Capital planning with climate models

Are our portfolios still calibrated to a climate that no longer exists? This is a valuable topic to discuss with your investment consultant during your next strategic asset allocation review. This question is more complex than most climate disclosures indicate. Many capital market assumptions still implicitly assume that the climate is stationary. Strategic asset allocations (SAA) are based on decades of historical data. Diversification assumptions may hold in typical years but can fail during critical periods. Physical risks are often treated as tail events, even as such risks become more frequent. This is not a fringe concern. The USS / University of Exeter No Time To Lose report and the Institute and Faculty of Actuaries' Emperor's New Climate Scenarios have made this case; many climate scenarios used by financial institutions may understate risk because they fail to capture tipping points, compound events and non-linear damages. Climate scenario analysis has improved significantly, but in many cases it remains separate from the strategic asset allocation process rather than fully integrated. It primarily supports reporting requirements. However, does it influence capital market assumptions, portfolio construction, or the strategic asset allocation itself? For funds with long-term, intergenerational mandates such as pensions, sovereign wealth funds, and endowments, the current El Niño is not the primary concern. The greater concern is the shifting baseline underlying future El Niño events and whether portfolio assumptions have adapted accordingly. Four questions worth exploring with your consultant at the next SAA review, borrowed from the world of cyber resilience: Anticipate: Do our scenarios address specific physical pathways such as multi-breadbasket failure, monsoon disruption, grid-cooling stress, and wildfires, or do they focus mainly on transition risk? Withstand: Where might hidden correlations exist? For example, Australian, Brazilian, and Indian agricultural exposures may appear diversified in typical years but can become highly correlated during an El Niño event. Recover: Do we have the governance, conviction, and liquidity to act as a stabiliser when assets and markets reprice? Adapt: Are climate-resilient infrastructure, energy systems, food systems, transport, water, and adaptation technologies considered core allocations over a 30-year horizon, or are they still treated as peripheral? At your next away day, ensure climate scenarios are integral to the strategic asset allocation process. A practical first step is to work with your investment consultant to review the climate scenario set used in the previous strategic asset allocation exercise, assess the severity of excluded scenarios, and evaluate how those exclusions influenced the final allocation. This discussion may reveal where the most future risks may lie. David Friedberg provides a useful four-minute overview of the developing El Niño on the All-In Podcast. 

