Industry leaders continue to urge companies to integrate climate change into business strategies, financial disclosures and risk management processes. Mark Carney opted to focus on climate risk when addressing the Toronto Board of Trade in July 2016. Moody’s will use national climate commitments in its analysis of the credit implications of carbon transition risk. And Global Risk Institute’s recent publication provides much-needed guidance on specific impacts financial institutions will face due to climate change.
But as our understanding of specific risks improves, so too does our ability to manage those risks and identify longer-term strategies and solutions. The financial services industry is uniquely placed to promote greater transparency on climate-related risks and accelerate the shift to a low-carbon, resilient future.
Mark Carney Talks Climate at Toronto Board of Trade Event
Mark Carney has been an international leader in understanding the implications of shifting to a low-carbon, climate-resilient economy. On July 15, 2016, Carney took his message on climate change to Canada’s financial community at a Toronto Region Board of Trade event. Instead of discussing the U.K.’s recent vote to exit the European Union (Brexit), Carney addressed the Toronto Board of Trade on the significant risks and opportunities for our financial system as climate impacts increase and fossil fuel use is phased out in G20 member states. There he warned that “only about one-third of the world’s 1,000 largest companies provide effective disclosure of the risks they face due to climate change”. Carney explained that consistent, comparable standards for corporate disclosure on climate risks are necessary for markets to better value companies and price climate-related risks.
Moody’s Integrates Climate Change and Carbon Transition Risk into Credit Ratings
Credit agencies are integrating climate risk and threatening to downgrade industries and companies that fail to identify and respond to climate-related policies and trends. Moody’s Investors Service just announced that it will use national climate commitments under the Paris Agreement in its analysis of the credit implications of carbon transition risk. The agency said “it views the Paris pledges as a plausible central scenario for forecasting in light of current policy commitments and clean technology trends”. Moody’s also shared its view that 13 of the industries in its corporate and infrastructure portfolio will be exposed to carbon transition risk over the next three to five years, with three of those sectors already experiencing material credit impacts and rating adjustments.
Global Risk Institute Details Climate Risk in Finance Sector
The Global Risk Institute just issued a paper on the specific climate-related risks and opportunities the financial services sector face. The report, entitled Climate Change: Why Financial Institutions Should Take Note, hones in on potential risks to insurance companies, banks and pension funds.
The report finds, for instance, that insurance companies are threatened by the rapid rise in extreme weather events over the past decade (as well as associated losses, which rose from about $10 billion annually to $50 billion). These events could result in changes to property insurance, devaluation of real estate and increased mortality. It concludes that, although many insurance companies have risk management processes in place, climate change could compromise the accuracy of current catastrophe models and the effectiveness of portfolio diversification and risk transfer. The report then turns to banks. Banks, it finds, could face losses if they do not scale back exposure to high carbon industries and other assets that could suffer in the low-carbon transition. Climate change legislation has risen from 54 laws and policies in 1997 to 800 laws and policies in 2014. According to the GRI, current asset valuation models generally do not take these climate change regulations adequately into consideration. Finally, the report explains that pension funds are exposed to potential legal liability if, as fiduciaries, they fail to fully consider the risks associated with climate change and manage them to the best of their ability.
But the GRI’s paper doesn’t stop at the potential risks. It reminds us that, with heightened risks often comes unexpected rewards. Insurers have new potential sources of premium and revenue growth, such as renewable energy project insurance or investing in emerging carbon markets. Banks can underwrite green bonds or finance other low-carbon products and services. Pension funds can take advantage of their portfolio size and longer-term investment horizon to influence public policy and decarbonize capital markets. Indeed, the report concludes that the financial services sector is uniquely placed to support the economy’s transition by promoting better climate risk disclosure, financing mitigation and adaptation projects and investing in low-carbon alternatives.
Climate change presents new opportunities for strategic companies to improve and expand their businesses—including those in the financial services sector. Forward-thinking financial services companies should move quickly to take advantage of these openings.