June 5, 2018 – 427 REPORT. Shareholder engagement is a critical tool to build resilience in investment portfolios. Investors can help raise awareness of rising risks from climate change, and encourage companies to invest in responsible corporate adaptation measures. We identify top targets for shareholder engagement on physical climate risks and provide data-driven strategies for choosing companies and approaching engagement. Our report includes sample questions as an entry point for investors’ conversations about climate risk and resilience with corporations.
Shareholder engagement on climate change has grown tremendously in recent years. Over 270 investors, managing almost $30 trillion collectively, have committed to engage with the largest greenhouse gas emitters through the Climate Action 100+. In addition to their ongoing efforts to engage and encourage companies to reduce emissions, investors are becoming aware of the financial risks from extreme weather and climate change. Climate change increases downside risks: a negative repricing of assets is already being seen where climate impacts are most obvious, such as coastal areas of Miami. As climate change can negatively impact company valuations, investors must strive to bolster governance and adaptive capacity to help companies build resilience.
This Four Twenty Seven report, From Risk to Resilience – Engaging with Corporates to Build Adaptive Capacity, explains the value of engagement, for both corporations and investors and describes data and case studies to drive engagement strategies. While news coverage of extreme weather events can clue investors in to which corporations may be experiencing climate-driven financial damage, new data can empower investors to identify systemic climate risk factors and proactively engage companies likely to experience impacts in the future. Reactive engagement strategies based on news stories can also use data to more thoroughly explore corporations highlighted in the news, by examining other hazards that may pose harm to their operations.
The report also identifies the Top 10 companies with the highest exposure to physical climate risk in the Climate Action 100+ and calls for investors to leverage their engagement on emissions to also address urgent issues around climate impacts and building resilience.
Once they identify companies, shareholders can use a variety of questions to gain a deeper understanding of companies’ vulnerability to climate hazards and their governance and planning processes, or adaptive capacity, to build resilience to such impacts. The report provides sample questions for different components of climate risk, including Operations Risk, Market Risk and Supply Chain Risk, as well as Adaptive Capacity.
• The impacts of a changing climate pose significant downside risk for companies; a risk bound to increase as the climate continues to degrade.
• At present, investors are likely to become aware of exposure to financial damages from extreme weather events only after they have occurred. Disclosure is limited but gaining traction.
• Corporate engagement is a tool to encourage companies to deploy capital and technical assistance to build resilience in their operations and supply chains.
• Investors can select target companies reactively based on prior incidents or pro-actively identify firms that would benefit from resilience plans.
• Investors should question companies on their exposure to physical climate risks via their operations, supply chain and market, as well as how they are building resilience to these risks through risk management and responsible corporate adaptation strategies.
From Recommendations to Action
March 15, 2018 – 427 ANALYSIS. The EU laid out a clear plan to move towards mandatory climate risk disclosure as part of a new set of regulations to finance sustainable growth and support the transition to a low-carbon economy. The European Commission’s Action Plan lays out a two year timeline for implementation, with a goal to create a taxonomy for climate adaptation finance by the end of 2019. These regulations from the EU will drive change into financial markets globally and set standards on reporting, disclosures and infrastructure resilience that will likely set the bar for the rest of the world.
The European Commission recently released its Action Plan: Financing Sustainable Growth to establish a regulatory framework that supports the goals of the Paris agreement. The Action Plan calls for transformation of the whole financial system and to enable the financing a sustainable, resource-efficient economy.
The Action Plan builds on the recommendation from a high profile expert group, the High-Level Expert Group on Sustainable Finance (HLEG), which was created by the European Commission in December 2016. The group included experts from banking, insurance, asset management and stock exchanges. Its final recommendations to the Commission, released in January acknowledged the responsibility of the financial system to drive change towards “enduring and inclusive economic prosperity”. HLEG recommendations aimed to both promote sustainable investments, so that capital reaches sustainable projects and also to ensure that the financial system itself addresses risk and builds resilience.
