April 30, 2019 – 427 ANALYSIS. The second year of reporting under Article 173 in France saw increased uptake of disclosures of physical risk. Our review of 2018 disclosures from 49 asset owners in France shows that almost half of the respondents conducted more substantial analysis of their exposure to physical impacts of climate change compared to last year. We find insurance companies Axa and Generali provided the most detailed analysis for property portfolios, while FRR and Comgest provided the most thorough assessment of physical climate risk in their investment portfolios and BPCE Group was the only bank with a complete analysis of physical risk.
Art. 173: A Second Year of Mandated Climate Risk Reporting
2018 was the second reporting year under Art. 173 of the French Law on Energy Transition and Green Growth, which was passed in August 2015. It requires major institutional investors and asset managers to explain how they take Environmental, Social and Governance (ESG) criteria, including climate change, into account in their risk management and investment policies.
Art. 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 reporting on both physical impacts of climate change and transition risks (impact of the transition to a low-carbon economy).
We carried out a desktop analysis of the 2018 reports (applying to 2017 portfolios) to understand how financial institutions responded to the requirements laid out by Art. 173 and how their reporting has evolved since last year. We reviewed 49 asset owners in France, including public pension funds, asset managers and insurance companies, with an aggregate €5.5 trillion euro ($6.8tn) under management. Our analysis included all public entities covered by the Art. 173, as well as private insurers with over €2bn in assets under management. 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.
Art. 173 Reporting Trends in Year Two
We were able to find Art. 173 reports for 36 out of 49 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 for companies to not publish reports if they can justify that climate change is not a material risk, or to solely file their reports with the regulator rather than releasing them.
We found twenty five Art. 173 reports from insurance companies, five from pension funds, two from asset managers and four reports issued by banking institutions. We also found a press statement from HSBC that mentioned an Art. 173 report but we were unable to find the report itself and did not include it in the analysis.
Did Firms Change Their Disclosure Strategy?
Overall, 23 companies (47%) have made significant improvements in their disclosure since last year. These companies have either kept the same methodological framework and refined it or have published substantially more comprehensive reports than last year. Among them, two firms, Groupe Macsf and Carac, have published a report for the first time. Only four companies (8%) have provided reports which were less complete than last year, including one company for which we found a report last year, but not this year. 45% of the firms published reports which were very similar to last year.
How Did Firms Report This Year?
Table 1 presents a detailed breakdown of how insurance companies and asset managers have taken physical climate risks into account in 2018 reports.
12 organizations (25%) only discussed their carbon footprint or their exposure to energy transition risk, without including physical risk disclosures. A small group of organizations (10%) mentioned physical risk as a topic they were exploring without being able to provide a complete analysis for the moment, many citing the lack of tools and models as a major impediment to reporting physical risks.
11 institutions (23%) used a thorough methodology to analyze their exposure to physical risks, compared to only seven companies last year. Several firms released noticeably improved disclosure this year. Out of those firms that did asses their exposure to physical climate risk, nine (19%) carried out a bottom-up analysis of physical risks by assessing the asset-level risk exposure of at least some of their portfolio. Two institutions (4%) performed a “top-down” analysis, carrying out a multi-asset class, sector-level analysis of physical climate risk.
Finally, eight firms (17%) were classified in the “work in progress” category. These companies studied physical climate risk at the company-level among many other criteria as part of a broader analysis of the sustainability of their portfolio. Many of these companies acknowledge that they have not yet been able to develop a complete methodology for assessing physical risks.
Axa is one of France’s leading multinational insurance firms holding 905B€ of assets. While Axa’s 2018 Art. 173 disclosure is very similar to last year, with a bottom-up approach and an internal analysis, the study has increased in accuracy and scope. Like last year, the methodology considers European natural disasters as well as the geographical location of individual assets and the destruction rate of building materials.
In addition to the traditional report about Art. 173 which lays out the principles and commitments of the firm regarding the ESG criteria, Axa released its first report aligning with the Taskforce on Climate-related Financial Disclosures (TCFD) recommendations. Axa’s analysis covered $34 billion worth of assets, compared to $15 billion last year, encompassing commercial real estate debt, infrastructures debt, and property debt. Unlike last year, the assessment was not limited to the financial impact of windstorms but also included the potential impact of floods on the infrastructure in its portfolio. Like last year, the analysis considers 100% of the infrastructure portfolio but this year it also covers 88% of the real estate portfolio in 14 countries, compared to 41% last year.
