April 25, 2018 – 427 REPORT. Financial institutions, corporations, and governments increasingly strive to identify and respond to risks driven by physical climate impacts. Understanding the risks posed by climate change for facilities or infrastructure assets starts with conducting a risk assessment, which requires an understanding of the physical impacts of climate change. However, climate data in its raw form is difficult to integrate into enterprise risk management, financial risk modelling processes, and capital planning. This primer provides a brief introduction to climate models and data from a business or government perspective.
The first of several reports explaining the data and climate hazards analyzed in Four Twenty Seven’s equity risk scores and portfolio analytics, Using Climate Data unpacks the process through which raw climate data is transformed into usable metrics, such as future temperature projections, to help financial, corporate and government users productively incorporate climate-based analytics into their workflows. Beginning by explaining what a global climate model is, the report explains climate data’s format, computational choices to hedge uncertainty and resources for aggregated climate projections tailored to specific audiences.
We chat with our new Chief Development Officer, Frank Freitas, about his motivations to join Four Twenty Seven after almost 30 years in finance and fintech, and his vision for new products and markets in climate analytics.
Why did you decide to join Four Twenty Seven?
First and foremost, the fact that our firm provides data-driven analytics that quantify real issues facing our planet today is very attractive to me. I have spent my entire career in finance and, like others, have increasingly come to see the need for alignment of investment decisions with those that preserve the future of our planet. To me, Four Twenty Seven’s mission and vision exist at the center of this nexus.
When I encountered the Four Twenty Seven white paper on climate risk in equity markets, I was impressed by the level of thought-leadership embedded in the research, and by the high level of quantitative rigor applied to the development of its risk scores. The acceleration of climate’s influence on corporate performance are upon us, and investors are rapidly awakening to the risks that climate change brings to financial markets. Four Twenty Seven’s sophisticated climate data analytics are at the forefront of identifying the most exposed corporations and assets globally.
My career to date has been focused on the development of analytical solutions for institutional investors, ranging from multi-factor risk models at Barra (now MSCI) to the solutions we built in my previous company, Pluribus Labs, where we combined data science and natural language processing with quantitative modeling to distill a variety of unstructured data sources into investible signals.
In my subsequent conversations with Emilie and the Four Twenty Seven team, I quickly came to realize that Four Twenty Seven’s research methodology really resonated with me, and that the culture here is fabulous. It’s rare that you have an opportunity to do what you love and also provide solutions that impact the planet’s future — my role at Four Twenty Seven enables me to do just that!
How is technology spurring innovation in research around financial risk?
There are a number of drivers at play in this respect. First and perhaps most obviously, the availability of computing power at our fingertips makes data analysis on large data sets more available and more affordable than ever before. If you had told me when I started my career that I would be able to create an account on a cloud computing platform like Google’s GCP or Microsoft’s Azure and have massive amounts of compute power available within minutes, I wouldn’t have believed you! Four Twenty Seven’s ability to distill terabytes of climate data from an ensemble of models into actionable insights at the asset level is a great way to leverage this computing power.
Relatedly, the ubiquity of meaningful data, both unstructured and structured, also provides a much broader set of lenses through which to view the world. Financial research has always focused on the development of insights from any and all available data sources on companies, industries and economies. Today, an ever-increasing volume of data sources are accessible for analysis. For example, features extracted from satellite images of our planet can be used to arrive at estimates on a wide variety of metrics, ranging from crop yields to consumer brand sales changes. Similarly, observations gleaned from the ‘Internet of Things’ (IoT) can provide us with insights into weather trends and CO2 emissions at the sub-city level. Moving forward, opportunities afforded by organizations’ self-reporting of their climate risks and mitigation plans specifically related to climate change will provide additional data points for firms like ours to incorporate into our ground truth analysis of companies, industries and economies.
Couple these two trends with increasingly sophisticated machine learning and feature extraction techniques and you wind up with tremendous opportunities to develop insights into both the physical risks of climate change and the steps that companies are taking to mitigate these risks.
What are the priorities during your first year at Four Twenty Seven?
Emilie and the team have translated their broad and deep base of intellectual property into purpose-built solutions for a number of key market segments in the financial sector. These solutions enable asset owners and investors alike to understand their holdings’ exposure to the physical reality of climate change.