Incorporating many of the recommendations of the HLEG, the Commission’s Action Plan lays out ten specific actions, setting deadlines within the next two years, with a number of thematic sub-actions that willbe pursued simultaneously. Action 1 lays the groundwork for many of the following actions as it will establish a Technical Expert Group on Sustainable Finance, with the responsibility of drafting a standardized EU sustainability taxonomy , including climate mitigation by Q1 2019 and adaptation by Q3. This effort will be supported by legislation this year that mandates the creation of the taxonomy.
The 10 actions are summarized in this infographic from the European Commission:
Of most immediate importance to investors is Action 7, which calls for the proposal by Q2 2018 of legislation mandating investors to explicitly consider sustainability factors in their investment decisions and disclose their methodology of doing so. This effort is particularly focused on improving the consistency and transparency of climate risk considerations by investors.
Likewise, Action 9 is focused on improving the methodologies and practice of corporate risk disclosure. The Commission will publish a report on current reporting legislation by Q2 this year, which will inform a revision of corporate reporting guidelines to help them align with the TCFD recommendations, by Q2 2019. Later this year the Commission will develop a European Corporate Reporting Lab, under the European Financial Reporting Advisory Group, to help develop best practices for corporate reporting. The goals of Action 10 will support these actions by supporting a shift in corporate governance. It aims to improve transparency and combat long-termism, by engaging with stakeholders around corporate governance starting by Q2 next year.
Revamping Credit Ratings
The Commission also commits to revamping the ways in which credit ratings incorporate sustainability metrics into their scoring. Through Action 6, the European Securities Markets Authority (ESMA) will examine the credit ratings’ current practices around this topic by Q2 2019 and the Commission will pursue comprehensive research on reporting standards, exploring the potential of mandating agencies to integrate specific sustainability metrics into their standards.
To improve consumers ability to identify sustainable investments, Action 2 calls for the technical expert group to publish a report exploring green bond standards by Q2 2019 and the Commission will consider expanding the EU Ecolabel to include financial products, initially focusing on retail investments. Likewise, Action 4 says that by Q2 2018, the MiFID II and IDD rules will be updated to ensure that sustainability preferences are considered when banks, investment firms and insurers offer accounts to clients and by the end of the year the ESMA will include these provisions in their guidelines. Through Action 5 the Commission will adopt acts that improve the transparency of sustainability benchmarks by Q2 2018.
Comprehensive Sustainability Support
The Commission identifies a lack of technical expertise as a challenge to pursuing sustainable infrastructure projects and aims to confront this by to increasing the technical support available to investors. It will run a pilot project offering tools for sustainable infrastructure projects, from 2019-2023 through Action 3.
Action 8 states that the Commission will consider including sustainability frameworks in prudential requirements, looping in the European Insurance and Occupational Pensions Authority (EIOPA).
“A Blueprint” for Change
While the HLEG emphasized that its report is only the beginning of an enduring effort to create a resilient financial system that supports a sustainable society, the Commission’s resulting Action Plan clearly defines the next steps. And as HLEG also emphasized its report’s relevance for financial sectors worldwide, the Commission’s Action Plan states that a “coordinated, global effort is crucial.” As “the HLEG hopes to stimulate a wide public debate that helps shift Europe’s financial system from post-crisis stabilization to supporting long-term growth,” that same widespread conversation is essential to driving global change. These regulations from the EU, as is often the case, will drive change into financial markets globally by setting new standards global financial institutions must meet.
For more resources on building a sustainable financial sector, read about Four Twenty Seven’s work providing the technical secretariat for an EBRD and GCECA initiative to build a resilient financial sector and download the GARI Investor Guide to Physical Climate Risk and Resilience.
The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) released their final recommendations in late June. The changes to the recommendations reflect the extensive feedback the Taskforce received from the stakeholder engagement process in the past six months. Some key changes include:
The recommendations were presented at the G20 summit in Hamburg, Germany, with hopes that the world leaders would formally endorse the guidelines. Climate change was high on the agenda for the summit, where all but the United States voiced a strong recommitment to the goals of the Paris Agreement, and the G20 included by reference, the TCFD recommendations in their Climate and Energy Action Plan for Growth.
The TCFD final recommendations were endorsed by over 100 CEO’s from a wide range of companies, including large financial institutions like Barclays and Morgan Stanley as well as energy and manufacturing companies like Suez, DuPont, and Unilever. Reactions from a broad range of financial analysts were also positive, noting the need for improvements and wider adoption of climate risk disclosure practices.