Figure 4 demonstrates the physical risk exposure to windstorms and floods for the analyzed infrastructure. On the left, the graph displays the annual average destruction rate, which is linked to the average loss generated every year (3.3M€ on average). The map on the right shows the destruction rates due to a 100-year event, with an estimated loss of 27.2 M€. In 2019, Axa plans to expand its internal model to evaluate the financial losses resulting from floods in more European countries.
Axa used a value at risk methodology to assess the potential costs and revenues associated with climate change for each company in its equity and corporate bond portfolios, but this assessment largely focused on transition risks.
Generali France is a French insurance company with 521B€ worth of assets. Generali also provided a more detailed evaluation of the potential impact of physical risks on its property assets than last year. It analyzed 268 assets, compared to 112 last year. Unlike last year, the analysis was not limited to the Paris area, but was expanded to all real estate assets held by the company. 89% of the assets are located in Paris, 7% outside Paris and 4% in the overseas department. They carried out a broader analysis of physical risks by adding earthquakes and avalanches to the study, in addition to flood and drought. The assessment rates assets from “high” to “very low” risk, finding that 5.4% of assets or 18 sites are classified as “high risk” for flood, 2% of assets (11 buildings) are classified as “medium risk” to drought and four of these 11 buildings are concentrated in the same building zone near Paris.
Comgest is an international asset management group with 25.7 B€ worth of assets. The firm released physical risk disclosure reports for its three largest funds: global, European, and emerging market. Four Twenty Seven conducted the physical risk analysis for Comgest, splitting physical risks into three categories: operations risk, market risk, and supply chain risk. The analysis also included a comparison of portfolio risk scores to relevant benchmark indices to highlight the holdings’ relative risk exposure. This asset-level assessment included exposure to storm, drought, extreme rainfall, floods, sea level rise, and heat stress. The analysis resulted in an aggregate score reflecting the portfolio’s exposure to physical climate risks, based on the sectors in the portfolio and the geographic distribution of companies’ assets.
Regionally, the portfolio companies in Asia are most exposed to physical climate risks. Half of the sites are located in Japan and China, which makes the portfolio vulnerable to cyclones and extreme rainfall. The rest of the portfolio is located in the United States and Europe, which have relatively low exposure to physical risks. The risk of rising sea level is relatively low for the portfolio, with only 15% of the sites being exposed.
Overall, 2018 showed an increase in the inclusion of physical climate risks assessment by French financial institutions. However, reporting on physical climate risk remains a challenging task for investors. Many organizations lack the tools, models and data to perform a comprehensive assessment of their portfolios, and for many firms, physical risks appear to still be a lower priority than transition risks. Those firms that are on the forefront of climate risk reporting disclose asset-level risk exposure and are beginning to explore how to assess value at risk and scenario analysis for physical climate risks. 2019 reporting is ongoing and has already brought some new high profile reporters, including the French Central Bank, Banque de France. The positive trends in 2018’s Art. 173 reports, along with continued uptake of TCFD recommendations, ongoing pressure from central banks and regulators, and increasing losses from extreme weather events, suggest that we will see continued growth in physical climate risk disclosures during the third year of Art. 173 reporting.
This analysis was written with support from Roman Dhulst and Natalie Ambrosio.
Four Twenty Seven’s ever-growing database includes around one million corporate sites and covers 2000 publicly-traded companies. We offer portfolio analysis to support TCFD and Article 173 reporting, real asset screening, and other solutions to help investors and businesses leverage this data.
Climate risk disclosure is essential to building market transparency and a resilient financial system. France led the way in mandating climate risk disclosure in 2015 and continues to play a key role in catalyzing the financial sector’s understanding and disclosure of climate risk. As part of its seven part series highlighting approaches to green finance in “pioneering countries,” Germanwatch published a piece by Four Twenty Seven on France’s role in promoting climate risk disclosure. Read the article below, or find the German version here.
Climate Risk Disclosure: France Paves the Way
Already in 2015, France adopted a law on climate risk disclosure paving the way for protecting economic systems from the consequences of climate change. But others need to follow.
Financial institutions and governments around the world are acknowledging the importance of climate change on the sustainable finance agenda. The World Economic Forum identified climate change-related risks as the top three most likely global risks for 2019, followed by data fraud and cyber attacks, and as four out of the top five most impactful risks, after weapons of mass destruction. This underscores the importance of building economies resilient to climate change impacts.
In 2015, just before the 21st Conference of the Parties (COP21) and the Paris Agreement, France became the first country to pass a law requiring publicly listed companies, institutional investors and asset managers to report their climate-related risks, including both transition risks (associated with the transition to a low carbon economy) and physical risks (associated with extreme weather events or chronic stresses affecting businesses and economic assets).
