Are U.S. Corporates Ready for Climate Risk Disclosures?

Introduction

The results from the U.S. presidential elections signal an impending radical shift in U.S. climate policy. President-elect Biden’s transition team identified climate change as one of four top priorities, promptly followed with the appointment of John Kerry as special envoy for climate. As part of his transition plan, Biden announced ten executive actions related to climate change that he intends to take on his first day in office. One of these measures is the requirement for public companies to disclose climate risks and greenhouse gas emissions in their operations and supply chains.

This disclosure requirement aligns with a global trend, following similar announcements in the UK and in New Zealand, with other financial regulators across Europe and the Asia-Pacific also actively considering such measures.

Disclosures are but one of many policy measures the new Administration may implement to address potential risks from climate change on financial markets and the economy. The report published by the US Commodity and Futures Trading Commission (CFTC) in September 2020 provided an extensive list of policy recommendations for financial regulatory agencies and the government at large to regulate climate risk.

A number of these policy recommendations overlapped with the September 2020 report from the Business Roundtable (BRT)[1], where large corporations employing over 15 million in total and representing $7.5 trillion in assets(revenues) called on bold policy action to address the looming climate crisis.

Our analysis examines recommendation from the BRT and CFTC, alongside data on corporate risk disclosure, to provide an indication of how US firms are currently standing against the recommendations, and to provide a comparison to other markets.

Methodology

We use the TCFD Climate Strategy Assessment dataset from V.E, an affiliate of Moody’s, which provides a granular view of how 2,855 companies report in line with the TCFD recommendations. This data is based on a comprehensive analysis of companies’ risk disclosures, across sectors and regions. For the purpose of this analysis, we grouped firms based on the region in which they’re listed, comparing the progress of firms in the US (498 companies), Canada (109), Japan (399) and the European Union (EU) (840). Each of these regions have different approaches to  climate policy, with the EU leading the way in terms of regulatory developments for assessing and disclosing climate risk, while Japan expects markets to address financial risks from climate change through emerging best practices and market pressure. Comparing recommendations from the BRT and CFTC to companies’ risk disclosures, we grouped our analysis into two sections, first looking at recommendations around emissions reductions efforts and then discussing recommendations around risk management.

Emissions Reductions

Carbon price

Both the CFTC and BRT recommend imposing a carbon price to develop a clear price signal associated with greenhouse gas (GHG) emissions. Firms sometimes use  internal carbon pricing as a management tool, which suggests that they are more prepared to adjust to a nationwide carbon price.

We find that only 3% of assessed US firms report using an internal carbon price, which is fewer than Canada, the EU and Japan. Alongside Canada, US firms also have the highest average carbon footprint of the assessed regions, based on carbon footprint data from V.E. However, Canada shows the largest proportion of firms reporting an internal carbon price, at 19% of firms. The data shows that US firms are behind their peers and have not leveraged the use of an internal carbon price as a management tool to incentivize carbon reductions and price the externalities associated with carbon emissions.

However, we find that many firms that disclose internal carbon prices in the US are from the automobile, energy, mining and pharmaceutical sectors. These sectors are among those with the largest dependencies on energy consumption or fossil fuels, which are expected to be most exposed to transition risks. The overall low numbers are therefore balanced by the fact that the firms in these sectors that do use internal carbon prices are also those that most need to prepare for shifting climate policy.

Table 1. The percent of companies in each region disclosing each indicator.

Low-Carbon Technology

The BRT emphasizes the significant opportunity for the U.S. to continue to lead in development and commercialization of energy efficiency and renewable energy to support the transition to a low-carbon economy. It underscores the need to invest in low-carbon and emissions reduction technology to allow us to capitalize on this opportunity.

In the US, 7% of assessed firms disclose the development of products that contribute to the transition to a low-carbon economy, which is less than firms of other regions.  Japan and the EU lead the way with 19% and 18% of firms respectively reporting investments in low carbon technology. Only 1% of US firms report acquisition of businesses contributing to the transition; although all regions assessed show low uptake of this indicator. In the US, 35% of the companies in industrials, 33% in electrics and 30% in the automobile sector disclose development of products contributing to the energy transition. This demonstrates the opportunities for firms in sectors with high exposure to transition risk, such as electrics and automobiles, to invest in developing new products which would be in higher demand if climate policy increased.

