From ESG Data to Decisions and Disclosures

Mastering Climate Risk Management

As more climate-related regulations are introduced globally, there is growing awareness among corporates that assessing and forecasting their future climate exposures is critical. In this in-depth interview, two experts from FIS and PwC discuss the latest compliance issues and how their firm’s respective work has resulted in an innovative solution to help firms model and assess their risk.

Eleanor Hill, TMI (EH): What are the most impactful financial compliance and disclosure regulations around climate risk management today, in your view? What do TMI readers need to be aware of?

Martin Sarjeant, FIS (MS): The regulatory environment has evolved significantly over the past 10 to 15 years from being fairly uncoordinated across governments and regulators globally to an increasingly concerted approach. The International Sustainability Standards Board [ISSB], which was formed as recently as 2021 and issued its inaugural standards just under a year ago, is certainly starting to help with that critical objective, most notably regarding corporate reporting.

The current key requirement, though, is for sustainability regulations to be adopted and promulgated across different territories. Last year we saw the EU’s Corporate Sustainability Reporting Directive [CSRD] come into force. The UK has pushed ahead with its corporate reporting measures under the Task Force on Climate-related Financial Disclosures [TCFD] initiative. In the US, the Securities and Exchange Commission [SEC] finalised climate change disclosure rules in March. Government and regulators across many other countries, including Canada and Australia, are also now active on this front.

We can expect further significant developments this year with regard to emissions reporting and compliance regimes. Organisations are becoming much more aware of all these developments globally and are beginning to get their heads around what they will need to disclose and report.

EH: In what ways are you seeing all this activity by governments and regulators beginning to impact corporates internally? What kinds of issues are cropping up for them as they analyse and prepare for what is coming down the road?

MS: Corporates know that developments from organisations including the TCFD, CSRD, and ISSB will have wide-ranging impacts across all functions. It’s all becoming far more interesting and relevant for treasurers and CFOs as a result – especially as there are real financial threats from climate risk. Regulatory proposals are increasingly more granular, and firms are beginning to recognise ‘climate’ as an actual risk that needs active management rather than just another element of their reporting exercises.

Operationally, data quality and collection is perhaps the biggest headache for organisations. Much of the data they need to model their climate risk exposures is fragmented. Some of it may be in document form, some on spreadsheets, some on databases and extended across multiple teams. Integrating all that, making it easy to access, analyse and manipulate, is a major challenge.

Companies are also having to understand where their climate exposure is in detail to properly assess their climate risks. It can be via physical assets, materials, and so on, but it can also comprise indirect assets, for example investments held by banks or loans made by them. The balance between these will obviously vary between organisations.  

Operationally, therefore, firms need to have a close handle on where their physical and transition risks lie at any given time to uncover potential opportunities for action that can help to mitigate them.

A good question for every company would be: “Do you understand where your climate risks are today?” I think it would be a very brave company that says it truly knows its position. In reality, as it stands, we are looking at a spectrum of understanding across companies. You can see that in their disclosures to date. Some companies go into great detail in their sustainability reports, others much less so. 

Richard de Haan, PwC (RH) I would also emphasise that we are now in a phase where we are moving away globally from voluntary reporting to formal disclosure and, ultimately, to independent assurance on some climate-related data. That, as Martin pointed out, is making life a lot more interesting for CFOs and treasurers. At PwC we are seeing many organisations taking a step back and looking at their entire financial reporting infrastructure to prepare to comply with new climate-related regulations.

I also agree very much with Martin that data is currently the major challenge. Traceable, verifiable, high-quality accessible data that can be readily interrogated for analysis and can stand up to auditing will be increasingly vital.

EH: Formalising processes within companies to accommodate these developments makes sense. However, I still encounter quite a few treasurers who are very circumspect and believe there are better ways to tackle climate risk. What would you say to them? What should treasurers be doing to help meet the emerging requirements?