Our goals for this year are to continue tuning our existing offerings through engagement with our clients and to position the firm for its next phase of growth. Thanks to entities like the Task Force on Climate-related Financial Disclosures (TCFD), market participants are increasingly aware of the need to incorporate climate risk analytics into their investment process, and we will continue to evangelize this message in our own interactions with the investment community. We are currently in fundraising mode and will use proceeds from our capital raise to support plans to leverage our proprietary facility database to quantify the relationship between weather and company performance. In addition, we intend to on-board additional data sources to inform our analytics and add desktop visualization tools to our client offerings. This promises to be a busy year!
427 ANALYSIS – The physical impacts of climate change drive millions of dollars of losses for corporations every year, as experienced by Honda and Toyota during the 2011 floods in Thailand. Investors equipped with data on corporate production facilities and climate projections can manage their risk exposure more effectively and reduce downside risk.
Risk is one of the most widely understood and discussed components of the investment management process today. Informed tradeoffs of risk and return are fundamental to modern investment practices across asset classes and investment styles. And yet, an important dimension of risk – physical risk from companies’ exposure to climate volatility – has yet to find its way into the mainstream investment process.
Monsoons Damage Automobile Manufacturers
Climate change’s influence on economies, sectors and companies is an increasingly important factor in identifying and balancing the tradeoffs between risk and return. For example, the heavy monsoon season that led to severe flooding across Thailand in late June 2011 through December, inundated 30,000 square kilometers1 and caused widespread economic damage. Automobile manufacturers such as Toyota and Honda were particularly affected by suspended operations and supply chain disruptions, which led to reduced production internationally and affected global sales and profitability long after the rains stopped.
As shown in Figure 1, both companies possess a diversified set of production facilities in the area affected by the flooding, including stamping facilities and sub-component manufacturers, which do not only service downstream processes in Thailand but in other production centers as well. These same facilities all score high for extreme rainfall in our global corporate facility database, signaling high vulnerability to flood risk for Honda and Toyota – a risk that will only worsen in the future.
Sea Level Rise in Japan
Investors must also anticipate forward-looking risks – what will climate change bring, and which companies are most affected? Understanding and preparing for volatility in returns requires an in-depth awareness of a company’s facilities and the climate risks which those facilities face. Given their global footprint, many businesses are exposed to diverse hazards such as extreme heat, water stress, cyclones and sea level rise, in addition to extreme precipitation. Thus, the factors we include to model a company’s physical risk to climate change include the sector characteristics, operational needs and the regional conditions where facilities are located. While flood damage and manufacturing delays in Thailand damaged Honda and Toyota, Figure 2. shows these companies are also exposed to sea level rise at hundreds of facilities in their home market of Japan.
Assessing Companies’ Exposure to Climate Risk
Our data interweaves climate analytics with financial markets data to provide a robust view of companies’ risks and identify those that are less likely to experience financial losses due to increasingly frequent extreme weather events. Facility-level assessment of these risks is an intensely data-driven exercise that requires the combination of terabytes of data from climate models with information on complex company structures. We translate this analysis into a clear result to inform financial strategy. Armed with this understanding, investors and corporations alike can achieve a new and more valuable balance of risk and return.
Four Twenty Seven’s ever-growing database now includes close to one million corporate sites and covers over 1800 publicly-traded companies. We offer equity risk scoring and real asset screening services to help investors and corporations leverage this data.
March 21, 2018 – 427 ANALYSIS. The first year of reporting under Art. 173 in France saw limited uptake of disclosures of physical risk and opportunities. Our review of disclosures from 50 asset owners in France shows only a quarter of respondents included substantial analysis and metrics on their exposure to physical impacts of climate change. We find insurance companies AXA and Generali provided the most detailed analysis for property portfolio, while FRR and ERAFP were the only pension funds to provide an initial assessment of physical risk exposure in their equity and fixed income portfolios.
Art. 173: the world’s first legal requirement to disclose climate risk
Article 173 of the French Law on Energy Transition and Green Growth passed August 2015 requires major institutional investors and asset management companies to explain how they take Environmental, Social and Governance (ESG) criteria into account in their risk management and investment policies. These institutions are also asked to report on the impacts of both physical risks and ‘transition’ risks caused by climate change on their activities and assets.
The law applies to French companies, meaning that French subsidiaries of large financial groups are potentially subject to requirements that do not apply to their parent companies. Its implementing decree invites these organizations to establish scenarios and models to take into account climate risks impacts on the value of their portfolios.
Article 173 covers publicly traded companies, banks and credit providers, asset managers and institutional investors (insurers, pension or mutual funds and sovereign wealth funds). In addition, asset managers managing funds above 500 M€ and institutional investors with balance sheets above 500 M€ are subject to extended climate change-related reporting obligations, including both physical impacts of climate change and transition risks (impact of the transition to a low-carbon economy).
