Assessing forward-looking climate risks in financial portfolios: a science-based approach for investors and supervisors

Climate risk is a new source of financial risk characterized by deep uncertainty, non-linearity, and endogeneity. Neglecting these characteristics leads to a severe underestimation of potential financial losses and gains. We present the CLIMAFIN methodology designed to help investors and financial institutions to address this challenge and to embed climate risk into pricing models and stress-tests. The method builds on the Climate Stress-test by Battiston et al. (2017), which has become over the years a reference tool for academics and practitioners. CLIMAFIN allows to translate forward-looking climate transition scenarios into financial shocks and to provide investors and financial supervisors with scenario-adjusted risk metrics and models (e.g. Climate Value at Risk, Climate Spread, Climate Stress-test). The chapter describes the technical details of the methodology and some recent policy applications carried out in collaboration with leading financial institutions