RH: The key points to stress for those sitting on the fence is that regulators are going to need this information, and before long, it will also require independent assurance. Stakeholders – including investors, consumers and employees – will also be watching closely. In fact, in a recent survey PwC conducted, over 7 in 10 consumers said they think it’s important for businesses to disclose the risk that climate poses to their business. So, there is a very strong incentive for corporates to get this right. 

Moreover, by starting to learn about their climate risk exposure and putting in place processes to help with that, companies will also gain valuable intelligence that informs their business strategy, and that includes their supply chain. It’s an opportunity to get ahead of some of the broader risks that are going to be heading their way over the next five to 10 years, and figure out how they might impact, for example, investment policies and sourcing of raw materials.

The rationale for this type of longer-term forecasting is starting to open many eyes within organisations. Certainly, we are seeing leading companies beginning to recognise its importance for their long-term strategies. And that means the CFO and treasury functions are being brought into view around key decisions that are being made, for example, on sourcing materials, carbon credits, and cost benefits of investments.

MS: I would also stress the impact of all this on financing. We already have ESG scoring and ratings in the background and they can certainly affect the ability to raise capital at certain rates, as well as how that capital is going to be used. Treasurers need to be centre stage regarding these issues in order to help develop ways to drive more sustainability into the business and, in turn, generate better funding rates from lenders.

EH: FIS has developed an interesting climate risk modelling solution for assessing exposure and meeting new reporting requirements, using PwC’s climate data. Tell us about the solution and how it can perhaps help firms mitigate financial uncertainty that comes from all of these risks?

MS: It’s a cloud-based SaaS solution that enables organisations to assess and model their exposure at a granular level. For physical assets, for example, it can help them analyse a portfolio of assets at a granular level.  So for example  a building in Miami, and model and assess the climate risks associated with it – with tropical cyclones in mind, for instance. Being a sophisticated modelling solution it can also address ‘what if?’ questions such as what happens if the location changes, for example, to New York? Is the risk profile better or worse? What happens if they add better hail protection, or better flood protection to the building?

The solution can also assess the impact of risk profiles on insurance. Imagine a situation developing where a client’s premium suddenly shoots up because of climate change, or that the climate risk for a particular property becomes so great it is almost uninsurable. Our solution can help predict such events. For a company, in terms of thinking about forecasting a cash flow, it’s modelling what their insurance premiums might be in the next 5,10 or 25 years.

So that’s pretty useful for corporates to understand and plan for. It enables them to explore potential alternatives to mitigate risk, say, through different insurance contracts or weather derivatives. There are also numerous dashboards in the solution to help with looking at the weather perils as well as different statistical analysis. We advise organisations to run through the model more than once a year, and at least  once every quarter, and leverage its accessibility by making it available to all key functions such as treasury, risk, and the reporting and finance teams.

It’s also important to note, especially with an eye on auditing requirements, that FIS provides the software and all the calculations are carried out within our solution. PwC is providing the climate risk data. So, there is a clear divide between our respective roles and responsibilities.

RH: To provide some context, what we are hearing from many of our clients is that the main challenges they face, particularly their treasurers, in climate risk reporting revolve around scenario analytics and forecasting. These are the types of capabilities that organisations need to look for when examining their business models and supply chain behaviour.

Clients often struggle with the complexity of analysing climate perils, such as tornadoes, sea level rise, or heat index changes, at a granular level, and many organisations lack the necessary capabilities for this detailed analysis.

To meet these challenges, a tool must offer super-granular data, specific location insights, and address the physical aspects of risk exposure. The tool’s information should be repeatable, auditable, and scalable for accurate reporting.

The unique strength of this solution lies in its global reach, scalability, and its ability to meet the stringent requirements that flow from the need for repeatability and auditability. When we think about the needs of treasurers in particular, it’s important that any such tool meets all of those requirements.

The climate team at PwC, developed over five years, combines climate scientists, financial engineers, and data scientists to  bring leading climate frequency and severity data to climate forecasting. The alliance between PwC and FIS, we believe, has resulted in a comprehensive tool that marries technical expertise with leading-edge scientific understanding and financial acumen for effective climate risk management and reporting. 