The EU’s Sustainable Finance Taxonomy helps investors identify which activities contribute to climate adaptation and mitigation which in turn informs portfolio alignment with the Paris Agreement or other emissions reduction goals. The Taxonomy puts additional pressure and incentive for corporations to develop activities that directly contribute to the transition. This may explain why EU companies have made among the most progress to date, although it also may be an indication of further pressure growing outside of the EU as global investors aim to align with the taxonomy.

GHG Reduction Targets

The BRT recommends aligning policy and greenhouse gas reduction targets with scientific evidence around the need to reduce emissions. While few firms have disclosed divestment from or decommissioning of carbon intensive assets, those in the US and Japan show the least progress with only 1% of the assessed firms disclosing this indicator, while the EU shows the highest with 6%. Similar to the developments described above, as investors increasingly strive to align their portfolios with emissions reductions targets, companies will experience increased pressure to align their activities with such targets. While the US has experienced less regulatory activity to date in this regard than the other regions, this is likely to change going forward and companies prepared for those change are likely to be better positioned than others.

Risk Management

Governance

The CFTC recommends that financial firms define oversight responsibilities for climate risks for the board of directors. While this recommendation is particularly directed at financial firms, it also aligns directly with one of the TCFD recommendations, and as such will  be increasingly relevant as companies are increasingly asked to disclose their climate risks and opportunities in line with the TCFD. The BRT also recommends voluntary and transparent climate risk disclosure by corporations in line with existing frameworks.

Only 8% of US firms disclose integration of climate risk into board oversight and Japan and Europe show similar progress. Canada stands out with 19% of firms disclosing processes used by the board to monitor and oversee climate progress.

Table 2. The percent of companies in each region disclosing each indicator.

Integration into Risk Management

The CFTC report recommends that financial firms integrate climate risk monitoring and management into their governance. However, only 10% of US firms disclose integration of climate risks into their enterprise risk management. While this is similar to progress in Japan, 17% and 20% of firms in the EU and Canada respectively report integration of climate risks into their management, indicating that they are likely more well prepared both for an increase in extreme events or transition risks and for regulations around assessing and disclosing risk.

The CFTC recommends that financial firms conduct scenario analysis aligned with international efforts, In the US, 11% of firms have disclosed use of scenario analysis, which is similar to Japan and the EU. Canada stands out with 20% disclosing use of scenario analysis. There has been a rapid uptick in both the pressure to conduct scenario analysis and stress tests, particularly for banks, as well as the resources available to support these assessments, such as the reference scenarios released by the Network for Greening the Financial system in June 2020.

Conclusion

Our analysis shows that the largest US corporations tend to be slightly behind in terms of disclosing key indicators compared to their international peers. However, among all assessed regions, only a small percentage of firms disclose the indicators highlighted in this analysis, which demonstrates that there is significant room for progress. Increasing firms’ capacity to assess and disclose climate risks in an informative manner remains a global challenge.

Our analysis focused on the largest publicly trading companies, which are the first that have to comply with upcoming regulations around climate risk disclosure. The picture of progress likely looks different for mid-market firms where integration of emerging best practices for ESG and climate risk is not yet as deep.

 

[1] Moody’s Corporation, Four Twenty Seven’s parent company, is a BRT member.

The Compounding Challenges of Climate Hazards and COVID-19

April 22, 2020 – Four Twenty Seven Analysis.  The devastating human health and economic impacts of the COVID-19 pandemic are exacerbated by climate hazards, which threaten communities around the world. This analysis explores exposure to floods, heat stress, hurricanes and wildfires in U.S. municipalities alongside the impacts of COVID-19 on the same regions. It discusses the compounding challenges for economies, infrastructure and human health and the importance of preparing for these overlapping disasters.

Introduction: Climate Preparedness Takes on New Meaning

Last week in the Southern U.S., residents and policy-makers weighed the risks of high winds and flooding alongside the risks of spreading COVID-19, as many evacuated to storm shelters, and 750,000 people lost power across ten states from Texas to West Virginia. Meanwhile that same week 50,000 people in Connecticut lose power because of a storm, with restoration efforts complicated by COVID-19 precautions. The threat of climate-driven extreme weather events takes on new meaning when standard responses such as evacuating to shelters conflict with guidelines for preventing the spread of the disease. The pandemic’s impacts have been compared to Hurricane Katrina hitting all 50 states. FEMA, which is leading the nation’s response, typically only battles disasters in a few states at once.

