How to reimagine risk modelling in sustainable finance

After the event, Finextra produced a visual record, which illuminates some of the key questions raised during the event, such as: What are the challenges and opportunities for risk management working with alternative data to inform credit decisions? How can these decisions be quantified against physical and transition risk?

With a top-down approach – and a focus on key sustainability components – the event sought to debunk the myth that revenue cannot be generated through careful implementation of ESG measures. In turn, participants examined the benefits of addressing transitional and physical risk by running real-time, forward-looking measurements of climate change and nature loss.

During the discussion, experts showed how alternative data, from sources such as satellites and sensors, are invaluable in augmenting traditional risk systems and providing actionable insights for the long-term prosperity sustainable financing.

Diving even deeper into the practical challenges of risk management, participants evaluated the merits of leveraging alternative data to inform credit decisions – with experts giving advice on how to better embrace sustainable finance practices.

Then, in the interactive forum, Richard Peers – founder of ResponsibleRisk and contributing editor for Finextra Research – brought together a set of cross-functional skills from individuals spanning the technology, business and finance sectors. While initially taking a generalised approach to understand reporting across ESG finance sectors, it soon became apparent that specific use cases are needed.

Here is an overview of the topics covered in each focused workshop.

Workshop 1: Using alternative data to inform physical and transitional risk

Short-term planning and lack of forward-looking climate risk predictions means investors have difficulty building a business case and pricing risk.

With this in mind, Workshop 1 used Green Bonds as a case study:

• Physical risk in a bond issuance can be found using the latitude and longitude position of assets collected during the business case phase.
• Satellite and earth systems’ predictive models can detailed physical risk, over past and future timeframes.
• Transition risk in a bond issuance will link the financial levers of a bond – such as interest rate – to targets on mitigation, such as high-quality forestry offsets.
• Satellite and real time data shows the quality of adherence to the commitments set out in the bond.

Nicole Anderson of Redsand Ventures added: “The remit of aggregating this data is unlikely to fall to the financial services community and it will remain the challenge and opportunity for those technology-centric among us.”

Workshop 2: How satellite data can provide insights for investment professionals

The second workshop showed that current risk practices are largely based on rearward looking analysis of annual data.

The solution put forward by experts was two-fold:

1. Design a forward-looking risk system with dynamic inputs that can identify carbon intensive and damaging biodiversity activities.
2. Use satellites, sensors, earth systems or disclosure data to predict, track and trace carbon intensive activities.

Workshop 3: Mainstreaming the use of data

In the final workshop, participants agreed that while universal asset-level data is key to enabling the measurement of physical and transition risk, it is virtually inaccessible.

As such, environmental risk plays a key part in company evaluations. However, we do not yet have a robust way to evaluate and price environmental risk.

Another issue raised is that climate risks tend to hit stakeholders in the long-term. This impedes positive action in the short-term. To overcome the challenge, an open banking solution for the exchange of relevant data in sustainable finance is needed.

The next Sustainable Finance.Live event will take place from 11th to 12th May, 2021. This time, the discussion will cover exactly how forward-thinking financial services firms and technology companies should go about achieving the UN’s Sustainable Development Goals by 2030.

To join the conversation, register here.