5 Reasons Why You Need Climate Data – Regulation Is Just One of Them

5 Reasons Why You Need Climate Data – Regulation Is Just One of Them

Under the Paris Agreement, normative frameworks are turning into binding regulations. In order to comply with them, the financial industry needs to be able to count on a reliable underlying data basis. But that’s not all. Read in this article where portfolio and asset managers are likewise reliant on trustworthy and consistent climate data.

In order to limit global warming to a maximum of 1.5°C above pre-industrial levels as stipulated in the Paris Agreement, greenhouse gas emissions need to be cut by 45% by 2030 and net zero must be reached by 2050. Achieving those goals also requires the involvement of the financial industry. What’s more, the financial sector plays a crucial part in the transition to a low-carbon economy. Last but not least, portfolio and asset managers need to become aware of their important role and must define and organize how they deal with climate risks.


What Is Net Zero?

“Net zero” means that for each ton of greenhouse gas emissions produced, an equivalent amount must be removed from the atmosphere. That would reduce the impact on the Earth’s climate to net zero.

In practice, achieving net zero means combining measures aimed at reducing existing emissions with actions designed to remove carbon dioxide from the atmosphere. The former includes, for example, switching to renewable sources of energy and improving energy efficiency, and the latter includes methods like reforestation as well as carbon sequestration and storage technologies.

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Regulation as a Driving Force

Pressure from shareholders and investors and, ultimately, the will of regulatory authorities have resulted in a deluge of new regulations in recent years. ESGBook reports that more than 1,255 regulatory interventions regarding ESG have been enacted worldwide since 2011, compared to “just” 493 during the previous decade. One of the major regulatory frameworks was established by the Task Force on Climate-Related Financial Disclosures (TCFD), which was set up by the Financial Stability Board.


What Is the TCFD?

The initially voluntary set of guidelines developed by the Task Force on Climate-Related Financial Disclosures (TCFD), which was established by the Financial Stability Board in 2017, have since evolved into the leading framework for dealing with climate change and disclosing the financial impacts of physical climate risks and transition risks. In the United Kingdom, TCFD-compliant reporting is already compulsory for certain publicly traded companies, public pension funds, and financial institutions and will become mandatory for all companies by 2025. In Switzerland, the TCFD disclosure framework was ratified as being binding for large companies effective as of January 2024.

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What Does the TCFD Have to Do with the CSRD?

The Corporate Sustainability Reporting Directive (CSRD) broadly aligns with the TCFD framework. The CSRD and the EU Taxonomy make extensive analyses concerning climate risks binding in the European Union depending on the size of the company.

What Is the Difference between the TCFD and the SFDR?

The CSRD complements the Sustainable Finance Disclosure Regulation (SFDR) because it delivers part of the information required for corresponding reporting to investors. Comparable to the TCFD framework, the SFDR requires portfolio and asset managers to disclose information at both the company and the product level. Unlike the TCFD framework, though, the information to be disclosed isn’t limited to just climate risks, but instead encompasses all aspects of ESG.

Ensuring Compliance with Climate Data

When formerly normative frameworks like the TCFD become binding and get incorporated into other regulations, the first practical use of climate data for financial institutions is an obvious one:

1. Compliance with Regulations

As the example with the United Kingdom illustrates, efforts are underway to largely align regulations with the TCFD framework to avoid fragmentation. The complexity nevertheless remains daunting when it comes to finding ways and means – data, in other words – with which to ensure compliance. Voluntary national initiatives like Swiss Climate Scores likewise attempt to assist financial institutions in quantifying and disclosing climate risks in conformity with existing and forthcoming regulations.

Climate Data: Applications that Go Beyond Regulatory Requirements

Portfolio and asset managers, however, have already long been compelled to factor a wide spectrum of climate risk metrics into almost all of their processes ranging from investment decision-making and portfolio construction to risk monitoring, return optimization, and impact considerations.

Climate data at the portfolio level therefore aren’t needed just to meet regulatory requirements. Here are four other use cases – the first two are backward-looking and the second two are forward-looking:

2. Screening and Footprinting

In order to analyze a portfolio’s exposure to climate risks, it is crucial to obtain access to pertinent information, including data on the greenhouse gas emissions, energy consumption, climate targets, and climate strategies of the companies contained in the portfolio. Screening can be tied to an “emissions footprint” score or to an analysis of physical risks (e.g. natural catastrophes) and transition risks (e.g. regulatory changes) connected with climate change.

3. Identification of “Brown” Investments

Some industries by their nature are associated with greater climate risks. The energy sector and the chemical industry are two examples. Investments in those industries may thus be “brown.” Ratings by independent organizations like the Carbon Disclosure Project or MSCI enable one, for example, to identify companies that derive more than 5% of their total revenue from business activities involving coal or other fossil fuels. That can be relevant for meeting label requirements, for instance.

4. Climate Compatibility Testing (Climate Alignment)

The aim of climate compatibility testing is to structure investments and portfolios in a way that supports the climate objectives of the Paris Agreement. Information on efforts to limit CO2 emissions, to promote renewable energy, or to enhance energy efficiency are examples of the data needed to conduct climate compatibility testing. A continual assessment of climate compatibility and adjustments wherever necessary ensure that investments and portfolios stay in line with climate goals. This also means evaluating portfolios with regard to potential future losses of value caused by climate risks (Climate Value-at-Risk) and staying within certain temperature metrics with them (Implied Temperature Rise).

5. Scenario Analysis

Scenario analysis is a vital, useful tool for quantifying business risks – but also opportunities – in connection with climate change and for making them understandable to investors. Scenarios are not forecasts; they are hypothetical constructs based on a framework-providing underlying data basis. The TCFD says: “In a world of uncertainty, scenarios are intended to explore alternatives that may significantly alter the basis for ‘business-as-usual’ assumptions.”

Climate Data at the Center of It All

Regardless of whether for disclosures and compliance, screening and analysis, or climate compatibility assessments and scenarios, a reliable and consistent data basis is needed in any case. However, climate data are not always crystal clear at their source. There may be gaps in data or biases, for example, because some companies disclose information while others don’t.

Moreover, there is only limited standardization of climate data. The sheer number of different industry standards, frameworks, and regulations is hardly conducive to harmonization.