𝗧𝗵𝗲 𝗡𝗚𝗙𝗦 𝗷𝘂𝘀𝘁 𝗿𝗲𝗹𝗲𝗮𝘀𝗲𝗱 𝘀𝗼𝗺𝗲𝘁𝗵𝗶𝗻𝗴 𝗯𝗶𝗴— for the first time, we now have 𝘴𝘩𝘰𝘳𝘵-𝘵𝘦𝘳𝘮 𝘤𝘭𝘪𝘮𝘢𝘵𝘦 𝘴𝘤𝘦𝘯𝘢𝘳𝘪𝘰𝘴 tailored for 𝘀𝘁𝗿𝗲𝘀𝘀 𝘁𝗲𝘀𝘁𝗶𝗻𝗴, 𝗳𝗶𝗻𝗮𝗻𝗰𝗶𝗮𝗹 𝘀𝘁𝗮𝗯𝗶𝗹𝗶𝘁𝘆, 𝗮𝗻𝗱 𝗻𝗲𝗮𝗿-𝘁𝗲𝗿𝗺 𝗺𝗮𝗰𝗿𝗼 𝗿𝗶𝘀𝗸. 🔸 This isn't about 2050. It's the next five years, i.e. 𝟮𝟬𝟮𝟱–𝟮𝟬𝟯𝟬. 🔸 This isn't abstract. It's 𝗚𝗗𝗣 𝘀𝗵𝗼𝗰𝗸𝘀, 𝗰𝗿𝗲𝗱𝗶𝘁 𝗿𝗶𝘀𝗸, 𝗶𝗻𝗳𝗹𝗮𝘁𝗶𝗼𝗻, 𝗮𝗻𝗱 𝘂𝗻𝗲𝗺𝗽𝗹𝗼𝘆𝗺𝗲𝗻𝘁. 𝗧𝗵𝗲𝘀𝗲 𝗮𝗿𝗲 𝘁𝗵𝗲 𝘀𝗵𝗼𝗿𝘁-𝘁𝗲𝗿𝗺 𝘀𝗰𝗲𝗻𝗮𝗿𝗶𝗼𝘀: 1.  A smooth transition ("Highway to Paris") 2.  A delayed, abrupt policy shift ("Sudden Wake-Up Call") 3.  Physical risk disasters without transition ("Disasters & Policy Stagnation") 4.  A fragmented world with climate chaos and policy misalignment ("Diverging Realities") These scenarios are a wake-up call for taking short-term climate risks seriously. ➤ Delaying climate action could increase global 𝗚𝗗𝗣 𝗹𝗼𝘀𝘀𝗲𝘀 𝗯𝘆 𝗼𝘃𝗲𝗿 𝟯𝘅, and unemployment spikes by 1.3 percentage points (Sudden Wake-Up Call vs Highway to Paris). ➤ Climate disasters aren’t just regional anymore. Floods, fires and droughts in Asia or Africa can cut European 𝗚𝗗𝗣 𝗯𝘆 𝟭.𝟳%, driven by supply chain exposure. ➤ Credit risk spreads explode in carbon-intensive sectors. In some cases, default probabilities jump by 20–30 percentage points, stressing banks and insurers alike. ➤ Green sectors could lose out if the transition is abrupt, fragmented, or disrupted by physical shocks. 𝗛𝗲𝗿𝗲 𝗶𝘀 𝘄𝗵𝘆 𝘁𝗵𝗲𝘀𝗲 𝘀𝗰𝗲𝗻𝗮𝗿𝗶𝗼𝘀 𝗮𝗿𝗲 𝗮 𝗴𝗮𝗺𝗲-𝗰𝗵𝗮𝗻𝗴𝗲𝗿 ➤ For the first time, compound hazards—droughts, floods, wildfires—are modelled together, showing how climate risk can become systemic through trade, finance, and supply chains. ➤ Monetary policy is now integrated, so climate shocks affect interest rate paths, inflation dynamics, and macroeconomic volatility. ➤ Financial contagion is now factored in. Using advanced modelling, the framework maps how climate-related losses feed into default risk, cost of capital, and sectoral investment flows. ➤ Sector-by-sector and region-by-region outcomes now include asset-level exposure, probability of default, and sovereign bond repricing, offering tools fit for risk management. 𝗠𝘆 𝘁𝗮𝗸𝗲 This release is a step-change in how we understand and model climate risk. These scenarios are critical because they model economic and financial impacts on business over the next five years. A timeline relevant for senior management, boards and shareholders. Because these scenarios capture dynamic feedback loops, sector-specific capital costs, and second-round effects that ripple through the financial system, the risk science is taken to a whole new level. These real-world complexities have been missing from science to date, which is why these scenarios are so critical. #NGFS #NetZero #ClimateRisk _____________ For updates, follow me on LinkedIn: Scott Kelly

I have spent nearly twenty years building energy system models. Continental-scale at granular spatial scales. Hourly (or finer) temporal resolution. Co-optimising generation, storage, transmission, distributed energy resources (DERs), and demand simultaneously. Thousands of scenarios. I have published in Nature Climate Change, Science and PNAS. My work has over 4,300 academic citations. Here is what I have learned: the tools most organisations still use to plan energy systems are not fit for the decisions ahead. Most capacity expansion models optimise generation only. They bolt on storage as an afterthought. They treat the transmission network as a copper plate or a simplified transport model. They run on annual energy balances, missing the hourly dynamics that determine whether the system actually works. They assume stable, predictable fuel prices. The last four weeks have demonstrated why every one of those assumptions is dangerous. When gas was £30/MWh, a model that ignored fuel price volatility produced a plausible answer. At £67/MWh and rising, with Ras Laffan physically destroyed, with the BoE pricing rate hikes instead of cuts, with the Ofgem cap headed for £2,000+, the same model produces an answer that could lead to billions in misallocated capital. What we actually need: models that co-optimise across the whole system (generation, storage, transmission, DERs, demand) at nodal or zonal resolution with sub-hourly dispatch, weather-synchronised across wind, solar, and demand, with stochastic fuel prices that reflect the world we actually live in. Where you build matters as much as what you build. A wind farm in northern Scotland connected to a constrained transmission corridor produces curtailed energy and consumer costs. The same wind farm sited where the grid has capacity produces revenue and system value. The UK is making decisions right now about grid investment, generation siting, storage deployment, and demand connections that will lock in infrastructure for decades. The grid queue reform, the Clean Power 2030 target, the SSEP, the data centre surge, the Hormuz shock. These are not separate problems. They are one system. The planning tools need to catch up with the reality. #EnergyModelling #EnergyTransition #UKEnergy #PowerSystems #CleanEnergy #RenewableEnergy #GridReform #EnergyPolicy #NetZero #EnergyStorage #CapacityExpansion #SystemPlanning