The inclusion of physical impacts of climate change in financial risk analysis is in line with the industry-led Task Force on Climate-related Financial Disclosures (TCFD) recommendations report, released in July 2017.
What did financial institutions report?
We conducted a desktop analysis of the 2017 reports (applying to 2016 portfolios) to understand how financial institutions responded to the requirements laid out by Art. 173 in the first compliance year. We reviewed 50 asset owners in France, including public pension funds, sovereign wealth fund and insurance companies, with an aggregate €5.5 trillion euro ($6.8tn) under management. Our analysis included all the public entities covered by the Article 173, as well as private insurers with asset under management above €2bn. Insurance companies play a particularly important role as asset owners in France, where individual savings are massively invested in life insurance savings products. French pension funds, on the other hand, are relatively small due to France’s pay-as-you-go retirement system.
We were able to find Art. 173 reports for 36 out of 50 organizations. It is possible that, in spite of our best efforts, we failed to locate reports. However, Art. 173 has a ‘comply or explain’ provision which also makes it acceptable not to publish a report if one can justify climate change is not a material risk.
Among the Art. 173 reports, we found 29 from insurance companies and seven from public entities. Among them, 20 organizations (40%) discussed only their carbon footprint and/or their exposure to energy transition risk, without including physical risk disclosures.
A small group of organizations (8%) mentioned physical risk as a topic they were exploring but not yet able to report on. Most of them emphasized the lack of tools and models as a major impediment to reporting physical risk.
All in all, we found 12 financial institutions (24%) of the institutions under review made an explicit attempt to disclose their exposure to physical climate risk.
We broke down this latter group in three categories. Eight companies (16%) provided an analysis of the physical risks threatening either their operations or property portfolios (for insurance), ranging in scope from a few buildings to €15bn worth of assets in the case of AXA. Most of the reports contain limited details on methodology and findings.
Two companies (4%) performed what we call a “top-down” analysis, working with investment advisor Mercer to perform a multi-asset class, sector-level analysis of climate risk using Mercer’s proprietary climate risk model, which blends transition and physical risk. Finally, two high profile investors, pension fund ERAFP and sovereign wealth fund FRR, included an initial assessment of climate risk in their equity and fixed income portfolios, at the asset level.
Table 1 presents a detailed breakdown of how those organizations take physical climate risks into account:
Case Studies: How do Investors Report on Physical Risk?
The best student in this 2016 reporting vintage is AXA France. AXA received the “International Award on Investor Climate-Related Disclosures” from the French Ministry for the Environment, for analyzing 15 billion euro of assets (real estate and infrastructures). The analysis takes into account most frequent European natural disasters and the geographical location of each individual asset as well as the destruction rate of their building materials. They found out that, over 30 years, the accumulated loss would aggregate to 24 million euro. The insurance company also reported that if a centennial storm was to occur, the portfolio would be impacted by a 15.2 million euro loss. While AXA provides some of the most detailed analysis, it also noted that “this new kind of analysis needs to be improved in order to take into account more natural disasters and other portfolios”.
The following graphs demonstrate the physical risk exposure to windstorms for the analyzed infrastructures. On the left, the graph displays the annual average destruction rate, which is linked to the average loss generated by windstorms every year (0.8M€ on average). The map on the right shows the destruction rates due to a 100-year event, with an estimated loss of 15.2M€.
Source (Award on Investor Climate-related Disclosures, AXA Group, October 2016: https://cdn.axa.com/www-axa-com%2Fcb46e9f7-8b1d-4418-a8a7-a68fba088db8_axa_investor_climate_report.pdf)
Generali France also provided a complete and detailed evaluation of the potential impact of physical risks on their property assets. They analyzed 112 assets, mainly in the Paris Area, accounting for 60% of their owned assets. Generali took into account two kinds of physical risks, flood and drought, to rate their assets from “high” to “very low” risk. Regarding drought, 3 assets enter the medium-risk category. As only 12 assets have been analyzed (Paris and the overseas departments being excluded), this risk is important as it accounts for 25% of their analysis. On the other hand, 10 out of 112 buildings owned by Generali France are exposed to a high risk of flood. They are mainly located in the Paris Area and would be heavily affected by a Seine flood.
