Climate risks are material financial risks.

Yet, for a long time, the financial world has mostly reacted to climate threats as they happened. They also relied heavily on Environmental, Social, and Governance (ESG) reporting to demonstrate compliance and show that they are “following the rules”.

However, this checklist approach is increasingly losing both relevance and credibility among investors and issuers, especially in light of today’s complex climate realities.

The conventional ESG ratings do not provide the much-needed independent, laser-focused, forward-looking, financially relevant assessment tools that are based on actionable metrics and grounded in scientific research.

In this article, we unpack five limitations of the conventional, ESG-focused approach to climate risk assessment and showcase how Scientific Climate Ratings, an EDHEC venture, offers an alternative framework that translates climate data into decision-useful financial insights.

1- They Cannot Offer Forward-Looking Assessment

ESG ratings do not model different climate scenarios or estimate future pathways. They primarily describe the past and current performance, and they do not evaluate interconnected future exposures that will shape tomorrow’s financial outcomes. For instance, an ESG assessment might report a company’s past emissions reductions but would not be able to evaluate its future financial vulnerability to escalating carbon taxes or the physical impact of a 2°C global warming scenario.

Scientific Climate Ratings addresses this limitation and provides a modelling framework that integrates future-looking metrics to assess exposure in different time zones (through 2035 and 2050), while assigning probabilities to various climate scenarios established by current scenario modelling frameworks.

2- They Do Not Provide Actionable Climate Metrics

ESG frameworks often fail to quantify potential losses, damages, or risks associated with physical or transition climate shocks. These frameworks are mostly compliance-driven and purely defensive, and they are not built on scientific forecasts or robust financial modelling.

Consequently, they lack the analytical depth essential for well-informed decision-making for investors.

One example would be an ESG report noting a company’s renewable energy targets, without providing a monetary estimation of the potential asset value loss from stranded fossil fuel assets or the projected cost of supply chain disruptions due to future physical risks.

Our Potential Climate Exposure Ratings (PCER) and Effective Climate Risk Ratings (ECRR) not only compute potential exposure scores but also measure the NAV impact using EDHEC research teams’ proven asset pricing model to give actionable financial insights.

3- They Are Not Built with Scientific Precision

ESG ratings are often subjective and inconsistent across different rating providers, which creates confusion rather than clarity.

They are mostly impacted by ideology, which results in ratings that can differ depending on the provider or issuer and their ideological stance.

For instance, a single company can be simultaneously labelled as an “ESG Leader” by one rating agency and an “ESG Laggard” by another, depending on the rating agency and the criteria used. This can be related to the differences in methodology, subjective interpretation, geographic location, or the agency’s specific agenda.

This limitation can be explained with the example of unions and how they are perceived by companies and organisations. In this context, an important question arises: Is it positive or negative for a company to have unionised workers? If you are a provider focused on social impact, their presence might be a positive, reflecting strong worker rights and fair treatment.

On the contrary, unionised workers could be perceived as a negative and the provider might consider them as a factor impacting labour costs, from a strict financial efficiency perspective.

4- Their Scope Is Too Broad and Lacks Focus

ESGs rate too many different risk dimensions (e.g. Environmental, Social and Governance) and their broad scope can dilute their analytical focus.

Unlike more specialised financial instruments such as credit ratings, which concentrate on a single risk dimension, ESG’s comprehensive nature often leads to a lack of specific focus.

A company’s strong social governance practices might overshadow a critical lack of adaptation measures in the face of physical climate risks, resulting in an incomplete risk profile from an investment perspective.

At Scientific Climate Ratings, we want to focus on one single thing: the financial materiality of climate risks.

5- Ideology Overrides Science and Rigour

These scores often reflect reputational or ethical considerations more prominently than systematic, science-led risk assessments, thereby creating a breeding ground for greenwashing.

For example, companies can make bold and ambitious pledges for emission reductions while doing very little to back them up with tangible, real-world actions or demonstrable progress, resulting in “climate-aligned” portfolios that cannot deliver.

This underscores the difference between “doing good” and “feeling good”.

An Evidence-Based Alternative: Scientific Climate Ratings

The financial community needs to move beyond these limitations.

Investors and issuers require evidence-based tools grounded in robust scientific research to quantify the financial impact of climate risks.

Scientific Climate Ratings, an EDHEC venture, addresses these needs directly.

Our approach developed by the EDHEC Climate Institute meticulously combines advanced climate science with in-depth financial analytics to provide a comprehensive set of insights:

• Independent, evidence-based risk ratings.
• Assessment of both physical and transition risks.
• Transparent and comparable metrics presented in both monetary and relational terms for comprehensive financial risk analysis.
• Assigns probability to climate scenarios across multiple timeframes, enabling a dynamic and holistic view of future risks and exposures.
• Leveraging ClimaTech, the most extensive knowledge base of adaptation and resilience strategies.
• Utilises geospatial risk analysis, offering granular location-specific insights into climate vulnerabilities.

Scientific Climate Ratings offers the analytical depth and scientific precision necessary for financial decision-makers to navigate the evolving landscape of climate risk effectively.

Is your current approach to climate risk providing you with the comprehensive insights required to thrive in this new era?

Now you know.

Further Reading