To ensure the safety of residents, many are typically urged to evacuate ahead of hurricanes and wildfires. However, crowded evacuation centers are prime conditions for diseases to spread. Authorities in several states are actively exploring the best responses to this challenge, considering options for increasing the capacity of evacuation centers, taking temperatures before admitting evacuees and booking blocks of hotel rooms as a last resort.

Hazards such as heat waves and wildfires pose human health risks that will contribute to already overwhelmed healthcare systems. Further, many communities rely on cooling centers and visit public spaces such as shopping malls to seek relief during summer months. Measures to reduce the spread of COVID-19 include the closure of facilities such as libraries and malls that typically serve as cooling centers. During a time when residents are encouraged to stay in or near their own homes, a heat wave would pose new danger. However, measures to improve preparedness, such as ensuring that hospitals have back-up power generators, improving availability of virtual healthcare and seeking alternative sources of personal protective equipment, will help communities prepare for the impacts of climate hazards as well as the pandemic.

The economic consequences of the pandemic also exacerbate the challenges presented by climate hazards for cities and residents. For those individuals who have lost their jobs due to COVID-19-related closures, decreased income may make it difficult to acquire needed emergency supplies or pay to relocate to a safe haven. Local governments already reaching deep into their coffers and straining existing resources, may have trouble allocating emergency personnel and resources to evacuate residents and to rebuild after a disaster.

This analysis explores the regions of the U.S. that are particularly exposed to the climate hazards of floods, heat stress, hurricanes and wildfires and how this exposure may exacerbate existing challenges due to COVID-19.

Extreme Rainfall and Flooding

Devastating flooding last year disrupted lives, threatened livelihoods and contributed to 19 million acres of cropland going unplanted. Seventy percent of those acres were in the Midwest, which was sodden for months. Communities are bracing for new floods this year which are expected to be severe, though not as devastating as last year’s floods. Counties in the Midwest are among the most exposed to increasing extreme precipitation due to climate change in the next several decades (Figure 1), where these floods are likely to become a regular occurrence.

Figure 1. Exposure to extreme rainfall by county, with red representing the most exposed counties and dark green representing the least exposed. Source: Four Twenty Seven.

This year, inundation would exacerbate the existing challenges of containing COVID-19, while COVID-19 containment precautions would, in turn, make flood response more challenging. Midwestern states such as Michigan, Illinois and Indiana are among states with the highest number of COVID-19 cases relative to their populations. While less densely populated communities have fewer cases to date, many Midwestern counties such as Cook County in Illinois and Franklin and Hamilton Counties, in Ohio already have a significant number of COVID-19 cases. Likewise, smaller towns typically have fewer financial resources and fewer staff dedicated to emergency relief.

The economies of many Midwestern communities depend upon agricultural and manufacturing industries, which require manual labor and the physical presence of the employees. Some manufacturing facilities reopened to produce personal protective equipment, and farms and grocery stores are both considered essential. However, these industries are at heightened risk of disruption from employees falling ill, as seen at several meatpacking facilities across the country. Floods can exacerbate these challenges, inundating roadways, manufacturing facilities, farms, and even grocery stores, preventing healthy staff from getting to and from their place of employment and disrupting the movement of goods. These impacts can also threaten food security if they disrupt food supply chains.

Heat Waves

Figure 2. Exposure to heat stress by county, with red representing the most exposed counties and dark green representing the least exposed. Source: Four Twenty Seven.

NOAA predicts above-average temperatures for much of the country through July, with no regions expecting below-average temperatures. Exposure to extreme heat is concentrated in Missouri and western Illinois, fanning out across the Midwest and South and including several areas that have had high numbers of COVID-19 cases to date (Figure 2). For example, the metropolitan areas surrounding Chicago and Detroit have both been hard hit by COVID-19 and face moderate exposure to heat stress. The Southeast corner of Florida faces high numbers of COVID-19 impacts as well as high heat stress and a looming hurricane season.

