EY is launching a climate stress test simulation program to enable financial institutions to better integrate climate risk into their portfolio management evaluation processes.

Running on Microsoft (MSFT-Q) Azure, the EY Climate Stress Testing and Scenario Analysis is expected to provide Canadian banks, pension funds and other financial institutions with a means of pricing climate risk into analytical methodologies.

The rollout comes amid increasingly stringent government regulatory and institutional stakeholder standards in addressing the threat posed by extreme climate events. Canadian corporations are under pressure to undertake infrastructural upgrades and technological enhancements to mitigate the impact of climate risk. 

This is why EY, the global consulting company which maintains its Canadian headquarters in Toronto and employs a domestic workforce of nearly 6,000, believes financial institutions need an analytical tool that will shape investment strategy and corporate ESG programs accordingly.

"By combining Microsoft cloud technology and EY ESG risk expertise, we’re providing a powerful solution, complete with the latest industry frameworks and standards to assist clients through the climate reporting process," Mario Schlener, EY Canada risk consulting leader, said in a press release. 

Model can help financial institutions comply with OSFI guidelines 

EY stated Canadian financial institutions are compelled to "prioritize climate reporting and transparency" to comply with new disclosure requirements from the Office of the Superintendent of Financial Institutions (OSFI), the independent Government of Canada agency reporting to the Ministry of Finance, as well as new international sustainability standards.

Climate risk scenarios and other modelling elements incorporated into EY's software help banks and other financial institutions optimize their assessments of climate risk across multiple business sectors.

This can promote greater coordination between the financial and corporate sectors in tailoring and accelerating the deployment of infrastructure and decarbonization measures according to outcomes and probabilities revealed by the EY stress tests.

"We recognize that operational readiness, resource constraints, and the evolving regulatory landscape pose significant challenges to the seamless execution of climate scenario analysis and stress testing programs," said Katerina Kindyni, EY Canada financial institutions sustainability leader. 

"(The EY climate stress test) solution offers a centralized tool that enables FIs (financial institutions) to efficiently identify, measure and monitor risks associated with the transition to a net-zero economy, while seamlessly integrating market intelligence into an organization’s infrastructure."

EY climate risk model a customizable tool

The EY climate tool is a tech package that combines the consultancy's informational and evaluative expertise with the latest data and metrics from climate science.

"One of the advances that we have tried to achieve by means of this solution is to ensure that financial institutions have a methodology that is robust. What we see in the markets today in Canada and globally is that there are lots of different and overlapping methodologies and regulations," Kindyni told Sustainable Biz Canada.

"We have tried to examine all the market-leading practices, all the regulations that we see across the globe, and develop our own solution to identify the risk that financial institutions are facing, measure the risk and then monitor and disclose those risks over time.

"This solution can be fully adjusted depending on our clients' needs. It doesn't come in a black box, it's constructed in a white box manner. We can assess and respond to our clients' needs and then adjust (the solution) depending on their own portfolio and their situation."

Unique insights into specific economic sectors

Kindyni has been tasked by EY with enabling financial institutions to proactively manage their investment portfolios and develop effective decarbonization strategies.

Inasmuch as the EY climate risk tool fills a gap in the knowledge base and methodology arsenal of banks, pension funds, et al., it also provides improved metrics to evaluate the sustainability quotient of Canadian companies, while pricing in climate risk and tracking implementation efforts.

"This solution has been, first and foremost, developed for financial institutions so they can navigate through the current regulatory landscape in a way that ensures they can be in compliance and, at the same time, manage their own decarbonization strategies.

"Today's operating environment is complex, it's fast-paced, and it comes with more socially conscious expectations both from regulators as well as from investors. Financial institutions can't merely keep pace with today's risk, they also need to be prepared for what is coming tomorrow, which is exactly what this solution focuses on," Kindyni said.

Quantifying risk for a more sustainable capital allocation

Despite disheartening conclusions being drawn by many world-leading climate scientists that countries are likely to fall far short of existing net-zero targets, Kindyni believes financial institutions can trigger changes in corporate sustainability practices and strategies. 

"Financial institutions have a key role to play because the way that they're allocating capital across the economy can influence the pace at which we can achieve the Paris goals.

"If we don't move fast enough, this can leave unprepared sectors behind. Our climate risk solution ensures that the financial institutions, and ultimately corporations, will be able to better manage their balance sheets by identifying, measuring and quantifying risk related to our transition to a low-carbon economy," Kindyni explained.

The EY climate risk model also takes into consideration sector-specific modelling. Progress toward a low-carbon economy can only be properly assessed by applying risk analysis to specific industrial sectors. 

"We need to understand how quickly the agriculture sector can be decarbonized, how quickly the oil and gas sector can be decarbonized, the real estate sector, etc.

"Our model explains what makes those sectors unique, so that then we can understand how the financial performance of corporations within those sectors will be impacted."

'Major pillars' must coordinate efforts to attain net-zero

Kindyni is also optimistic "the laws of chemistry and physics" still hold out the possibility of attaining Paris climate accord objectives, which call for limiting global temperature rises "to below 2 degree (Celsius) and to 1.5 degrees (Celsius) if possible." However, she believes this will require enormous action by the governmental, finance and scientific sectors. 

"The amount of investment required to transition to net-zero is huge. But effective government policies can point the way forward. Financial institutions need to follow those policies and make sure that the way that they allocate capital proceeds at a pace that will enable us to make the transition.

"And our universities and scientists will need to provide the innovation because technology has a huge role to play in this regard . . .

"We need all these three major pillars to come together and help accelerate the transition . . . it's going to be challenging."