A number of initiatives are already under way to think through and plan the implementation of the TCFD recommendations, such as the UNEP FI’s effort with major banks from around the world who have pledged to work towards adopting these recommendations, and put forth actions they see as needed for broader adoption of climate risk reporting.
Four Twenty Seven helps investors, Fortune 500 companies, and government institutions understand how to quantify and monetize climate change impacts on operations and asset portfolios. Our clients rely on Four Twenty Seven’s tools and models to factor into financial and operational planning processes. Learn more about how we are helping our clients assess and adapt to climate risks.
Four Twenty Seven’s founder and CEO Emilie Mazzacurati was invited to speak during the Investing in the Age of Climate Change symposium on April 28, 2017, at the University of Oregon. Emilie presented through a video call and talked about Four Twenty Seven’s work, but mainly discussed climate-competent boards. She delved into what a climate-competent board is, the opportunities they provide, and steps to implement climate-competency on a board. She also discussed economic impacts from climate change, the TCFD climate risk disclosure recommendations, the Paris Agreement, and how these topics relate to climate-competent boards.
Investing in the Age of Climate Change was sponsored by the University of Oregon’s Office of the President and the Office of Sustainability. The symposium tackled issues around climate risk, their connection to investment decisions, and the need to understand how these risks can affect an organization’s business in the long-term.
This article was first published on the Huffington Post.
While the Trump administration is trying to roll back climate policy in the U.S., concerns over climate change are mounting on financial markets. In September 2016, the largest asset management firm in the world, BlackRock, with $5 trillion under management, released a report where it stated climate change is a material risk and “climate-proofing portfolios is a key consideration for all asset owners.” A few weeks back, BlackRock doubled down in announcing that it expected companies in its portfolio to disclose their exposure to climate risk. BlackRock is not the only investor that has publicly voiced concern over climate risk in its portfolio.
State Street Corp, which manages $2.5 trillion worth of assets, sent a letter in January to the boards of corporations it invests in, asking the companies to disclose their plans to account for climate change and other social issues. Over the long-term, these issues can have a material impact on a company’s ability to generate returns,” State Street said in the letter. “Corporate scandals of the last few years around automotive emissions, food safety or labor issues have emphasized the need for companies to assess the impact of Environmental, Social and Governance (ESG) risks.”
The call for disclosures is rising from individual fund managers as well. Canadian pension manager OPTrust released details of its approach to climate considerations when investing, and asking for more standardized measures for disclosing these risks.
Why are investors concerned over climate risk, and how do they expect these risks to materialize in their portfolios?
Climate change is expected to have impacts on the natural environment, but also on human systems and global and local economies. From decreased crop yields to physical impacts on built infrastructure and labor productivity, impacts are predicted to be uneven but ubiquitous. Business leaders are well aware of this risk, and over the past years, failure to adapt to climate change has consistently been listed among the top five risks for economies in impact and likelihood in the World Economic Forum’s Global Risk Report.
These impacts on the economy at large, on industry sectors, on infrastructure and on physical assets like manufacturing plants, corporate campuses or supply chains can in turn create financial risk for the investors who own equity or have loaned capital to these companies. Researchers from Cambridge and Oxford University estimate in a plausible worst-case climate change scenario (a 4°C-increase outcome), the value at risk of an equity portfolio in 2030 may be between 5% and 20% versus a no-warming scenario.
Financial regulators have also been raising the alarm, most famously Mark Carney, the Governor of the Bank of England and Chair of the Financial Stability Board (FSB), who referred to the phenomenon as the “Tragedy of the Horizon,” citing outcomes like the impact of rising seas on the world’s coastlines and infrastructure as one of the largest risks to financial stability around the world. The FSB, under the authority of the G20, created last year a special Taskforce on Climate-related Financial Disclosures (TCFD), which recently released its recommendations for investors and corporations on better assessing and disclosing climate risk.