💸 $𝟭𝟮.𝟱 𝘁𝗿𝗶𝗹𝗹𝗶𝗼𝗻 𝗶𝗻 𝗰𝗹𝗶𝗺𝗮𝘁𝗲-𝗿𝗲𝗹𝗮𝘁𝗲𝗱 𝗹𝗼𝘀𝘀𝗲𝘀 𝗯𝘆 𝟮𝟬𝟱𝟬, 𝗮𝗿𝗲 𝘄𝗲 𝗽𝗿𝗶𝗰𝗶𝗻𝗴 𝘁𝗵𝗮𝘁 𝗿𝗶𝘀𝗸 𝗶𝗻𝘁𝗼 𝘁𝗼𝗱𝗮𝘆’𝘀 𝗶𝗻𝘃𝗲𝘀𝘁𝗺𝗲𝗻𝘁𝘀? The new PCRAM (Physical Climate Risk Appraisal Methodology) framework and tool from Institutional Investors Group on Climate Change (IIGCC) gives investors a clear, practical way to assess and act on physical climate risk. Here’s why it matters: 🔹𝗦𝘆𝘀𝘁𝗲𝗺𝗶𝗰 𝘀𝗰𝗼𝗽𝗲: Goes beyond individual assets to evaluate risks across funds and portfolios, including interdependencies with surrounding systems. 🔹𝗠𝘂𝗹𝘁𝗶𝗱𝗶𝘀𝗰𝗶𝗽𝗹𝗶𝗻𝗮𝗿𝘆 𝗶𝗻𝘁𝗲𝗴𝗿𝗮𝘁𝗶𝗼𝗻: Brings together climate science, engineering, and finance into one replicable and practical framework. 🔹𝗥𝗲𝘀𝗶𝗹𝗶𝗲𝗻𝗰𝗲 𝗮𝘀 𝘃𝗮𝗹𝘂𝗲: Shifts the lens from cost and loss to resilience premiums like stable returns, stronger credit quality, and reduced lifecycle costs. 🔹𝗦𝘁𝗮𝗻𝗱𝗮𝗿𝗱𝗶𝘀𝗲𝗱, 𝘁𝗿𝗮𝗻𝘀𝗽𝗮𝗿𝗲𝗻𝘁 𝗽𝗿𝗼𝗰𝗲𝘀𝘀: Follows a 4-step approach: scoping, materiality, resilience building, and financial analysis, scalable across geographies and sectors. 🔹𝐁𝐫𝐨𝐚𝐝𝐞𝐫 𝐚𝐝𝐚𝐩𝐭𝐚𝐭𝐢𝐨𝐧 𝐬𝐭𝐫𝐚𝐭𝐞𝐠𝐢𝐞𝐬: Incorporates nature-based solutions and explores insurability and credit-strengthening opportunities. 𝘊𝘭𝘪𝘮𝘢𝘵𝘦 𝘳𝘪𝘴𝘬 𝘪𝘴 𝘪𝘯𝘷𝘦𝘴𝘵𝘮𝘦𝘯𝘵 𝘳𝘪𝘴𝘬. We need to act not just to climate-proof portfolios, but to future-proof capital. Read the report and explore the tool → link in comments. #ClimateRisk #ClimateFinance #Investors #PhysicalRisk #RealAssets #ESG #NetZero #IIGCC #AdaptationFinance #ResilienceInvesting

