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How Do You Quantify Climate Risk?


Three years ago, I settled into my seat in a swish meeting room at London’s Tate Modern gallery as Michael Bloomberg and Mark Carney (then-governor of the Bank of England) outlined a new set of climate risk guidelines for the financial sector.

The rules were developed by the Task Force on Climate-related Financial Disclosure (TCFD), one of the first major initiatives to really bring concerns about climate risk into the mainstream. It was set up in 2015 by the Financial Stability Board, an international body that makes recommendations about the global financial system.

The goal of the guidelines was to show companies how they can better identify climate-related financial risks—and define the best practices for reporting them as part of a firm’s mainstream financial filings. (They were finalized in 2017.)

Some investors were already taking action to protect their money: As the plates were cleared from the fancy lunch, a responsible investment exec from asset management firm Aviva Investors told me that the company had already decided to vote against the annual corporate report and accounts of firms failing to follow the guidelines.

Three years on, and more than 1,000 corporates, worth a combined $12 trillion in market capitalization, have now signed up to the voluntary TCFD guidelines. Earlier this year, BlackRock chairman Larry Fink’s annual letter to CEOs argued climate change has become a “defining factor” in the long-term prospects of companies—no small statement, considering that BlackRock manages nearly $7 trillion in assets, equivalent to a third of U.S. GDP.

“[W]e believe that sustainable investing is the strongest foundation for client portfolios going forward,” added Fink. “[…] Companies, investors, and governments must prepare for a significant reallocation of capital.”

Fink’s position gives a strong signal to the entire financial services sector. “Regardless of politics, if Wall Street is swimming in the direction of trying to price climate in, then everybody eventually will,” says Evan Kodra, chief executive of risQ, a spinout of Northeastern University that sells analytics around risk to municipal bond investors.

Extreme weather events in the U.S. have “made this all come alive to people,” says risQ CEO Evan Kodra.

Events such as the 2017 hurricane season, flooding and California wildfire sharpened the interest from the private sector in thinking about climate risk seriously, says Kordra. 

“Even around five years ago, the mentality collectively around it was that it was the future and not something we need to worry about super seriously,” he adds. “That feeling is much different now.”

With such a changing landscape come new players. Companies such as exposure and risk data firm Insurdata and solar energy risk experts kWh Analytics are helping investors navigate a plethora of newly recognized climate risks. Says Kodra: “Over the last few years, there’s certainly been an uptick in the number of companies we’ve seen trying to solve these types of problems.” 


Understanding the Threat

The financial impact of climate risk can be separated into two broad areas, says Frances C Moore, assistant professor at the University of California Davis. 

The first concerns overall exposure to climate change impacts, she says. “I think some companies are increasingly aware that yes, maybe they are exposed to climate change impacts, and they should be at least kind of planning for that and disclosing that,” she says.

The second looks at the effects of current or future climate policy, such as moving away from fossil fuels or carbon-intensive infrastructure. If projects are out of step with a low carbon world, investors may be exposed to lost value as climate policy is ramped up: a concept known as “stranded assets.” 

“That’s what a lot of fossil fuel companies know they’re exposed to,” says Moore. “If the world is really serious about a 2C target, you know, that doesn’t look good for the prospects of those fossil fuel companies.” 

The way Kodra thinks about climate risk in practical terms is simply as something that should be factored into price, but is not. “In particular, we focus on the U.S., and in that ecosystem, things like municipal finance, real estate, climate risk really should be priced and are not priced into those assets, securities transactions, etc,” he says.

Another way of gauging climate risk: ranking it against other risks. The World Economic Forum’s global risks report has a annual survey that asks business leaders, investors and policy-makers what they consider the most likely long-term global risks. This year, for the first time, environmental concerns dominated the top five spots, with extreme weather events at the top, followed by climate action failure.

“It’s not, let’s be clear, a definitive reflection of where risks are in the world,” says Oli Brown, associate fellow at Chatham House, a British nonprofit. “It’s a very interesting straw poll of what the top executives think about these issues. It shows, I think, a growing awareness of some of the risks presented by climate change.”

