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

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.

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.

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.

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:

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.

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:

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.

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.

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).

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.”

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.