Adding Climate Change Risk into Scoring Models Robert Reoch HSBC

Why embed climate risk into scoring? 1. We need a redistribution of global finance towards the green economy 2. Current approach of ESG scoring is not standardised, subject to bias, qualitative 3. Finance community is relying on standard financial models that do not capture the complexity of climate risks

Climate Change Risk Physical Transition Liability Severe, unpredictable weather events 2017 costliest year on record USD 337bn insurance losses Physical Insurance losses Real business disruption Reduces value of Municipal Bonds Global transition to a low-carbon economy USD 6.74tn forecast wasted capital for planned carbon-intensive CAPEX if reserves unburnable Transition Return on investment Capex Stranded assets Real business change Legislation and fines for environmental damage Moving from reactive liability to proactive liability Liability Insurance losses Real business risk Regulatory change

Fintech is changing capability to 1 Ingest more data sources 2 Integrate new data into financial infrastructure 3 Change financial decision-making

Integrating climate risks Climate risks affect all corners of company financials Financial and commercial well-being at risk Climate Risks Liquidity Risk Market Risk Interest Rates Physical Risk PPE Damage Inadequate Cash Reserves Liabilities Capital Annual Profit Assets BALANCE SHEET FX Solvency Risk Cost of Capital Internal Process Money / Debt / Equity Markets Stranded Assets People Operational Risk Exposure Systems Financial Transition Risk Default Risk External Event INCOME STATEMENT Sales Expenses Annual Profit Credit Risk FX Physical Risk Supply Chain Market Share Commercial Transition Risks Input Prices Customer Preferences Microec or Company-specific Inputs Risks Input Prices We can now add a climate risk overlay to our diagram. The assets of the company could be affected by damage (physical risk) or commercial transition (stranded assets); The liabilities are mainly subject to Financial Transition risk that could restrict access to capital or at least to cheap capital. Moving to the income statement: here revenues may be affected by PR that limits transportation or by CTR whereby buyers (corporate or retail) stop buying the company’s goods. Ex penses are also vulnerable: the supply chain could be affected by PR requiring expensive substitutes or delayed production; the company itself may have committed to divest from carbon based inputs and the replacements could increase costs; and finally interest costs could be higher due to financial transition. << slide build 2: 2.1remove inputs and risks; 2.2 add in climate risk for assets, then for liabilities; 2.3 Add in risks for Expenses and then Sales Margins Physical Risk Distribution Financial Transition Risks Commercial Transition Risk

Use case: Credit Scoring Credit ratings are key: • Important decisioning tool • Can act as trigger to sell • Downgrades can result in material price moves Peabody Energy: • Downgraded to CCC+ in 2016 • Failure to disclose exposure to climate risk impacted rating Vattenfall: • Upgraded by S&P after it sold its brown coal-powered stations in Germany

Use case: Green Tagging Green finance previously unavailable to institutional investors Green bonds are changing this 50% global FI investors keen to increase green bond exposure Helping investors to address ESG mandates

Blockchain for carbon trading Use case: Blockchain Blockchain for carbon trading Blockchain for supply chain efficacy Blockchain for energy efficiency using smart meters https://www.etondigital.com/blockchain-startups-transform-environment/ Source: Poseidon Carbon Credit Blockchain

Use case: Agent-based Modelling New modelling approaches to quantify climate risk Stress testing a simulated supply chain Challenging traditional approaches Drawing on broader data sources

Mapping risk to the supply chain Climate risk brings additional supply chain challenges Physical risk amplifies commercial risks Climate Risks Physical Risk PPE Damage Liabilities Capital Annual Profit Assets BALANCE SHEET Cost of Capital Money / Debt / Equity Markets Stranded Assets Financial Transition Risk INCOME STATEMENT Sales Expenses Annual Profit $ Physical Risk Supply Chain Market Share Commercial Transition Risks Input Prices Customer Preferences Microec or Company-specific Inputs Input Prices Margins Physical Risk Distribution $ Need to talk about the different actors in supply chain - introduce them - familiarise the symbols Financial Transition Risks Commercial Transition Risk

Climate risk and financial decisioning 1 Commercial and financial decisioning is taking account of climate change risk 2 As the transition to greener decisioning gains pace there will be risks and opportunities 3 FinTech well placed to turn the noise into numbers