Dylan November 27, 2024 Incorporating Climate Risk Data in Securities: A Berlin Roundtable Value Destruction or Value Movement? The Implications of Information Symmetry The Big Green Short Betting on Technology An Overlapping Interest: The Red Cross Next Steps With contributions by Luca Borella and Simon Redfern. “We are not pricing risks correctly.” This assertion kicked off the conversation, setting the tone for a critical roundtable discussion on the role of climate risk in financial markets and security pricing. As the world faces increasing climate-related disruptions such as extreme weather events, there is a growing need for risk assessments that take into account climate change, which has gone from abstract concern to a material factor that can significantly affect the value of financial assets. Although awareness has grown, in many cases these risks are still difficult to predict without the right tools and data. Current models fail to paint an accurate picture, leading to a mispricing of assets, particularly in sectors more vulnerable to environmental shifts. Investors could end up with stranded assets that lose value as climate regulations tighten or as environmental conditions worsen. To successfully factor in climate risk, institutions require not only accurate data but also innovative tools that can integrate such data into their decision-making processes. Value Destruction or Value Movement? As climate change reshapes the planet, it will also reshape the value of real estate, investments, and resources. But it’s not just about value destruction—it’s about value movement. The book Nomad Century by Gaia Vince discusses how climate change will influence migratory patterns in the near future. As conditions near the equator become potentially unlivable, the result could be a mass migration towards livable land, in this case towards the poles. Of course, this has happened countless times in human history. One example from our past is thought to be the desertification of the Egyptian Sahara around 7000 years BP, which may have forced people to migrate towards the East, leading them to settle next to the Nile and potentially driving the establishment of new civilizations. This serves as a historical precedent for how climate can shift human settlements and value. The roundtable saw conversations around the phrase “Uninsurable means unsellable” – properties or assets deemed too risky to insure will become unattractive to investors, further shifting value to safer regions. A high-value property in equatorial regions might lose its worth as climate conditions worsen, while land in more temperate areas like Scotland could become prime real estate. The Implications of Information Symmetry The growing concern is that the financial sector is underestimating long-term climate risks, similar to how the mortgage crisis was underestimated in 2008. The implications of announcing that securities are mispriced due to underappreciated climate risks could cause market disruptions, including to existing assets and current pricing methods. This raises questions about how to gradually introduce such information without causing panic or a market collapse. Simon used an intriguing analogy, describing the integration of climate risk into financial models as adding a new piece to the game of chess. “So in a game of chess, this wouldn’t be changing just the strategy. This would be adding an entirely new piece to the game.” This new piece, representing climate risk, doesn’t just influence the squares where it stands—it alters the entire game board. The game becomes more complex, reflecting the systemic nature of climate risks. The Big Green Short Considering the above aspects, this could be the next “big short,” where climate risk is the hidden factor that upends market expectations. Coined by Johnny Mattimore, Managing Director and Global Head of Risk & Sustainable Finance at First Derivative, The Big Green Short is the concept that, over time “all asset prices are going to be impacted by their relative investment performance (as now) but also in the ratings and changes in ratings across ESG criteria.” As a result, the industry will find itself betting against climate-blind projects. To stay ahead in the future, we will need to place bets on technological innovation now. Betting on Technology Several emerging technologies can support investment professionals in this challenge. First, open-source technologies will play a key role because they: Facilitate collaboration and transparency in developing solutions, Allow for faster innovation since contributors worldwide can participate in improving the tools, Provide cost-effective options for companies that cannot invest in proprietary technologies but need advanced tools to assess climate risks. In addition to open-source concepts, the event highlighted specific technologies that investors will be able to harness to minimize risk. Disaster Prediction Technology: A representative from NVIDIA presented a demo capable of modelling not just a handful of scenarios but thousands. Climate Risk Data: The misconception is that there is no accurate climate risk-related data to be used within financial risk models. But such data is becoming increasingly available and accurate, as seen with OS-Climate. The open-source platform provides geospatial data linked to climate risk, helping investors and companies visualise and understand the impact of increasing extreme weather events. Open Bank Project: Known for its open-source API tools in the financial sector, the Open Bank Project helps enable secure and standardised data-sharing. By connecting to climate data sources such as OS Climate, it can enable financial institutions explore and test scenarios involving climate risk data. Interestingly, financial institutions aren’t the only ones pushing for better climate-related data and technology. An Overlapping Interest: The Red Cross Alessandra Gilotta, Head of the Red Cross’ Anticipation Hub, highlighted the importance of acting earlier on climate-related risks. The Red Cross focuses on anticipatory action, which aims to “reduce the humanitarian impact of forecast hazards before they occur.” This refers to not just weather-related risks being anticipated, but broader systemic risks such as slow-onset disasters (e.g., sea-level rise, desertification). Anticipatory actions allow teams to predict and allocate resources for emergency services ahead of a crisis. It’s not only about reactive measures but shifting towards proactive resilience-building. This overlapping interest led us to participate in the Anticipatory Hub’s yearly Dialogue Platform event focusing on ‘Mainstreaming anticipatory action and collaborating in complex contexts’, which took place from 22-24 October in Berlin. Simon Redfern (CEO) setting the networking atmosphere with his set. Next Steps The roundtable concluded with a strong interest in forming a working group to continue exploring the integration of climate risk data into investment/portfolio pricing. Want to get involved? Follow Open Bank Project and Luca Borella on Linkedin to stay in the loop!