#ClimateAdaptation is moving from side project to balance-sheet priority. McKinsey estimates climate-resilience technologies could represent $600B–$1T in addressable markets by 2030, across building hardening, grid resilience, water systems, wildfire and flood mitigation, supply-chain protection, and risk transfer. We’re already seeing the demand signal that feeds those markets:  premium hikes and FAIR-plan growth push owners toward risk transfer and upgrades; outage spikes drive backup power and grid/storage spend; and code-plus retrofits (impact-rated roofs, debris-resistant openings, WUI) funnel capital into building hardening—the very categories McKinsey sizes. Climate isn’t one more risk... it’s a risk multiplier. First Street’s 11th National Risk Assessment: Portfolio Pressures documents how “idiosyncratic” events are giving way to same-year, multi-hazard hits across regions, lifting portfolio tail losses. To reflect that reality, we incorporate cross-peril and cross-property correlations when producing portfolio loss curves—showing that ≤1% AEP outcomes can be materially higher than single-peril views, which is exactly where capital planning is most exposed. How exposure becomes financial stress. After a hazard, the credit channel runs through a few tight mechanisms: non-renewals and lender-placed insurance raise escrow and DTI; deductibles and sublimits shift more loss to borrowers; unrepaired damage and appraisal haircuts erode equity and push LTV higher; and refi frictions (overlays, comp scarcity, proof of coverage) slow prepayments. These effects are most acute for LMI households with thin buffers, accelerating roll rates and raising LGD. Because they cluster geographically, localized shocks become correlated loss periods at the portfolio level. Why this points to adaptation and resilience. If climate amplifies losses, targeted resilience is a return-on-avoided-loss strategy: flood management that reduces depth and downtime; wildfire mitigation that lowers damage severity and insurance frictions; water and grid upgrades that cut business interruption; building hardening that preserves collateral value and speeds appraisals. The financial translation is straightforward—lower expected loss and tighter tails, better cash-flow durability, improved cure rates, and more stable LTV/DSCR. Connecting market opportunity to portfolio need. The adaptation categories McKinsey highlights line up with where portfolios experience the largest stress multipliers. The job now is to direct capital to site-specific measures with measurable payoff—prioritizing assets and geographies where resilience most improves cash flows, collateral values, and loss distributions while reducing the chance that local shocks scale into portfolio-level credit stress. The aim is simple: quantify climate-to-credit pathways, target interventions with measurable payoff, and finance resilience at scale, so portfolios get stronger while communities face fewer disruptions.

As global temperatures rise, adverse impacts from human caused climate change increase in scale and intensity. These impacts are documented across water availability, food production, health, infrastructure, coastal areas, and ecosystems, with strong scientific confidence in human influence. Economic systems are already absorbing these effects. Higher temperatures reduce labor productivity and increase electricity demand for cooling. Drought affects agricultural output and water intensive industries. Heavy rainfall and flooding disrupt logistics networks and damage facilities. Sea level rise raises exposure for coastal assets and ports. Ocean warming and acidification affect fisheries and marine supply chains. These physical pressures translate into financial variables. Insurance premiums rise. Asset impairment risk increases. Operational downtime becomes more frequent. Supply chains require redesign. Capital expenditure for adaptation expands. Investment in resilience is becoming embedded in capital planning. Upgrading infrastructure, diversifying suppliers, adjusting design standards, and incorporating climate scenarios into financial models help protect asset value and stabilize long term performance. Early adaptation reduces cumulative losses and supports stronger financing conditions. Resilience strengthens business continuity, protects long lived assets, and sustains competitiveness in a changing climate. Source: IPCC 2023