Also in the fall 2015, France became the first country to pass a law introducing mandatory extensive climate change-related reporting for asset owners and asset managers, the Energy Transition Law and its Article 173. The European Union also passed a directive late 2016 requiring pension funds in Europe to assess and disclose climate risk. Financial markets are global, and regulations in Europe very much affect U.S. investors.
These recent regulatory efforts typically break down climate risk into two distinct categories: energy transition risk, and physical climate risk.
The Energy Transition risk refers to the potential large-scale impacts of rapidly decarbonizing our economies and energy systems—as might happen, for example, if policymakers decided to take climate science seriously. The sectors most exposed are, of course, the energy sector, in particularly fossil fuels, but also energy intensive industries like steel, cement, and chemistry. The entire value chain of the transportation sector, from airlines to car companies, could see their financial performance altered dramatically depending not only on their emissions, but also on how they have prepared and manage this transition.
To measure and compare the energy transition risks, a few methodologies have emerged. The 2 Degree Investment Initiative(2dii) released its methodology as well as a “Transition Risk Toolbox” on how to integrate energy transition risk into scenario analysis for corporations, and is continuing to explore in depth the implications for financial markets. CDP, a central player in the world of corporate climate disclosures, has also developed a pilot methodology on Assessing the Low Carbon Transition (ACT), in partnership with ADEME, the French Environment and Energy Agency.
Physical climate risk includes both shocks and stresses from climate impacts: shocks refer to extreme weather events, ranging from storms to drought, cold snaps, extreme precipitation and windstorms. Stresses encompasses physical conditions that change over time and can affect anything from agriculture to retail sales or real estate property values, such as a shift in season—as observed most recently on the East Coast, with an unseasonably warm, spring-like weather, changes in precipitation patterns, gradual increase in temperatures, depletion of water, as well as sea level rise.
A few research institutions have started developing methodologies to quantify the linkage between climate hazards and economic indicators, including most notably the Risky Business Project on the economic risk of climate change in the United States, and Norwegian think tank CICERO’s recent report on Shades of Climate Risk. However, as shown in the Global Adaptation and Resilience Investment working group (GARI) report published at COP 22 in November 2016, investors are concerned over lack of data and tools to better measure risk in a financial portfolio, and benefits of investing in resilience.
Despite the lack of established tools and methodologies, investors and portfolio managers can significantly hedge climate-related risks by assessing exposure of their asset portfolio, rebalancing exposure across assets, sectors and geographies, and developing targeted engagement strategies.
1. Assessing Exposure in their Asset Portfolio
Climate impacts can be felt across all asset classes. Real assets (infrastructure, real estate) represent the most direct risk for asset owners, but also the easiest to understand and manage. Investors typically know the exact geographic location for these assets, which enables a direct exposure hotspot analysis, as well as direct engagement with asset operators on climate risk and potential risk mitigation measures. Equity and credit portfolios are more complex to screen for and assess physical climate risk. Specialized providers like Four Twenty Seven provide screening tools, benchmarked equity scores, as well as custom portfolio risk assessments focused on physical climate impacts.
2. Developing Targeted Engagement Strategy
Investors have a critical role to play in ensuring climate risk management and disclosures become the norm rather than the exception. Especially in the U.S., in a context of regulatory pull back from financial regulations and climate policy, market forces must impose the transparency and responsibility needed to price assets accurately. This engagement can take many forms, from supporting proxy motions from activist investors like As You Sow to engaging with working groups like the Investor Network on Climate Risk (INCR) at Ceres, or direct engagement with portfolio companies.
Companies are also encouraged to develop climate competency in the boardroom so that at least one of the corporate directors has a technical understanding and direct responsibility for bringing climate science and climate change considerations to the Board during strategic and risk management discussions. This pressure was heeded by ExxonMobil, after an extensive campaign to demonstrate that ExxonMobil was not accurately accounting for climate change science in its asset and reserve valuation: the company’s board recently added Susan Avery, a physicist and atmospheric scientist, to its board of directors.
Change will be slow, but the growing recognition that climate change is an economic and financial issue is our best hope to drive meaningful, long-term policy change, as well as to increase resilience and our society’s ability to adapt to climate change. Contrarian climate policy in the U.S. may slow down the adoption of new standards, but it won’t slow down climate change, and the need to address its social and economic impacts.