It is currently unclear how warmer temperatures will affect the spread of the virus. However, heat waves hinder worker productivity and can lead to safety concerns for outdoor workers, such as farmers. In addition to their human health impacts, heat waves also lead to higher peak energy demand as use of air conditioning surges. If governments and businesses alike continue to require or encourage their employees to work from home, reliance on air conditioning and power will likely be higher this year than in typical summer months. Resulting power outages can disrupt business continuity, particularly with operations dispersed across employees’ homes.

Hurricanes

Figure 3. Exposure to hurricanes by county, with red representing the most exposed counties and dark green representing the least exposed. Source: Four Twenty Seven.

Climate change is contributing to more frequent intense hurricanes and more severe storms are expected this season compared to the average season. States along the Gulf Coast and Atlantic Ocean are highly exposed to hurricanes (Figure 3), and several of these states, such as Louisiana and Florida, also have among the highest numbers of COVID-19 cases to date.

Local governments that depend upon sales tax are likely to feel the most immediate fiscal impacts from COVID-19, while those that rely more on property tax may feel longer term impacts influenced by foreclosures. In Florida, sales tax was responsible for 77% of the state’s general revenue in the 2018-2019 fiscal year, which suggests that it will face the fiscal impacts of COVID-19 over the next several months, corresponding with the hurricane season, when funds may be most needed. Other states, such as Louisiana, have extended their tax filing date indefinitely, which will delay tax income. Regions that depend on tourism, such as the Florida Keys, will be going into hurricane season with fewer fiscal resources than usual this year. A lack of fiscal resources will challenge preparedness efforts and emergency response to hurricanes.

Wildfires

As climate change contributes to more severe droughts and extreme heat events, wildfire season in the western U.S. has worsened over the past several years. California, Washington and Colorado are among those states most exposed to wildfires, and they are also among those states with the highest numbers of COVID-19 cases to date.

While the spring is usually spent preparing for wildfire season, these preparations have been hindered this year. Annual efforts to remove brush have been postponed, while hiring has been delayed and annual trainings have been canceled. Fire agencies are going into this year’s season understaffed, with many firefighters already sick or quarantined. They are also wary of the dangerous conditions of base camps, where firefighters sleep in close quarters on the front lines.

The economic impacts of COVID-19 on employment and incomes will exacerbate the losses caused by wildfires and will likely lead to higher numbers of residents facing tough questions around whether or not to leave an area if they lose their homes. The resulting emigration or delayed rebuilding will in turn reduce local government revenues.

Residents in fire-prone areas increasingly wear N95 masks to protect themselves from wildfire smoke. However, these masks are in short supply and authorities have directed that masks should be saved for medical personnel. If shortages persist into this year’s wildfire season, communities could face greater long-term respiratory health impacts due to wildfire smoke.

Conclusion

As COVID-19 continues to spread and its timeline remains unknown, each region of the country faces exposure to climate hazards which will complicate containment efforts. However, in a time when local jurisdictions and individuals are paying increased attention to disaster preparedness there is an opportunity to strategically prepare for climate hazards and invest in resilience that supports responses to any disaster. Hurricanes, wildfires, floods and heat waves are inevitable in our changing world, and the more proactive resilience-building that occurs, the better positioned communities will be to minimize the loss of lives and livelihoods.

Responding to the COVID-19 Crisis: Can Industry Help?

March 26, 2020 – Four Twenty Seven Analysis. We leverage our global database of manufacturing sites to identify industrial plants that may be able to contribute to the production of personal protective equipment and medical equipment to address the global public health crisis. The data is available free of charge to state and national governments seeking to engage with manufacturers in their jurisdictions.

Introduction

As COVID-19 continues to spread, states and countries experience shortages of essential first response equipment such as masks, hand sanitizer, ventilators and hospital beds. A few manufacturers in the perfume, automobiles and electronics sectors have responded by repurposing their facilities to produce equipment that will help deal with the public health crisis.

These companies demonstrate the potential for more widespread public-private partnerships during this global crisis. To support these efforts and encourage public-private partnerships, we leveraged our global database of corporate facilities to identify the companies that have facilities that may be repurposed to contribute to this effort.

Methodology

Based on news coverage of companies that have announced efforts to repurpose their manufacturing facilities to support COVID-19 response efforts, we identified facilities within SIC industries that may be able to contribute. The table below provides the list of sectors included in our analysis. Note that many factors influence whether or not a specific facility can be repurposed, so this data is intended as an entry point for a dialogue and engagement with industry.

Findings

Starting with a database of about a million corporate facilities owned by large, publicly-traded companies, we identified 11,322 facilities globally in sectors of interest.  2,755 of these are in the United States. Below we provide examples of industries in the four states with the largest number of facilities based on this analysis, which are also among the states with the most diagnosed COVID-19 cases to date.

New York

As of March 26, New York has the most diagnosed cases of COVID-19 in the United States. We found 149 manufacturing facilities in the state with the potential to be repurposed to support response efforts. Household and personal products make up 48 of these facilities and include 20 manufacturing facilities owned by Estée Lauder and 10 owned by L’Oréal. On Monday Estée Lauder announced that it would reopen one if its facilities in New York to produce hand sanitizer. Meanwhile, cosmetic company LVMH transformed three of its French perfume factories into hand sanitizer producers, supplying health authorities and hospitals in France. L’Oréal Group has also joined other cosmetics companies in Europe to use its manufacturing facilities to produce hydroalcoholic gel and hand sanitizer. This suggests that cosmetic companies in the United States may also be able to repurpose their facilities.

There are 57 manufacturing facilities owned by pharmaceuticals, biotechnology & life sciences companies in New York State, including 16 owned by Pfizer. In addition to having the necessary machinery and supplies, companies also need to address regulatory constraints around manufacturing different types of medical equipment. However, there are opportunities for businesses and governments to work together to identify appropriate exceptions to allow companies to support the urgent public health demands. For example, pharmaceutical company Roche recently got emergency approval to distribute high-speed coronavirus tests.

New Jersey

New Jersey and California have the second and third largest number of residents diagnosed with the virus and they each have 228 manufacturing facilities with the potential to be repurposed for COVID-19 response efforts based on their industries.  Similar to New York, there are 160 facilities owned by pharmaceuticals, biotechnology & life sciences companies in New Jersey, with Pfizer, Merck and Johnson and Johnson representing the largest number. Likewise, there are 27 facilities owned by household and personal products companies, 10 of which belong to L’Oréal. New Jersey also has 21 chemical manufacturing facilities, which could potentially use their equipment to produce hand sanitizer or test kits depending on their equipment and resources.

California

California facilities that may be able to contribute include 29 owned by automobile and component companies. Those with more than one applicable facility include Autoliv Inc, Aptiv PLC, Ford, Tesla, Toyota and Honda. General Motors and Tesla have already begun producing ventilators, while Ford has said that it’s considering the possibility. The FDA has waived some approval regulations typically required of new ventilator manufacturers, which helps open the door for companies to step up. We also identified 18 facilities owned by textile and apparel manufacturers in California, such Adidas, Nike and VF Corporation that could potentially use their equipment to produce masks.

While medical-grade masks are made from specialized fabric that many fabric companies don’t usually have access to, there is already a collaborative effort between yarn spinner Parkdale Mills, Inc and textile companies such as Fruit of the Loom and Hanes brand to create a manufacturing supply chain for masks. This indicates the potential for other clothing companies to contribute to the efforts by producing masks or hospital gowns. There are also 137 manufacturing facilities owned by healthcare companies in California, which can potentially transition their production to materials directly relevant to the COVID-19 crisis. For example, Allergan and Pfizer both have 13 facilities across the state. Roche, discussed above, also has nine facilities in the state.

Michigan

Michigan, the state with the fourth most COVID-19 cases as of March 26, has the largest number of manufacturing facilities owned by companies that may be able to produce response equipment. Out of 262 applicable facilities, the state has 181 owned by automobile and component companies, with 27 owned by Aptiv PLC, 26 owned by General Motors, and 24 owned by Magna International Equipment. The transformation of several other car manufacturing facilities into ventilator production centers shows the potential for these facilities to be repurposed.

Conclusion

As states and countries strive to identify the most efficient responses to an unprecedented global public health crisis, there is an opportunity to leverage existing capabilities. Understanding which companies may have tools that can help support response efforts can help inform conversations around addressing this crisis.

Four Twenty Seven is making the underlying data available free of charge to state governments, please send requests to Natalie Ambrosio, Director of Communications (nambrosio@427mt.com) if of interest.

This analysis was written with support from Lindsay Ross.

