Highlights
THE CLIENT: A Japanese investment bank with global presence
USERS: Sustainability Solutions Department
In an era with escalating climate change impacts, investment banks and sustainable finance advisory firms face an imperative to integrate climate risk into their analytical frameworks. As investors increasingly prioritize sustainability, understanding the financial implications of climate-related factors becomes crucial. Climate risks, both physical risks from extreme weather events and transition risks associated with shifting to a low-carbon economy, can significantly affect company valuations and investment strategies. Failure to account for these risks threatens not only the long-term viability of green loans or bonds in a rapidly evolving market landscape but also results in missed opportunities in rightly identifying transition financing needs. Moreover, if not properly accounted for, these risks also invite risks related to reputational damage and activism.
By integrating climate risk into the valuation and risk pricing criteria, Japanese investment banks are positioning themselves as global leaders in sustainable finance, thus attracting a growing base of conscious investors.
The newly established – Sustainability Solutions Department at a leading Japanese investment bank with a global presence recognized the urgent need to quantify climate-related impacts to effectively advise their global clients effectively. As climate change increasingly influences market dynamics, understanding its financial implications is crucial for providing sound guidance. By using robust methodologies to assess and simulate the effects of climate risks on the financial statements of corporates, the department can deliver actionable insights that enhance decision-making. This quantitative approach fosters confidence in strategic recommendations across corporate finance advisory and sustainability-linked issuances in capital markets. Equipping themselves with accurate financial projections enables the department to position their clients advantageously in a rapidly evolving landscape, ensuring informed decisions.
Pain Points
While the department was newly set up, it consisted of existing staff from the Investment bank who were not necessarily experts in the topic of climate risk. This presented challenges in effectively quantifying the impact of climate change. These pain points hindered their ability to provide comprehensive advisory services to their global clients:
- Lack of Expertise in Quantifying Climate Risk:The department required a granular quantitative framework for assessing the projected impact of climate risks to the financial profile of a corporate.
- Inability to Identify Transition Financing Opportunities: Without established methodologies for quantifying climate change, the department struggled to provide actionable insights on transition financing gaps that needed to be fulfilled.
- Lack of Industry-Specific Analysis: Without sector-specific nuances within climate scenario analysis, the industry research team was unable to conduct the appropriate research on the impact of climate change on specific industries for its recommendation to clients.
These pain points collectively underscored the need for the department to adopt a robust climate risk assessment framework. By addressing these challenges, the firm can enhance its advisory capabilities, ensuring that clients receive well-informed guidance in navigating the complexities of climate change and its financial implications. This proactive approach will not only strengthen client relationships but also position the firm as a leader in sustainable finance.
The Solution
The award-winning Climate Credit Analytics is a climate scenario analysis model suite, which was launched in 2021. Climate Credit Analytics makes the critical link between climate change and credit risk by translating climate scenarios into drivers of financial performance (e.g., production volumes, fuel costs and capex spending) tailored to specific industries. These drivers are then used to condition and forecast complete financial statements of corporates under various climate scenarios, including those published by the NGFS, a group of over 160 central banks, financial authorities, and observers [1].
Developed through a collaboration between S&P Global Market Intelligence and Oliver Wyman,[2] Climate Credit Analytics includes an automated capability to evaluate more than 2.2 million public and private companies in over 145 sectors[3], as well as the ability for users to input proprietary information to expand this analysis. The solution covers five carbon-intensive sectors (Airlines, Automotive, Metal & Mining, Oil & Gas and Power Generation) and provides an Emissions-based approach for all other sectors to complete the portfolio analysis. Climate Credit Analytics leverages S&P Global Market Intelligence’s proprietary datasets and capabilities, including financial and industry-specific data, sophisticated quantitative credit scoring methodologies and the company-level environmental and physical risk datasets that powers many of S&P Global’s sustainability solutions.
Key Features
- Industry leading methodology based on a framework developed in collaboration with the United Nations Environment Programme Finance Initiative, tailored to provide comprehensive sector coverage.
- Road tested solutionwith broad market adoption, including use by major financial Institutions participating in regulatory climate scenario analysis and stress testing exercises in multiple jurisdictions spanning Europe, Asia, and the Americas. Also leveraged and referenced in industry research.
- Flexible scenario analysiswith pre-loaded scenarios from the Network for Greening the Financial System (NGFS) and major regulators globally. In addition, users have the option to run customized scenarios or assess near-term exposure to climate transition risks, such as the implementation of a global carbon tax.
- Comprehensive portfolio analysisvia six bottom-up models which cover 140+ industries under the GICS (Global Industry Classification Standard) code via a product specific approach for high carbon emitting sectors, such as oil and gas, power generation, metals and mining, automotive and airlines, plus an emissions-based approach for the remaining non-financial sectors, and a top-down approach for name-based extrapolation.
- Coverage of private and public companiesutilizing S&P Global Market Intelligence’s company fundamental information and a waterfall approach to data enabling full portfolio analysis, even in cases where granular data is not readily available. The offering enables automated bottom-up analysis for 2.2 million companies. Where users have the requisite information, a proprietary analysis capability is also available.
- Differentiated datasetsincluding industry and asset-specific data, emissions data, and physical risk data from Sustainable1, all of which enrich the analysis and provide granularity to the approach.
- Validated model suite supported by a detailed methodology guide (200+ pages), that has been successfully accepted and approved for use by Model Risk Management teams at multiple banks.
- High degree of flexibility enabling users to perform sensitivity analysis on many parameters and tailor key assumptions (e.g., counterparty transition planning) for decision-useful insights.
- Easy Implementationvia a selection of delivery methods (e.g., Excel and API) to enable smooth integration into existing processes and workflows.
- Sophisticated quantitative credit scoring methodologiesthat translate the risk into credit scores and default probabilities, using either CreditModel™ or Probability of Default Model Fundamentals model (“Credit Analytics models”), a statistical suite of credit models by S&P Global Market Intelligence [4].
Key Benefits
Implementing a comprehensive climate risk quantification solution offers several key benefits for the Sustainability Solutions Department, enabling the investment bank to enhance its advisory services significantly:
- Enhanced Risk Assessment:By utilizing advanced analytical tools and reliable data, the department can accurately assess and quantify climate-related risks for their clients. This capability allows for a more nuanced understanding of how environmental factors may impact corporate financials, leading to more informed decision-making.
- Informed Client Advisory: With the ability to project climate conditioned financials, the department can provide clients with tailored insights on potential climate impacts on corporate finance transactions and capital requirements.
- Competitive Advantage: By integrating climate risk assessments into their advisory framework, the firm positions itself as a leader in sustainable finance. This proactive approach not only meets the growing demand for environmentally responsible investment strategies but also differentiates the firm in a competitive market, attracting a broader base of environmentally conscious clients.
Overall, these benefits not only enhance the department’s operational efficiency but also contribute to the firm’s long-term sustainability and success in a rapidly evolving financial landscape. By adopting this solution, the firm Is well-equipped to navigate the complexities of climate change, ensuring that it remains at the forefront of sustainable finance.