While today’s conversations about the Paris Agreement and sustainable finance require a transition to a low carbon economy, governments have realized that they also require discussion of the economic risks of physical climate impacts that will occur whether or not Paris climate targets are met. Reaching the adaptation goals of the Paris Agreement requires catalyzing investment in climate resilience. Increasing transparency on companies’ and investors’ exposure to physical climate risk is an essential first step towards identifying opportunities to invest in adaptation and build resilience.
The Approach: Comply or Explain
The French Energy Transition Law and its Art. 173 laid the regulatory groundwork for integrating climate risk transparency into the national sustainable finance approach. The regulation uses a comply or explain approach, providing flexibility for how firms disclose their risks and allowing firms to opt-out from reporting, with an explanation. This fosters discussions among investors, insurers and businesses to find the most informative and feasible risk analysis and reporting methodology across sectors.
The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) released its final recommendations for climate-related disclosures in June 2017. These voluntary recommendations provided additional direction on how to disclose climate risks, but still do not provide concrete metrics. French organizations, such as Finance for Tomorrow and I4CE, the Institute for Climate Economics, help to catalyze continued research on this topic and keep climate on the sustainable finance agenda.
International initiatives also help facilitate ongoing thought leadership: for example the report Advancing TCFD Guidance on Physical Climate Risks and Opportunities prepared by the European Bank for Reconstruction and Development and the Global Center for Excellence on Climate Adaptation, based on working groups of financial sector experts. While data providers, such as Four Twenty Seven, help to fill data gaps by providing asset-level data on climate risk exposure, there will continue to be ongoing conversations about how best to incorporate this information into actionable disclosures.
Other countries follow the example of France
Art. 173 has helped to center the Paris marketplace in the landscape of green finance. Action on climate risk disclosure continues to increase both within France and internationally. Influential financial actors are beginning to report their own risk exposure, encouraging the market to follow suit. The French Central Bank (Banque de France) for example, released a comprehensive analyses of physical and transition risk in its portfolios in compliance with Art. 173 and TCFD, aiming to set an example for emerging best practices for disclosure. The Dutch Central Bank assessed the exposure of its financial sector to water stress and other environmental risks. Countries such as Spain and Sweden have voiced their support of the TCFD and their consideration of legislation similar to Art. 173, and in July 2018 the Italian insurance supervisor IVASS released a comprehensive reporting requirement for Environmental Social Governance (ESG) risks, including climate change.
In early 2018, the European Commission published an Action Plan: Financing Sustainable Growth, outlining ten actions with timelines by the end of 2019. This led to the development of a Technical Expert Group, which has four workstreams underway: developing a sustainable finance taxonomy, integrating climate change into non-financial reporting requirements, creating a green bond standard and creating carbon indices standards.
Art. 173 mandates an assessment of reporting progress made during the first two years of its application. This review may lead to more explicit guidance on reporting methodologies, potentially expanding the directive to apply to more actors. This, alongside increasing regulatory and investor pressure, will propel the continued improvement of physical climate risk disclosure. As uptake of climate risk and opportunity disclosure increases and is integrated into financial decision-making, France, along with other nations, will make important progress on building more sustainable economies.
To find out more about developments in climate risk disclosure read our newsletters “France’s Central Bank Publishes First TCFD Report” and “TCFD Reporting on the Rise.”
How have the Task Force on Climate-related Financial Disclosure’s (TCFD) recommendations changed the landscape of climate risk reporting and where is the market headed? The Climate Change Business Journal interviewed Founder & CEO, Emilie Mazzacurati, about the history of the TCFD, it’s uptake to-date and how the recommendations influence other developments on risk disclosure. Emilie explains her view that “early TCFD reports…are focused on showing good faith efforts more than providing hard data on climate risk exposure.” This is due to the preliminary need to explore datasets on climate risk, familiarize stakeholders with the subject and overcome challenges associated with being among the first to disclose risks.
Ongoing industry efforts to develop best-practices for climate risk reporting will likely lead to more widespread adoption of metrics for disclosure. Such initiatives include France’s Article 173, the European Commission’s Action Plan on Sustainable Finance, and the Network of Central Banks and Supervisors for Greening the Financial System. Emilie says, “The market is in exploratory mode: this is an emerging issue, and the collective understanding of impacts on corporations and financial markets is fast evolving. What is clear, however, is that this is a very material issue, and that is here to stay.”
To learn more about developments on climate risk disclosure download the report Advancing TCFD Guidance on Physical Climate Risks and Opportunities or read our newsletter, TCFD Reporting on the Rise.