COVID-19 and Climate: Multifaceted Impacts

March 18, 2020 – 427 ANALYSIS.  The spread of the coronavirus (COVID-19) has created a global public health emergency and catalyzed an economic recession.  The crisis also has important implications for climate action and resilience-building. This analysis highlights several of these interacting factors.

The unprecedented global public health crisis from COVID-19 has led to a deteriorating global economic outlook, but  also presents a range of implications for climate change. While COVID-19’s immediate impacts include emissions reductions, the longer-term impacts on climate action and resilience-building are more complex. Likewise, COVID-19 may provide insight into how prepared communities are for the increasing frequency of disasters and how financial institutions can prepare for sudden disruptions. This article will explore several of these impacts, outlining topics to watch as we strive to understand the long-term implications and ensure the safety of communities and businesses.

COVID-19 and Emissions

The rapid spread of COVID-19 has led some of the world’s largest economies to grind to a halt as social distancing measures prohibit non-essential business. The resulting emissions reductions provide a small silver lining to this unprecedented global crisis. In mid-February China’s emissions were 25% lower than a few weeks prior and Italy’s nitrogen dioxide emissions have dropped significantly. However, these may be short-term victories for the planet.

There is much more uncertainty on long term effects. On the one hand, this period of disruption will likely be followed by economic stimulus efforts, providing credits to industries with large emissions, such as steel, cement, and airlines, driving a rapid rebound in emissions. On the other hand, experts note that there is potential for the outbreak to shift travel patterns for the long-term, leading to more telecommuting as companies get acclimated to remote work. There is potential for permanently behavior changes that would have long term impact on oil demand and emissions. Whether or not governments focus on promoting a rebound in traditional energy or use this as an opportunity to catalyze a systemic shift to reduce emissions could be a key determinant in the impact on long-term greenhouse gas emissions.

Setbacks to Climate Action

It is evident that in the short-term ambitious climate policies are not a priority, as the attention of citizens and legislators turns to safeguarding communities and economies from the multifaceted impacts of COVID-19. Numerous climate-related events have been canceled, and in-person negotiations planned ahead of COP-26 have been delayed through at least April. The U.K. changed its generous environmental budget allocations and Spain stopped all legislative activity, with implications for climate action. While the European Union has announced a continued commitment to its Green Deal, meant to make the European Union climate neutral by 2050, the news has gotten limited attention due to the circumstances.

As increasingly severe travel and gathering restrictions begin to have rippling impacts, ongoing climate research is disrupted, including arctic research expeditions and several NASA projects. These studies include research on the ocean-atmosphere heat exchange, seasonal hydrology in the Mississippi River, and thunderstorms across the U.S. While NASA does not expect the delays to be detrimental to the projects, delays may range from several months to over a year. This may challenge efforts to ensure that the most current science underpins resilience-building efforts and climate progress.

Lessons Learned in Preparedness

A global pandemic is a well-rehearsed scenario in risk management, and institutions that had prepared and thought through implications of such an occurrence are faring better than those with less preemptive planning. For example, last October banks in Hong Kong underwent a stress test that simulated a pandemic, cyberattack and telecom breakdown happening concurrently. Now facing an actual pandemic, some banks are grateful for additional preparedness measures they had implemented due to the stress test. The COVID-19 crisis may in turn lead banks, other businesses and governments to identify opportunities for additional preparedness measures for future risk.

Reduced Resilience

As communities around the world face various levels of restrictions and concern for large gatherings grow, supply chains are threatened and manufacturing grinds to a halt, vulnerability to climate impacts increases. If a devastating storm or wildfire forced residents from their homes into crowded evacuation centers, the typical damage, loss and public health costs would compound upon the danger and challenges already being faced due to COVID-19. Likewise, the costs of recovery from a climate disaster would be dire on top of the increasing economic uncertainty.

Similarly, as companies face the impacts of the pandemic, including adapting to remote work if possible, an extreme weather event would complicate their efforts. While office buildings and key facilities may be prepared with generators in case of power outages and water proofing for floods, business’ operations are now particularly dependent on public power and communication infrastructure, as well as the resilience of each employee’s home. In addition to the disruption if employees are ill, many businesses are more vulnerable to disruptions from climate hazards during this time, which in turn increases macroeconomic vulnerability. Of course, the pandemic itself has many multifaceted economic and business impacts.