To sum up, both AXA and Generali reports are valuable examples of emerging best practices as they show the willingness of those organizations to take physical risks into account in their reporting practice. However, their analyses would benefit from being extended to a broader portfolio and to other natural events.
In November 2017 the French pension fund, “Fonds de Réserve pour les Retraites” (FRR), released a report addressing Article 173 requirements. Four Twenty Seven performed the analysis, and applied its proprietary methodology to measure the types and levels of climate risk embedded in FRR holdings. Portfolio exposure was evaluated according to their respective industry and sector. The analysis produced a sector risk score based on three indicators:
This hotspot analysis gave FRR tools to get an initial understanding of its portfolios’ exposure. It highlighted strongly exposed sectors such as Materials and Consumer Staples, due to their dependency on natural resources, and Pharmaceuticals and Electronics hardware, due to their complex and global supply chains. Conversely, the results brought out the low exposure of service-based industries such as Media and Telecommunication.
Reporting on physical climate risk is a challenging task for financial institutions – many organizations lack the tools, models and data to perform a comprehensive assessment of their portfolios, whether they’re composed of real assets or equities. As TCFD reporting becomes standard for financial institutions and corporations, pressure will increase to report on physical risk. We expect fast changes in disclosures in this regard, starting as early as the 2018 reporting season.
This analysis was written with support from Thomas Poloniato.
Four Twenty Seven’s ever-growing database now includes close to one million corporate sites and covers over 1800 publicly-traded companies. We offer equity risk scoring and real asset screening services to help investors and corporations leverage this data.
March 2, 2018 – 427 ANALYSIS. As Winter Storm Riley threatens to flood the Boston area, we find pharmaceuticals and airlines industries are most exposed to flood risk. Boston is a hub for both research and industry and the long-lasting financial consequences could be dramatic for some of the corporations with facilities in low-lying areas.
Only two months after Winter Storm Grayson flooded Boston with its highest water level on record (4.88ft), Winter Storm Riley is now inundating the city and is predicted to bring water levels about 4.5ft above average high tide levels. The timing of Riley exacerbates this flood risk, as the storm surge is on top of already higher than average tides associated with the full moon.
The greater Boston area is a hub for both research and industry and as this flooding is expected to worsen into the evening, the long-lasting financial consequences could be dramatic. Four Twenty Seven’s database of corporate facilities shows several industries and companies most exposed to coastal flooding. Our coastal flooding risk indicator measures exposure for low-lying facilities considering a combination of future sea level rise and storm surge from storms of varying intensity. A facility with high risk is likely to flood even during low intensity storms (e.g. 1 in 10 year events) and is also likely to experience a relatively large increase in storm surge.
Pharmaceutical companies are highly vulnerable to flooding in Boston, with medical research facilities and pharmaceutical preparation sites belonging to Eli Lilly and Pfizer showing the most risk. This industry exposure is particularly alarming given the thousands of lab animals (often kept in basements) and years’ worth of research that were lost by cancer and neuroscience research labs that were flooded during Hurricane Sandy. The recovery of these facilities required months and extensive funds, affecting this industry long after the storm.
Airlines and other related airport services companies are also likely to be badly impacted by today’s storm. Storm damage of runways takes time and funds to repair, while impacting travelers and airlines in wide-reaching causal chains. While the location of Boston Logan International Airport makes it particularly vulnerable, the scheduling offices of airlines such as Delta and United are also largely exposed. Thus, in addition to costly delays and cancellations due to the local conditions, these airlines may experience more widespread scheduling difficulties if these buildings are inundated.
While understanding the long-term economic impacts of Winter Storm Riley will take many months, these findings highlight potential implications for the pharmaceutical and airline industries, their investors, and those who rely on their services.
Four Twenty Seven’s ever-growing database now includes close to one million corporate sites and covers over 1800 publicly-traded companies. We offer subscription products and advisory services to access this unique dataset. Options include data feeds, an interactive analytics platform and company scorecards, as well as custom portfolio analysis and benchmarking.
The Investor Guide to Physical Climate Risk and Resilience, published by the Global Adaptation and Resilience Investor (GARI) working group, provides a “plain language” introduction for investors to physical climate risk and resilience. It describes physical climate risk and resilience, explains why it matters to investors, and suggests practical actions investors can take.
Specifically, the guide suggests investors can manage the physical effects of climate change on investments, and seize climate-resilience investment opportunities in three ways: investigating the physical impacts of climate change on asset values, requiring asset managers and advisors to consider climate risk, and allocating capital to climate-resilient investment.