Brown himself has a broad concept of what climate risk is. “It’s the negative impacts of climate change, across economies, societies and politics,” he says. “We’re conducting this planetary-wide experiment with a climate that is having tremendous impacts. And we’re only beginning to understand those impacts and what they themselves could trigger.”

The hope is that the threat of higher premiums will pressure local governments to do something about it.

The concept of climate risk can also be used in a much wider sense. For NGO Germanwatch, the risk to human life from climate change is equally as important as financial risks. Its annual Global Climate Risk Index looks at a mix of financial and human losses in each country from extreme weather events.

“It’s really important to show that there’s already a lot of people in the world suffering from extreme weather events,” says Maik Winges, policy adviser at Germanwatch and co-author of the report. “Especially when knowing that these extreme weather events will become or are already becoming more frequent and more severe.”

The GermanWatch report looks at the risk from all extreme weather events: it does not attempt to separate out how much of this is caused by climate change. But its findings can be linked to the increasingly sophisticated science of attribution, which links human activity to some types of extreme weather.

“Of course, extreme weather events have always existed,” says Winges. “[…] But the [scientific] research is really clear on the fact that extreme weather events increase in frequency and severity due to climate change.”

Companies like Kodra’s are trying to find ways to put this human risk in financial terms. RisQ’s approach is to sell analytics around risk to municipal bond investors, to help them understand where they should be considering higher premiums. The hope is that the threat of higher premiums in turn will put pressure on local governments—often too stuck in short-term political cycles to consider climate risk—to do something about it.

“The thesis of what we’re doing is: you start with the people that do care because they have some money that they could potentially lose,” he says.


What Counts As Climate Change

With such different perspectives on what the term climate risk even means, let alone on how to understand the multiple, complex impacts of climate change, it may seem a problematic task to try to measure and quantify it.

That’s why it’s so important to be clear about what is actually included in each study. When I spoke to Winges, one of the first things he emphasized about the Germanwatch index was all the climate risk it didn’t include. 

Germanwatch uses data from reinsurance firm Munich Re, one of the world’s biggest reinsurers. This covers losses from extreme weather, such as drought, floods and heat waves, but not from slow onset events such as sea level rise and higher temperatures. 

But even measuring the economic damage caused by extreme events is tricky, says Winges. How do you define when a drought begins, for example? Or how long its impacts last after it ends? The impacts on people are also hard to quantify. “It doesn’t start being a bad or negative influence when somebody dies,” he says.

According to the latest index released in December 2019, Japan, the Philippines and Germany were the three countries most impacted by climate change in 2018. Japan was hit by torrential rains, a major heatwave and the country’s most intense tropical cyclone in more than 25 years. The Philippines experienced the most powerful typhoon recorded worldwide. Germany experienced a severe heatwave, leading to its hottest year since records began. 

The index has found that, in general, non-industrialized countries suffer far more from extreme weather events than industrialized countries, though, with Puerto Rico, Myanmar and Haiti the most impacted in the past 20 years. “This isn’t even without considering that they have less capacity to recover,” says Kodra.

While Germanwatch looks at the climate risk as experiences in the present, climate researchers such as UC Davis’s Moore use models to project expected climate risks into the future. This allows them to perform cost benefit analyses of climate policy, she says.

Cost-benefit analysis can be helpful in looking at the advantages of reducing emissions, as well as answering questions about how much we should be doing about climate change right now, adds Moore. In fact, the U.S. has an executive order that requires new regulations to undergo a cost-benefit test, she notes.

The financial sector appears to finally be taking the threats climate change poses to its bottom line seriously. A growing number of firms are moving to protect themselves from climate risk, while others are responding to an array of new opportunities to make positive change.

“Talking to people 10 years ago, nobody thought climate change was really that relevant because they didn’t feel like it was showing up on the balance sheet,” says Kodra. “That’s changed.”

→ Learn how 600+ publicly traded U.S. companies are taking steps to address climate change through the Ceres Roadmap to Sustainability

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