Assessing physical climate risk in private markets: A technical guide

This guide details a three-part process for private markets investors to assess physical climate risk. It covers data collection, risk assessment and options for taking action.

The increased unpredictability of weather patterns and severity of weather events is changing how investors think about risk. As the link between physical climate risk and financial impact becomes more evident, climate risk assessment needs to become more sophisticated and embedded within the investment process.

However, PRI reporting data from 2024 indicates significant gaps in the use and disclosure of physical climate risk metrics. While real assets investors, who are often on the sharp end of climate-related impacts, demonstrate more advanced practice in this regard, private equity and other investors are lagging (see Figure 1).

Figure 1: Real assets investors lead in reporting on physical climate risk

Figure-1_Real-assets-investors-lead-in-reporting-on-physical-climate-risk

Source: PRI Reporting Framework 2024, Indicator PGS 45: During the reporting year, which of the following climate risk metrics or variables affecting your investments did your organisation use and publicly disclose? (Physical climate risk was among the answer options.)

In response to signatory demand for clarity around assessing physical climate risk, the PRI developed this guide to:

help private markets investors understand the core elements of conducting a physical climate risk assessment;
explain how assessment results can inform critical next steps, such as integrating outputs into valuation models and/or working with investments to implement adaptation measures where appropriate;
support less-advanced practitioners in developing a consistent process for assessing physical climate risk;
provide a baseline of good practice against which more-advanced practitioners can assess their current processes and practices.

The guide begins by defining physical climate risk and the broad range of associated risks and opportunities. It underlines the relevance of the issue to private markets investors then introduces a three-part assessment process for physical climate risk.

The guide incorporates case studies throughout to illustrate how signatories are carrying out these assessments and includes an extensive list of additional resources in the appendix.

Information gathering

Investors must start from a well-informed position. We suggest three components of gathering relevant information:

Scoping: Top-down and bottom-up approaches to defining the scope of any assessment are reviewed.
Gathering data: Four types of data and how best to collect them are discussed.
- Hazards: Climate hazards should be analysed by considering the likelihood/frequency of the hazard occurring and its intensity.
- Exposure: Real assets and private equity investors may require different location-specific data to assess the exposure of their investments to climate hazards.
- Vulnerability: Assessing vulnerability helps investors understand what adaptation measures may already be in place or be required for individual investments or in the surrounding area.
- Impacts: By expanding the analysis beyond physical damage, investors gain a broader understanding of operational and financial impacts.
Identifying frameworks: Investors need to select climate models, climate scenarios and time horizons that will generate the most meaningful assessment for the investments concerned. Commonly used scenarios, and their limitations, are explored.

Risk assessment

The most common starting point for private markets investors is to carry out a high-level assessment to obtain a quick view of where and what key risks may arise for their investment(s). These assessments are often carried out as part of due diligence in the initial stages of the investment process, or as a first review of potential risks within a portfolio.

The goal of the assessment is to inform potential investment and asset management decisions; highlight the need for more in-depth analysis of higher-risk investments; and build awareness and understanding of potential risks, both internally and at the investment level.

This type of assessment can be conducted by using either external tool providers or developing an in-house approach. A variety of outputs and metrics – and their limitations – are reviewed.

An in-depth assessment may follow on from the previous approach, or it may be the starting point for higher-risk investments. An in-depth assessment may allow investors to:

make more informed comparisons of potential or actual investments in different geographies or sectors;
better identify existing or potential adaptation measures for a specific investment(s) where needed, and the impact of such measures on the investment’s resilience and ultimately its financial performance;
more accurately calculate associated financial assumptions – for example, in relation to potential capital or operational expenditure requirements – and as a result, make more-informed investment decisions.

These assessments typically depend on more in-depth engagement between investors and key stakeholders, such as the investment’s management team, as well as site visits and input from technical consultants.

Taking action

Information from risk assessment can prompt a variety of responses. Investors may:

alter investment strategies and decisions. This could be at the portfolio level, as investors better understand the overall risks and opportunities related to different asset types, sector(s) or geography(s). Or it may be at an individual investment level, by enabling investors to make more accurate investment valuations and to understand the need for and depth of insurance coverage;
engage and/or work directly with investments to implement adaptation measures, where needed;
improve disclosures and reporting to regulators, clients and other stakeholders.

This guidance details how direct investors in private equity and real assets can develop a process to assess physical climate risk in their portfolios. Asset owners investing in private equity and real assets through external managers may also use the guidance to better assess those managers’ understanding of, and approaches to, physical climate risk.

The guidance is intended for investors at different stages of understanding and practice on physical climate risk.

For investors new or less familiar with the topic, it provides a general introduction to the importance of physical climate risk and breaks down the different elements of conducting physical climate risk assessments.
For investors with an existing physical climate risk assessment process, the guidance can be used to review the current process against leading industry practices, and to learn from peers using the case studies and examples provided throughout the document.

Throughout the document, we use the terms “investors” or “private markets investors” to mean direct investors in private equity and real assets. The guidance also most directly speaks to majority or control investors; however, we reference considerations for minority or co-investors, where appropriate. Finally, where we refer to “investees” or “investments” we mean the underlying or potential portfolio company or asset.

The content in this guide is based on: