Courtesy of The Financial Times, an article on the limitations of financial models currently used for climate risk:

Financial institutions often did not understand the models they were using to predict the economic cost of climate change and were underestimating the risks of temperature rises, research led by a professional body of actuaries shows.

Many of the results emerging from the models were “implausible,” with a serious “disconnect” between climate scientists, economists, the people building the models and the financial institutions using them, a report by the Institute and Faculty of Actuaries and the University of Exeter finds.

Companies are increasingly required to report on the climate-related risks they face, using mathematical models to estimate how resilient their assets and businesses might be at different levels of warming. 

The International Sustainability Standards Board last week launched long-awaited guidance for companies to inform investors about sustainability-related risks, including the climate scenarios chosen in their calculations.

Countries including the UK and Japan have said they plan to integrate these standards into their reporting rules. 

Companies will also have to report the full scope of their emissions, including those from their supply chains, from the second year they begin to report under the guidelines due to come into effect in 2024.

That was a particular “challenge”, since companies would need to collect the data from all their suppliers, said George Richards, head of ESG reporting and assurance at KPMG.

In California, lawmakers are expected to vote in coming months on a bill that would require big companies doing business in the state to report the full scope of their emissions.

Some models were likely to have “limited use as they do not adequately communicate the level of risk we are likely to face if we fail to decarbonise quickly enough,” the paper released on Tuesday said. 

It also found that significant factors were sometimes missing from models. For example, an assessment of global gross domestic product loss in a so-called “hothouse” world of 3C higher temperatures by a group of 114 central banks and financial supervisors, known as the Network for Greening the Financial System, did not include “impacts related to extreme weather, sea-level rise or wider societal impacts from migration or conflict”.

As a result of such overly “benign” models, large financial institutions had reported that they would suffer minimal economic impacts if the world warmed by significantly more than 1.5C higher than pre-industrial levels, it said.

The Paris Agreement commits countries to strive to limit warming to 1.5C by 2100, though policies in place now put the world on track for a rise of between 2.4C and 2.6C, say the UN body of scientists.

In Task Force on Climate-Related Financial Disclosures reports, several large UK financial institutions had reported that they would fare equally well or better economically in a hothouse scenario compared with more moderate warming scenarios, the researchers found, without naming the institutions.

Some economists had even predicted “relatively low economic damage” from high levels of warming, said Tim Lenton, a co-author of the report who holds the chair in climate change at Exeter.

It was “concerning” to see those models being used by financial institutions to estimate their risks, Lenton said.

The consequences of passing climate “tipping points” — self-reinforcing and irreversible negative planetary changes — were often not captured by the models, the researchers said.

Financial institutions often did not understand the assumptions baked into the models and their limitations, they added.