Assessing Physical Risk of Green Bonds: A Case Study

Affirmative Investment Management partnered with South Pole to produce this case study, Assessing Physical Risks of Green Bonds, as part of our continued commitment to pioneering best practice in green bond verification, impact measurement and reporting.

This physical risk assessment tool is forward-looking and examines three forms of green bond issuers’ exposure to physical climate risks under two scenarios: warming of 2°C and of 4°C. It analyses the issuer’s overall risk profile, as well as the risk profile of energy generation assets and that of assets funded by the issuer’s green bond framework. The tool provides an indication of the issuer’s exposure to risk and its projected financial stability, with additional insight into the soundness and adequacy of specific investment actions to address future climate challenges.

In this study, a small sample of issuers in AIM’s portfolios were scrutinised. AIM and South Pole determined that the issuers’ level of exposure can vary significantly when modelled for 2°C warming and 4°C warming scenarios, and green assets can be vulnerable. For example, both extreme flooding and drought may severely affect the performance of hydropower assets—one of the leading renewable energy technologies deployed globally. 

This physical risk assessment can be used to enrich reporting frameworks for green and sustainability bonds, and to assess the climate resilience of the green bond market. Improved information also facilitates more focussed engagement between issuers and investors on the resilience of investments. AIM will use findings from the pilot study to strengthen our engagement with issuers on the vulnerability of their investments and/or operations, while seeking to enhance our own reporting on the resilience of portfolios for our clients. 

While this new South Pole tool is applied only to green bonds in our case study, it can be equally effective for non-green bond issuers and facilitates comparative benchmarking. It is a starting point for better understanding the climate-associated physical risks of funded projects, enabling better investment decision-making.

To read the full report, click here.