![Risk.net](https://www.risk.net/sites/default/files/styles/print_logo/public/2018-09/print-logo.png?itok=1TpHrpuP)
Climate risk innovation of the year: Baringa and XDI
Energy Risk Awards 2020: Baringa and XDI’s climate risk scenario model takes in physical and transition risk at global, portfolio and asset level
![Colin Preston Colin Preston](/sites/default/files/styles/landscape_750_463/public/2020-05/Colin-Preston.jpg.webp?itok=4ap6lVFl)
Over the next several decades, climate change will up-end the global economy. Both physical and transition risk will cause the repricing of climate-exposed and climate-resilient assets worldwide.
However, predicting the impact on investment portfolios is extremely challenging. The degree of warming is uncertain, the timing and stringency of regulations unknown, the interconnections between different sectors and markets highly complex, and the number of assets involved enormous.
“Most financial services institutions currently don’t understand the climate risk inherent in the assets that they own and the lending that they make, or the temperature alignment of those assets,” says Colin Preston, global financial services sector and climate change lead at consultancy Baringa. “That is a huge risk to those institutions as well as to the planet. And, if you don’t understand the risk or temperature alignment, that’s going to drive the misallocation of capital and future losses.”
Step forward the Climate Change Scenario model that Baringa has developed with partner consultancy XDI, and which won Energy Risk’s Climate risk innovation award. The model was built with financial services group Legal & General, whose assets of £1.14 trillion ($1.39 trillion) make it the UK’s largest asset manager. The aim was to embed climate change scenarios into its risk management framework.
“What we’re dealing with here is an interconnected system of intense complexity,” says Nick Stansbury, head of commodity research at the firm’s investment management unit Legal & General Investment Management (LGIM). While climate change models have been built by academic researchers, “what we needed was something built for finance professionals”.
That need brought together Legal & General and Baringa in a development project that combined Baringa’s modelling framework with Legal & General data and insights to develop the L&G Climate Risk Framework. “We understand asset markets, valuation, credit risk models really well. What we wanted to improve was our understanding of how to connect it to the world of climate and energy transition risk,” Stanbury says.
Key criteria for Legal & General were that the model was internally consistent and methodologically rigorous, and captured both the effects of the low-carbon transition and the physical effects of a changing climate. That requirement encouraged Baringa – which has been modelling transition risks for some 20 years – to team up with Australia-based XDI Systems, which has what Baringa’s head of climate risk James Belmont describes as “industry-leading” physical risk information, with an ability to assess the changing risk across all hazard types, based upon leveraging detailed data on the location and characteristics of 70 million assets globally, owned by 4 million companies.
![Rohan Hamden Rohan Hamden](/sites/default/files/styles/medium/public/2020-05/Rohan-Hamden-XDI.jpg.webp?itok=tZqkC7T4)
“We’ve been in the market for 10 years – we’ve solved a lot of the technical and data problems that the new entrants haven’t even come across yet,” says XDI’s chief executive Rohan Hamden. The firm’s analysis involves building virtual models of every physical asset, taking into account the materials with which they are built and the engineering standards to which they are constructed, and then subjecting those assets to eight physical hazards, such as windstorm, sea level rise, flooding, etc.
“We’ve learned to work with really complex climate and weather models and translate these into how the assets respond in location. That’s completely unique,” he adds.
By integrating physical and transition risks, Baringa’s Climate Change Scenario model generates an estimate of the financial impacts of different climate scenarios at the portfolio, company and individual asset level, says Oliver Rix, Baringa’s head of climate change, energy and environment.
“One of the biggest challenges is that you need a framework that [allows you to] look at a scenario that’s aligned with a particular global greenhouse gas pathway and temperature outcome, all the way down to a particular physical asset or company,” he says. “That’s the value of the model.”
LGIM also wanted the model to be configurable at every level, allowing its analysts to plug in their own assumptions about the changing climate, regulations, technologies and the responses of particular sectors and companies. “The great advantage of the model is that every part of the calculation framework can be adjusted, adapted, configured and stress tested,” says Stansbury.
![Oliver Rix Oliver Rix](/sites/default/files/styles/medium/public/2020-05/Oliver-Rix.jpg.webp?h=45f1cc97&itok=d4W0qYwG)
The model can generate a climate value-at-risk figure for an entire portfolio, as well as provide company-level insights that can prompt dialogue with company management. It is also able to meet reporting requirements in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), the initiative set up by the Financial Stability Board.
And, just as the risks and opportunities that climate change present are economy-wide and all-pervasive, so too is the application of the information the model generates, says Belmont. “The model is designed to support use-cases all the way from TCFD down through investor relations, strategy formation and individual front-office and risk management decisions”.
While Legal & General is the solution’s reference client, Preston says Baringa is working with several other banks to embed the model in their organisations, and is in advanced conversations with many leading financial institutions: “We want this to become a global standard in how our clients manage climate risk and understand temperature alignment, and how they communicate [the] impact they’re having.”
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.
If you would like to purchase additional rights please email info@risk.net
More on Commodities
Foreign funds are bulls in China’s onshore commodity futures
Growing participation from overseas investors is boosting liquidity in what’s already a boom market
Energy Risk Software Rankings 2024: IT demands increase amid rising risk
Heightened geopolitical and credit risk increase requirements on commodities software
Energy Risk Asia Awards 2023: the winners
Winning firms demonstrate resiliency and robust risk management amid testing times
ION Commodities: addressing the market’s recent pain points
Energy Risk Software Rankings winner’s interview: ION Commodities
Energy Risk Commodity Rankings 2023: adapting to new market dynamics
Winners of the 2023 Commodity Rankings provided reliability when clients faced extreme change
Energy Risk Software Rankings 2023: managing uncertainty
Unpredictable markets make CTRM software choices key
Navigating the volatility and complexity of commodity markets
Commodity markets have experienced significant challenges since the Covid-19 pandemic, the conflict in Ukraine and the subsequent sanctions imposed on Russia. These unprecedented events have caused fluctuations in supply and demand, disrupted global…
Energy Risk Asia Awards 2022
Recognising excellence in energy risk management