A new methodology allows investors to evaluate and report on the physical risks climate change pose to their real assets.
In a world where the climate is changing in ways that are hard to predict, assessing future risks to infrastructure and property has proven difficult – and methodologies have been fragmented and opaque.
But the Institutional Investor Group on Climate Change (IIGCC) believes it has hit on a method that could solve many of these problems, providing a comprehensive toolkit for investors to measure and report on the manifold risks to real assets.
On Thursday, the group announced it had completed the first pilot phase of the Physical Climate Risk Assessment Methodology (PCRAM) – a programme that aims to bridge the gap between the infrastructure and financial sectors by “providing a consistent approach for evaluating climate risks across both public and private finance”.
So far, the results are encouraging.
“The pilot phase of PCRAM 1.0 proved the credibility of the approach, providing a practical demonstration of the assessment process and illustrating three key value propositions for investors,” the IIGCC said.
Those three value propositions were: the integration of physical climate risks into investment appraisal processes; a standardised method to accurately value assets’ climate resilience; and a “clear, dynamic, and meaningful process” that can be integrated into existing reporting regimes, such as the International Sustainability Standards Board’s (ISSB) Sustainability Disclosure Standards.
“A small but growing range of case studies shows that PCRAM can be applied broadly across different infrastructure assets, financing and ownership models and geographical locations – each facing different climate risks,” said Mahesh Roy, IIGCC’s Investor Strategies Programme Director.
“These positive results have paved the way for the second phase of this methodology – PCRAM 2.0 – which will offer broader coverage across infrastructure and real-estate assets, with work already underway with IIGCC, investors and broader stakeholders in the PCRAM working group.”
The PCRAM was initially kicked off by the Coalition for Climate Resilient Investment (CCRI), but was passed on to the IIGCC last year.
Case studies
The pilot programme report focuses on two case studies: a run-of-river hydropower project, and a wind farm.
In the case of the hydropower project, which would generate around 200 gigawatt hours of electricity a year over a lifetime of 40 years, PCRAM assessed two key climate risks: drought and precipitation. It followed four steps: scoping and data gathering; materiality assessment; resilience building; and economic and financial analysis.
In the first step, PCRAM analysed global and regional climate projection models to identify potential climate hazards in the area. These determined that heat, drought, and precipitation events were relatively high and likely to rise. The analysis also showed that the biggest climate-related risk was drought, given the plant’s dependence on river flow for energy output.
The next step was to establish how material this risk was, with the use of climate models. The conclusion was that in the first 20 years, there would be a small increase in energy generation, followed by a significant decrease between 2041 and 2060.
The third step then looked at how to act on this information by building resiliency, making nine recommendations designed to increase efficiency and encourage “quicker recovery from decreased rainfall and drought events”.
The final step – the key one for an investor considering investment in the project – involved calculating internal rates of returns (IRRs) that fully capture the financial impact of physical climate risk across three different timelines. These could be used by investors to get a clear idea of the return they can expect from an asset that is exposed to climate risk.
A similar process was used for the wind farm, except the key risks examined were not drought and precipitation, but flooding and potential changes in wind speed.
Value of resilience
The pilot phase showed PCRAM could provide investors with insights that not only protect them against risks, but also help them identify investment opportunities relating to climate risk.
“These case studies show how PCRAM can capture and quantify the value of resilience throughout an asset’s life, leading to more reliable cash flows and cost savings,” said Roy. “They also hold the potential to make it easier to monetise resilience benefits and share investment costs among stakeholders.”
By adopting PCRAM as a basis for a sound physical climate risk assessment, investors could fund infrastructure projects with more predictable future cash flows and optimised lifecycle costs, Roy said.
“This approach helps build systemic resilience from the bottom up – not just within asset portfolios, but also in the communities where they operate,” he added.
The IIGCC is now planning to expand PCRAM’s scope by adding other elements such as nature-based solutions, to provide more comprehensive strategies for managing climate risks. The group will also be releasing a discussion paper on the methodology for investors before the end of the year.
