Climate risk analysis:
How to improve its assessment?
Study by The Shift Project think tank for AFEP

A crucial business risk with too many analysis methodologies

“Climate” risk is urgent, global, systemic and irreversible in nature, closely linked to the use of fossil fuels, a determining factor in economic development. It can be broken down into a “physical risk” (increase in abnormal natural phenomena) and a “transition risk” (arising from the requirement for businesses and government to limit greenhouse gas emissions).

As an issue, climate has picked up momentum since the signing of the Paris Agreement in December 2015. The finance sector in particular is continually exerting pressure on companies to prepare for “climate” risk, develop their strategies and their reporting accordingly.

This background encourages a proliferation of “climate” risk analysis methods and the emergence of new company assessment standards, which until now have been mainly based on financial indicators alone.

Companies are increasingly questioning the maturity, relevance and diversity of these analysis methods.

Study goals and approach

AFEP asked The Shift Project think tank to carry out an analysis of the key players in “climate” risk assessment, their methodological choices and the main directions of this market. The purpose is to give companies a better insight into the environment they operate in, in terms of “climate” risk analysis.

In particular, The Shift Project team held:

  • meetings with AFEP companies, to better understand their questions on the key players in “climate” risk assessment and their methodologies, and to establish common positions with them;
  • discussion meetings based on these common positions, with most of the stakeholders involved in “climate” risk analysis: extra-financial rating agencies, financial rating agencies, data providers, financial professionals and index providers;
  • discussions with public organisations and national and international think tanks (General Treasury Department, TCFD, HLEG, AMF, among others), to clarify the development of the national and international regulatory context.

The 5 lessons of the study

  1. For many years, climate as an issue was embedded in wider ESG analysis (Environmental, Social and Governance), but is increasingly being treated as a distinct issue by risk analysis and rating organisations. This separation is expected to increase, due to the fundamentally systemic, irreversible, global and very long-term nature of the “climate” risk.
  2. Despite considerable progress, the importance of the “climate rating” is still limited. “Climate” risk is only being integrated slowly and partially into mainstream analyses and research by the major financial rating agencies. As for the extra-financial rating agencies, their analyses are focused on assets for which there is a specific demand (still very small) among final investors (green bonds, SRI funds, low carbon indices).
  3. The climate rating sector, like the entire ESG sector, is characterised by a lack of funding which (i) delays the inclusion of systemic risks linked to climate change; (ii) inhibits R&D in this field; (iii) encourages simplification and automation of the analysis; (iv) raises governance issues and reduces trust among the stakeholders.
  4. The analysis of “climate” risks and opportunities requires the development of expertise and mobilisation of resources that are currently inadequate. As well as assessing direct or indirect greenhouse gas emissions,the analysis methodologies increasingly need to factor in the dynamic and prospective nature of the strategies used.
  5. In the financial world there is a temptation to use excessively simple investment portfolio qualification methodologies,  resulting in simplistic and static analyses. These approaches are methodologically fragile and should only be a small part of helping the markets take account of “climate” risk in an effective way.
The issue of climate is becoming ever more central, and there is a notable consensus in French political and financial circles on the gravity of the situation. Out of this, a long-term national ambition should emerge. France has already almost completely decarbonised its electricity production and passed proactive legislation, and has many other assets that will allow it to face up to the climate challenge and become a leader in the future low carbon economy in Europe and the world.
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