Climate Risk
Immediate and Systemic
Increased volatility in weather patterns is disrupting supply chains and agricultural production, forcing companies to consider diversification of supply sources and investments in less climate-sensitive regions. Strategic decisions around decarbonization and climate financing are growing more urgent.
Physical risks posed by events such as floods and hurricanes and transition risks posed by changes in policies and new technologies are often assessed separately. However, this split ignores the interaction between the drivers and impacts, which can lead to an underestimation of losses. For example, when Spain was hit by a catastrophic deluge after a year"s worth of rain fell in one day in October 2024 the impact was more than could be imagined with over 220 people killed and €10+ billion of damage to businesses alone.[1] The central bank"s head of financial stability stated that climate risks were materializing faster than expected and banks should now focus on measuring accelerating physical risks, as well as addressing the transition risks of shifting to a lower-carbon economy.
Scenario analysis is critical to assess, quantify and disclose climate-related risks and opportunities, evaluating a range of hypothetical outcomes under a given set of assumptions and constraints. S&P Global Market Intelligence has developed an approach that captures the effect of both physical and transition risks on companies in a granular bottom-up manner. Climate Credit Analytics, developed in collaboration with Oliver Wyman,[2] provides a framework for integrated climate risk assessment helping companies apply a consistent, intuitive and detailed approach to their analysis.
A financial institution recently used climate stress tests to inform its sector exposure strategies and identify transition financing opportunities. Under a delayed transition scenario, with policy implementation initiated only after 2030, the average change in credit notches for the firm’s automotive portfolio was almost the same under both a static and adaptive scenario. However, the differentiation came into play post 2030, with companies facing credit deterioration under the static approach, leading to higher costs and reduced demand for non-electric vehicles. In contrast, under the adaptive assumption, companies performed significantly better, as the benefits of the transition were seen across all drivers of financial impact, including price, volumes, costs and asset valuation.
[1] “Valencia floods highlight climate vulnerabilities of Spanish banks”, S&P Global market Intelligence, December 5, 2024, www.spglobal.com/market-intelligence/en/news-insights/articles/2024/12/valencia-floods-highlight-climate-vulnerabilities-of-spanish-banks-86629330.
[2] Oliver Wyman is a separate company and is not affiliated with S&P Global or any of its divisions.