Why do I need climate intelligence?

According to a recent United Nations report¹, climate-related disasters jumped 83% in the past 20 years and yet, against this backdrop of risk and uncertainty, 76% of global CEOs stated they are under-prepared for climate change².

Risks posed by climate change

Whilst businesses have long engaged in risk analysis, an understanding of the range of risks posed by climate change is evolving. However, there is a taxonomy of sorts and this ‘new era’ of risks can be categorised into physical, transition and natural capital risks:

Physical risks

Physical risks have been well explored, being relatively easy to understand and measure and – importantly – being fairly obvious in their day-to-day presence. There is ongoing discussion around what constitutes acute, as opposed to chronic, risks, but key climate risk indicators include:

• heat stress
• water stress
• extreme precipitation
• wildfires
• sea level rise
• hurricanes and typhoons.

Transition risks: Adaptation & Mitigation

Adaptation risks refer to the measures needed to adapt to physical risks, and the risks inherent in that adaptation. Adaptation risk indicators may include:

• negative operational impacts (such as losses in efficiency or quality)
• costs of adapting/ adjusting the business
• asset valuation risks
• subsidy loss.

These categories are typically used in the assessment of credit or lending risks but also apply in this context. Of course, as adaptation measures are implemented, so the risk profile changes. Ongoing review is therefore critical.

Mitigation risks are less well explored, but relate to the potential impacts of activities directed at mitigating climate change. They may include many of the typical risks associated with financial analysis and are also likely to carry financial implications:

• changes in national and international regulation
• changes in national and international legislation
• changes in technology – and in the regulation of technology.

Natural capital risks

Natural capital refers to the global stock of natural resources and includes soil, clean air, groundwater and biodiversity (all living things). It is the ‘free’ suite of resources that many businesses rely on and it has – up to now – been highly undervalued.

These are less well understood and less well defined but the signs are that this is changing. Moody’s (for more information on Moody’s see a brief description in the Downloads section below) has recently begun to incorporate natural capital issues into its environmental, social and governance (ESG) assessments and its environmental issuer profile score now consists of five ‘exposures’: carbon transition, physical climate risks, water management, waste and pollution, and natural capital. Investors are now paying serious attention to natural capital with funds dedicated to such investments.

Risk reporting

The Inter-governmental Panel on Climate Change (IPCC) has emphasised that risks apply to both the impacts of and the responses to climate change. The new and increased risks of climate change to financial firms are calculated at almost $300 billion (physical risks) and almost $400 billion (transitional risks). At present most firms do not have the tools to evaluate and monitor these risks accurately. Consortium groups like the global Task Force on Climate-related Financial Disclosures (TFCD) are however shaking things up and the UK has begun a programme to make it mandatory for large businesses to report on their climate-related risk in line with TCFD recommendations.

Demonstrating how the financial environment affects businesses in general, in January 2020, Larry Fink, CEO of the world’s largest asset management firm (BlackRock), announced the firm’s new approach to climate change. In his annual letter to CEOs, Fink asked the companies in which Blackrock invests to “disclose climate-related risks in line with the TCFD’s recommendations, if you have not already done so”. He also asked companies to set science-based emissions reduction targets.

Central banks in the UK, France, Singapore and the Netherlands have also all suggested stress tests for investments, making it harder to invest in companies or projects heavily exposed to climate change. So, not only should companies use climate information for their own internal risk management and planning, they are now also being asked to ensure that they report risk and risk mitigation measures to their investors and shareholders. This trend is only set to continue and, as the world becomes more severely altered by climate change, physical risk reporting and climate resilience planning will become more than just an option.

A range of sectors and industries now access and apply climate information in strategic decision-making and you’ll now hear from three very different businesses about their experiences in the case studies this Week, one serving the heritage sector one providing resources for the renewable energy industry and one in the aviation industry.

References

1. The human cost of disasters: an overview of the last 20 years (2000-2019). Centre for Research on the Epidemiology of Disasters, United Nations Office for Disaster Risk Reduction
2. 2020 FM Global Climate Risk Survey.