As evidence of climate change’s impact on all asset classes mounts, investors should consider starting to understand, assess, and mitigate their climate risk exposure. The time has come to address climate risk.
Download the GARI 2017 Investor Guide
Read the press release:
‘TIME HAS COME’ TO ADDRESS CLIMATE RISK, SAY GLOBAL INVESTORS AT PARIS SUMMIT
PRACTICAL INVESTOR GUIDE TO PHYSICAL CLIMATE RISK AND RESILIENCE PUBLISHED BY GLOBAL ADAPTATION & RESILIENCE INVESTMENT WORKING GROUP AT ONE PLANET SUMMIT IN PARIS
Paris, France – December 12, 2017: The “time has come” for investors to address climate risk, concludes the Investor Guide to Physical Climate Risk and Resilience released today by the Global Adaptation & Resilience Investment Working Group (GARI) at the One Planet Summit in Paris, France, where nations of the world are meeting to advance the aims and ambitions of the Paris Agreement. The summit is being hosted by the President of the French Republic, Emmanuel Macron, the President of the World Bank Group, Jim Yong Kim, and the Secretary-General of the United Nations, António Guterres.
The GARI Investor Guide provides a “plain language” introduction for investors to physical climate risk and resilience. It describes physical climate risk and resilience, explains why it matters to investors, and suggests practical actions investors can take. Specifically, it suggests investors can manage the physical effects of climate change on investments, and seize climate-resilience investment opportunities in three ways: investigating the physical impacts of climate change on asset values, requiring asset managers and advisors to consider climate risk, and allocating capital to climate-resilient investment.
“We believe the time is now for investors to consider both physical climate risk as well as the opportunity to invest in climate resilience,” said Jay Koh, Managing Director of The Lightsmith Group, Chair of GARI, and a lead author of the GARI Investor Guide. “The investment risks and opportunities created by climate change are immediate and increasing.”
“Leading investors have started using practical tools today to screen and assess their equity, credit, and real asset portfolios for physical climate risk,” stated Emilie Mazzacurati, CEO of Four Twenty Seven and another lead author of the GARI Investor Guide. “There’s no need to wait to understand the impacts of climate change on financial markets.”
“Understanding physical climate risk can guide investors’ decisions today, both to reduce exposure to risk and seize climate resilience investment opportunities,” concluded Chiara Trabacchi, Climate Finance Specialist at IDB Invest, and the third lead author of the GARI Investor Guide. “The Investor Guide is a tool for investors that want to anticipate the risk – rather than experience it – and to deliver long-term value.”
ABOUT THE GLOBAL ADAPTATION & RESILIENCE INVESTMENT WORKING GROUP (GARI)
The Global Adaptation & Resilience Investment Working Group (GARI) is a private investor-led initiative announced at COP21, the global climate summit in Paris in 2015. GARI is a partner of the UN Secretary General’s A2R Climate Resilience Initiative. GARI has brought together over 150 private and public investors, bankers, leaders and other stakeholders to discuss critical issues at the intersection of climate adaptation and resilience and investment with the objective of helping to assess, mobilize and catalyze action and investment. It released a first discussion paper, “Bridging the Adaptation Gap,” at the COP22 Marrakesh global climate summit in 2016. For more information on GARI, please see: www.garigroup.com.
The Global Adaptation & Resilience Investment Working Group (GARI), of which Four Twenty Seven is a founding member, developed an Investor Guide to Physical Climate Risk and Resilience and a discussion paper highlighting innovations in adaptation, investment and climate resilience. Four Twenty Seven CEO Emilie Mazzacurati is a lead author on the draft investor guide, which was released this week at COP23. The final 2017 Investor Guide will be released in Paris this December.
This paper is an introduction to physical climate risk and how it applies to investors. Serving as a concise conversation starter, the five-page paper outlines three steps for investors to begin addressing physical climate risk: know what physical climate risk is, know why physical climate risk and resilience matter to investors and begin to assess, disclose and act. The report emphasizes how important it is for investors to get started and take the first steps to understand and manage risk.
GARI was launched at COP21 in conjunction with the UN Secretary General’s A2R Climate Resilience Initiative, with the goal of bringing together private investors, climate experts and other stakeholders around the challenges and opportunities that climate change presents to investors. In 2016 the group’s discussions culminated in a paper, “Bridging the Adaptation Gap,” describing measurement of physical climate risk and highlighting examples of current investments in climate adaptation.
GARI welcomes feedback on this public draft. Please contact Emilie Mazzacurati with comments or for more information.