The investment case for climate adaptation has been made many times and in many registers, through policy frameworks, market sizing exercises, and loss data. What has been harder to produce is a number that speaks the language of infrastructure underwriting with enough precision to move a capital committee. A new report from the The World Bank Group, IFC - International Finance Corporation, AXA Climate, and Scientific Climate Ratings does exactly that. Low Cost, High Yield: The Adaptation and Resilience Investment Opportunity for Infrastructure, published in June, reaches a conclusion that reframes the entire adaptation finance conversation: investing less than 10% of asset value in adaptation and resilience measures can protect multiples of that amount. The analysis is grounded in three infrastructure sector case studies in Brazil under high emissions scenarios, and the return figure is specific: up to $8.50 in protected asset value for every $1 invested. That is not a policy estimate or a modelled projection. It is a return on resilience calculation built from asset-level data. The macro context gives the number its weight. Natural hazards cost low and middle income countries approximately $390 billion annually, equivalent to 1 to 2% of GDP. Without sustained adaptation investment, climate risks could eliminate 43 million jobs across 49 countries by 2050. This is the trajectory of the current baseline, and every year of delayed investment compounds the gap between what infrastructure was designed to withstand and the conditions it is now operating under. What the report establishes, and what Equilibrium Climate Capital has been underwriting against since inception, is that adaptation is not a cost centre sitting alongside a conventional investment thesis. It is the investment thesis. The companies delivering water infrastructure, energy resilience systems, and health services in climate-exposed markets are not managing risk as an externality. They are generating revenue from the structural demand that physical climate exposure creates, and that demand is non-cyclical, non-discretionary, and compounds with every degree of warming. The World Bank and AXA Climate are making the case from the outside with rigour and institutional authority. Equilibrium Climate Capital is making it from within the markets where the assets sit. The report confirms what the field has known and struggled to quantify: the cost of not investing in resilience is already larger than the cost of investing in it. Capital that has not yet reached that conclusion is the opportunity. Link in comments.

🤓Here’s one for your holiday reading list: A new report from our Institute aims to help finance practitioners use #climate scenarios, which are a critical tool for quantifying the impact of a warming world on the value of investments. They are, however, challenging to implement for even experienced proponents. Read it here: https://lnkd.in/d_2Uzu9Z The report, which provides a practical guide to climate scenario analysis, classifies climate scenarios into four types, based on their complexity and characteristics. It also advocates for adoption of climate scenario analysis across four levels, which start with using fully narrative scenarios to identify key pathways and continue with quantifying the financial impact of scenarios using quantified or model-driven scenarios, refining the analysis, and integrating the output of climate scenario analysis into decision-making. “The report espouses a holistic approach to climate scenario analysis designed to improve financial decision-making and infuse planning with resilience,” write co-authors James Edwards, executive director for climate risk research at MSCI Research and an Institute fellow for the climate scenario landscape, Nathan Faigle of MSCI Research, and Wenmin Li, an associate for climate risk with the United Nations Environment Programme Finance Initiative (UNEP FI). The authors consider the use of climate scenarios in specific applications, including internal stress testing for both prudential supervision and regulation, and uses of scenario analysis to fulfill disclosure obligations. They further consider scenario analysis in the context of stress testing for investment activities, as well as for risk management and engagement. The report complements work by the Institute and MSCI’s Climate Risk Center to develop a climate scenario informed by market participants’ consensus expectations on how the risks of a changing climate and the transition to a low- carbon economy could impact their investments. “By organizing these scenarios based on their complexity and offering a roadmap for integrating them into investment decision-making, the paper can help stakeholders make informed choices,” notes David Carlin, former head of risk at the UNEP FI, in a foreword to the report. You can find the full report here: https://lnkd.in/dq49hz7V

CMIP7 climate model data will start to roll out soon and will ultimately feed into the next IPCC AR7 report expected around 2028. This new round is a big step forward in making data application‑ready for users across society, including financial institutions. A key shift is that CMIP7 is explicitly designed around Impacts & Adaptation (I&A) Opportunities: 60 variable groups that bundle what is needed to run impact models or derive climate indicators, for example for Agriculture and Food Systems Impacts or Energy System Impacts. Instead of treating bias‑correction and downscaling as second-class components, CMIP7 plans for them from the start, with more standardised, archive‑wide access to sub‑daily data, higher spatial resolution and the variables needed for bias‑adjusted and downscaled products. This should make it easier to build robust climate services, local risk assessments and asset‑level analyses on top of the same data. Compared with CMIP6, CMIP7 aims to reduce methodological fragmentation by standardising variables and by explicitly connecting Earth system outputs to real‑world decision needs, including those of regulators and financial institutions. In practice, that means better hazard inputs for heat, drought, flood and wind risk models, and in addition more comparable products across providers. In general, we should see a smoother pipeline from global climate scenarios to portfolio‑ and asset‑level insights. CMIP7 remains a complex, protocol‑based global community effort, but with a much stronger focus on decision‑relevant variables for sectors such as energy, agriculture, water, ecosystems, cities, health and finance. For anyone interested in how this is being set up, this paper is an excellent overview of the initiative and its priorities: https://lnkd.in/evjrpxYz