Project summary

Mainstreaming of climate risks and opportunities in the financial sector

Climate-related opportunities and risks in insurance, asset management and lending (with a focus on asset management)

Germanwatch, University of Potsdam/ PIK Potsdam Institute for Climate Impact Research, DIW German Institute for Economic Research, Wuppertal Institute for Climate, Environment and Energy

Climate change entails substantial risks, and also opportunities, for the financial sector: Damages in the billions threaten the performance of investments and companies, while at the same time new business segments emerge. If the financial sector succeeds in adapting to this situation rapidly and comprehensively, opportunities could be seized ensuring social and economic value added along with effective climate protection. Therefore, institutional investors, insurance companies, asset managers and pension funds have increasingly been dealing with climate change issues in recent years. This comprises both mitigation and adaptation aspects.

Assisting actors from the financial sector incorporating climate change aspects by mutual focussing on open issues in this context is the main topic of the three-year project "Mainstreaming of Climate Risks and Opportunities in the Financial Sector". The endeavour started end of 2006 and is funded by the German Federal Ministry of Education and Research (BMBF). Project partners are Germanwatch (consortium manager), the University of Potsdam, the German Institute for Economic Research (DIW), the Wuppertal Institute for Climate, Environment and Energy, as well as the Potsdam Institute for Climate Impact Research (PIK) and the European Climate Forum (ECF). Further partners include financial service providers such as Munich Re, WestLB, HypoVereinsbank, Allianz Global Investors and the Society of Investment Professionals in Germany (DVFA).

Starting from actual requirements voiced by German financial service providers, the project develops and proposes solutions on how to adequately incorporate climate-related risks and opportunities into financial management. This includes the valuation of companies, financial analysis, risk measurement and control, investment decisions and asset management. 

The project aims at developing instruments, methods and techniques enabling financial analysts, asset managers, underwriters and investors to integrate climate change and protection considerations into their decision-making process. This applies both for adaptation and mitigation issues. An adequate implementation-oriented, expert-based classification system shall be compatible with and integrable into tools used by sell-side analysts, asset managers and underwriters.

One focus is to develop new approaches to risk assessment. Climate change is modifying the general climatic and political frameworks in such a way that statistical methods and a simple extrapolation of previous trends are no longer suitable for drawing reliable conclusions regarding future developments. Thus, an increasing number of decisions is taken on an uncertain basis. A promising approach lies in Bayesian risk management techniques. They facilitate improved assessments of climate change impacts, as well as of climate policy and its financial implications. Bayesian risk management techniques therefore constitute a core element of the project. Results shall be achieved in collaboration with selected financial service providers, and shall be made available to financial market actors who can then use them to set the course for improved adaptation and climate protection measures in the economy. 

Core items of the working programme are to raise the status quo as well as actual requirements. Options will be sounded out by means of interviews and stakeholder processes. The project partners will examine both financial service providers' abilities of appropriately modelling climate risks, and the compatibility of different techniques with existing risk management practices. On this basis, three case studies will be carried out, which will serve to develop and implement new products and procedures. Finally, the results of the case studies will be analysed both separately and jointly, in order to draw conclusions for products and procedures designed for financial service providers. Further examinations, studies, expert meetings and workshops will complement research on this subject and enhance the practice- and solution-oriented approach of the project. Consequently, all project activities are directly linked to financial market activities, thus gaining the most far-reaching effects possible. 

In cooperation with the European Climate Forum, the working group "Bayesian Risk Solutions", which is jointly run by the University of Potsdam, the Potsdam Institute for Climate Impact Research and the German Institute for Economic Research provides tools and techniques for Bayesian climate risk management. These tools and techniques will be adapted and/or newly developed in such a way that they can be used throughout the project. The German Institute for Economic Research furthermore brings in its skills for the projection of time series on energy consumption, shipping demand, oil price development and other variables essential to the project.