward-looking, and may not accurately capture how a firm’s profitability is likely to be affected by an increase in the cost of emissions. Empirically, we find low correlation between measures of a firm’s emissions intensity and direct measures of its climate transition risk (see Figure 3 below).
  • Quantifying transition risks to financial institutions is inherently complex. Multiple metrics may be needed to provide a comprehensive view of a financial institution’s exposure to transition risk.
  • More complex and risk-sensitive metrics may be better suited to financial institutions’ internal measurement and management of transition risk. Metrics that are more verifiable and objective have the benefit of enabling comparison across firms; they may, therefore, be better suited to use in financial institutions’ disclosures.
  • Financial institutions and authorities should be mindful of the relative strengths of different metrics, and use metrics for purposes to which they are suited. 

Transparency disclaimer: The IIF and WTW have collaborated to produce this analytical paper, which is not intended to promote any specific metrics or providers. WTW is a provider of climate-related data and metrics one of which, Climate Transition Value at Risk (CTVaR), is used and profiled in this paper. The paper is not an exhaustive overview of all available metrics, nor is it an endorsement of CTVaR or any other metric. Other firms, including other IIF members, provide alternative metrics.

For more information about WTW and its capabilities relating to climate risks, please visit the WTW Climate and Resilience Hub.