But this is just the beginning of the journey. Clients’ needs are going to evolve and their level of sophistication in climate risk management is going to grow over time. They will demand increasingly greater precision with their modelling and analysis and we intend to respond proactively to that by listening closely to their needs as they evolve.

MS: The climate risk data that goes into supporting the solution is absolutely huge due to the granularity of the data across the perils. The SaaS solution runs on AWS public cloud and is therefore scalable in every direction.

Imagine analysing potential financial impact of flooding in one location versus another, looking at all various risk scenarios and then, moreover, layering the other potential climate perils [see chart 1] on top of that. That requires an awful lot of data. Behind the scenes, by joining forces with PwC, we are taking all that complexity away from corporates so they can focus on their priorities and gather the information they need.

So far, we have had good feedback from pilot clients about the solution. Being a SaaS solution, we deploy updates for it every two weeks and all clients automatically receive the updates. As we take on more clients, and we get more feedback, we’ll further enrich the functionality, dashboards and solution.

PERILS OVERVIEW

EH: Are there particular industries for which the modelling solution is especially applicable?

MS: Given the focus of the solution initially is on physical risks, it is industries with large physical asset footprints that would find the tool especially helpful. So, think of the construction industry and the more upstream businesses such as large retail and hotel chains and commercial real estate concerns. Banks would also fall into this category because they have property exposure through their mortgage blocks.

And though not very obvious, the solution can also help with assessing the climate impact of remote working. For example,  a media company may have  no buildings, but everyone works from home. The company needs to account for the impact of employees wherever they are based, including working from home. All of that can also be modelled by the solution and as regulations stiffen, I think increasing numbers of firms will find that particular capability extremely useful.

RH:  We see every industry facing climate risk exposure though it varies across sectors in terms of transition and physical risks. The most complex modelling and significant exposure occur in industries with supply chain involvement or substantial physical assets, such as real assets strategically located or in transit. 

As Martin said, particularly exposed sectors include real estate, retailers, investment firms and major banks with exposure to mortgages and home loans. Essentially, any industry reliant on physical assets falls within our modelling focus.

EH: Clearly this is just the beginning of the journey with the solution and the alliance between FIS and PwC. What are your hopes for the tool and what should corporates keep an eye on as this whole space continues to evolve?

MS: Corporates clearly need to keep a close eye on the regulatory landscape, particularly what emerges from the ISSB and SEC. That needs to be embedded in thinking within organisations. Most financial regulations we have to deal with translate to matters of compliance, so organisations need to be increasingly lively to need to steer their culture, management, and operations to ensure alignment at any given time.

The question for many senior managers will be how best to manage their business in this evolving regulatory environment. There is also a Taskforce on Nature-Related Financial Disclosures, [TNFD] which is obviously different to climate, but that is also gathering momentum. What I’d hope for is that climate and nature risks are completely embedded at all levels within organisations so that it’s part of their risk management framework and culture. Starting to lay down strong foundations now will save a lot of time and trouble later.

RH: When companies start having to produce audited numbers, stakeholders such as investors as well as analysts and ratings agencies are going to have access to more information to aid their decision-making. They will be keen to know whether companies are covered from a risk perspective and whether they have the right strategy for risk mitigation.

Yes, it’s still early days on this journey, but I think it’s vital that organisations begin to try to quantify their exposure to climate risks. And that means paying close attention to regulations and acting on regulatory proposals even if voluntary.

As we’ve seen with other financial reporting standards when they come into force, companies are good at fine-tuning their responses and become more precise with their adherence to new rules over time. We foresee that same journey for them with climate disclosures. As such, the level of precision, particularly that coming from finance and treasury functions, is going to become increasingly important in this space.

_{Please note; FIS’ Climate Risk Financial Modeler solution allows end clients to use a climate data model developed by PwC.  Due to PwC’s independence obligations as a public accounting firm, PwC Climate data will not be available to certain companies, therefore FIS’ Climate Risk Financial Modeler solution is currently only available to companies that are not subject to these independence restrictions.}