How can we mainstream major climate risks into financial reporting?
25 Oct 2018
The physical impacts of climate change pose a threat to our environment, society and economy. The impact of these risks can already be seen across geographies and sectors, as severe climate events become more frequent. If we don’t act now, the incidence of droughts and floods will increase by a dangerous degree in the next 12 years. Cutting emissions at an accelerated speed before 2030 is a critical part of avoiding such consequences.
But, how can we also avoid the financial implications resulting from the exposure of investments and physical assets to these risks?
While looking to minimise economic risks related to potential loss in revenue or access to capital due to climate change, investors who prefer climate smart investments while avoiding climate risky assets can engender real systems transformation. Given the urgent need to take action, why not mobilise the financial sector’s existing expertise in identifying sustainable investments to catalyse the low-carbon transition of our economies now?
South Pole’s vision is an investor landscape that can reach well-informed decisions on where to move funds quickly and efficiently, based on clear and comparable data on climate risks and opportunities. But how do we get there, and how much time is left?
The Intergovernmental Panel on Climate Change report on Global Warming of 1.5ºC tells us that we have 12 years to deliver transformative change. One of the first steps to do this is creating greater transparency in a way that will shift the trillions required from brown to green assets and investments. While there is less time available than previously acknowledged, we now know the importance of delivering systemic change quickly, and the role of financial sector is increasingly crucial in achieving this goal. A swift systems transformation will require efforts across the financial sector – and committing to increased transparency will ensure that we create the requisite synergies for systemic low-carbon transformation.
Encouraging transparency and mainstreaming climate-related financial disclosure is an objective which calls for establishing certain industry-wide practices. To achieve this, we must accelerate the development and implementation of best practices, as well as collaboration between stakeholders. Scaling up the existing knowledge on climate risks and identifying related opportunities is now of vital importance.
With this being the case, why do we still lack harmonisation across climate risk assessment practices?
One of the key challenges is limited access to data and metrics comparable across sectors and geographies. To be applicable on an international scale, a solution must be capable of providing an overview of the risk exposure of global portfolios, without being overly complex, or time- or resource-intensive. Encouraging transparency through climate-related financial disclosure is one thing, but identifying the investments most aligned with meeting the 1.5ºC goal is another. This will require leveraging existing knowledge about climate risk analysis and connecting the dots across climate science and finance to create solutions that guide concrete action towards the 1.5ºC goal.
Fighting climate change is smart, given that the risks posed to investments by climate change should not, and cannot, be ignored. Thus we should not only be calling upon the early adopters of innovative practices, but also upon the collective efforts of stakeholders to identify not only the greatest risk hotspots, but also the key areas of opportunities. Hence, we encourage investors, asset managers and asset owners to take an important step forward by integrating climate risk exposure into their portfolio analysis and investment strategies.
To guide informed decision making, ideally investment climate risk assessment practices and tools should allow the user to select the key parameters most relevant to their objectives. For example, being able to analyse a portfolio’s climate risk exposure by selecting scenarios (e.g. 1.5-4ºC) and time horizons (e.g. 2020-2080) according to preference, or changing industry and holding weights within the portfolio, allows for a dynamic look at how this portfolio could be adjusted for lower climate risk exposure, and helps to identify alternative options with more conservative levels of risk exposure.
At South Pole, we believe that a dynamic approach can truly make the difference in the efforts towards mainstreaming climate-related financial disclosures. Our ambition is to deliver a portfolio screening tool applicable across entire portfolios and asset classes, allowing for benchmark comparison that can also be adjusted for different investment strategies and time horizons. At the same time, we are confident that efforts for increased transparency can be further supported through collaboration among different financial sector stakeholders and the scientific community. Such collaboration will be vital in creating climate risk assessment practices that are understandable, transferable, and allow for a risk overview that feeds into disclosure practices while also informing climate strategies and concrete action.
Hanna Värttö is a Senior Consultant at South Pole Group. She will be speaking at the “Green Bonds for Cities Masterclass” on 8 November, 12:00-1:00 p.m., at the Climate Innovation Summit.
Related GoalGoal 11: Democratise climate risk information