Climate change is still a poorly understood global crisis, claims Edward Baker from Principles for Responsible Investment (PRI). 

– Climate change is a risk multiplier. It doesn’t create new problems in the near term per se, but it does aggravate existing issues around food, water and energy security by changing the odds on extreme weather events. The climate system is characterised by a delayed dose and response; the effects of heat trapping gas we are putting up now will not show up for decades, he says. 

Financial markets have an important role to play in combatting climate change. But financial industry professionals are judged on performance and the question is:  how does climate change impact financial returns? Baker says there are three types of risk to consider:

Physical – Super storm Sandy did $60bn worth of damage to the east coast of the US. Climate change is altering the odds on these type of events and making them more deadly.

Financial – Financial institutions could still be exposed even when such weather events occur in a third country. Lloyds of London, for example, had to pay out £2bn in insurance premiums as a result of the 2011 Thai floods. 

Transitional – Technological change and the public policy response to the physical and financial risks of climate are fundamentally changing the economics of energy. As a result, investors could have capital at risk. US coal shares, for example, have lost 75% of their value over the past three years as a result of the shale gas revolution and competitive renewables. 

TCFD risk management framework to guide you

– Industry professionals need to consider how exposed their assets are, continues Simon Messenger from Climate Disclosure Standards Board (CDSB).  

The Task Force on Climate-related Financial Disclosures (TCFD) provides a useful risk management framework to assess these issues. 

– We want to encourage organizations to evaluate and disclose, as part of their financial filing preparation and reporting processes, the material climate-related risks and opportunities that are most pertinent to their business activities, Messenger says. 

Companies need to translate their sustainability information into business impacts. To understand what this means in practice, consider what the traditional sustainability reporting looks like: 

Companies report the impact that business has on the environment.
e.g. Company X produces 100,000 tons CO2e / year. (Scope 1: 30,000 tons CO2e; Scope 2: 50,000 ton CO2e; Scope 3: 20,000 tons CO2e)

When you turn it around, companies report the financial risks or opportunities that the environment places on the business. 
e.g. Company X produces 100,000 tons of CO2e per year. We estimate that, with a carbon tax of $500/ton by 2020, this creates a previously unrecognised, material, financial risk of $50million / year from 2020 onwards.

See the difference?

The TCFD recommendations include elements of disclosure on governance, strategy, metrics and risk management.

A recent research found that 80 % companies have board-level oversight into climate change, but only few provide incentives to their board members to manage it.

– There is a huge gulf between oversight and action. The thinking is not strategic and has not been incorporated into the wider business models. These recommendations are still voluntary, but every signal out there says these will become requirements, concludes Messenger.

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