Conclusion: Underscoring the Need for Resilience

COVID-19 has understandably pushed climate action to the back burner as the public health crisis unfolds and fears of a long-term economic recession are pressing. However, the ways policy-makers, business and individuals respond to today’s public health emergency and the resulting successes and failures may provide lessons for responding to other multifaceted disasters, applicable to extreme weather events and natural disasters. Likewise, the COVID-19 crisis may reinforce the value of preparedness for businesses and communities and help highlight opportunities to invest in adaptation and resilience.

 

Economic Impacts of Bushfires: What California’s Wildfires May Foreshadow in Australia

January 29, 2020 – 427 ANALYSIS. As Australia’s bushfires rage on, questions arise on the long-term impacts on human health, biodiversity and the economy. This analysis shares lessons learned from the recovery from recent wildfires in California to offer some pointers of what might happen when the bushfires finally subside. While immediate economic impacts include emergency relief bills, business interruptions, costly loss of goods and reduction in tourism, the long-term impacts vary based on municipalities’ financial resources, economic make-up and preparedness.

Real Estate Markets

Over the past three years wildfires have razed thousands of buildings across California, destroying multiple communities. The impacts on real estate markets varies depending on the share of properties destroyed in a local community, as well as insurance penetration. After five percent of Santa Rosa’s housing stock burned in 2017, the city experienced an increase in property prices and rents following the fire: displaced households needed new dwellings, construction workers and emergency relief officials needed housing and amenities, and local businesses found new clientele. Although an estimated 3,300 people left Sonoma County after the 2017 fires, in Santa Rosa, CA, rebuilding has occurred more rapidly than expected. The areas affected by the fires had relatively high insurance rates, and families were able to pay for the reconstruction of their houses. Irreplaceable personal items were lost, but the city experienced a mini-economic boom due to construction in the area.

In contrast, the city of Paradise went from 26,000 residents before the Camp Fire down to 2,000. More than one year later, only a handful of houses have been rebuilt, and many residents struggle with whether they should move back. Insurance penetration was much lower in Paradise, and many low-income households cannot afford to rebuild their lives there.

Aside from short-term shortages in housing stock, long-term impacts on real estate and local economies depend on two main factors: whether the area experienced a permanent or long-term population loss, and whether insurance companies continue to offer policies for the area. This phenomenon has also been at play after other climate-related events, such as when Hurricane Maria hit Puerto Rico. The storm led to a four percent decrease in the island’s population.

Impacts can also indirectly touch other communities near wildfires: the same Camp Fire that devastated Paradise narrowly missed the neighboring city of Chico, CA. While Paradise’s economy has yet to recover, within three months of the fire, Chico’s population grew by 20%, with the addition of about 20,000 people. While Chico became the nation’s hottest real estate market the month after the fire, it also missed relief funds offered to towns touched by flames. From a sewer system now tasked with transporting 600,000 more gallons per day, to the need for more police force and a higher hospital demand, a year after the event, the city struggled to accommodate a population the city planners hadn’t expected for a decade.

Business Impacts

In California, the biggest impact was on the utility sector. As power lines and electric equipment were found to have started the wildfires, the liability ultimately resulted in Pacific Gas & Electric’s (PG&E) bankruptcy, coined “the first climate-change bankruptcy.” In Australia fires are most often started by dry lightning so utilities are not so exposed to liability risk, but may still be exposed to significant costs from disruptions and repairs associated with wildfires.

The insurance sector is also very exposed. Merced Property and Casualty local insurance company went bankrupt after California’s Paradise fire. The company had USD23 million (AUD34 million) in assets and owed USD64 million (AUD94 million)  in liabilities after the fire, which the state of California took over after the company defaulted. Insurance claims for the bushfires have already reached around AU939 million (USD646 million). Australian insurance companies could face material losses, particularly those with concentrated portfolios of properties or companies in regions affected by the fires.

For example, insurer IAG is the primary insurer in New South Wales and is thus expected to face the most financial risk from the current fires. IAG and Suncorp have both temporarily stopped selling wildfire insurance in exposed areas of Australia, to prevent last-minute insurance purchases. The final bill may be absorbed by reinsurance companies, which also need to contend with multiple, costly events globally. Increased losses, even if they do not lead to a bankruptcy, can also open the door to liability. In 2019 insurance giant QBE saw a shareholder resolution regarding its lack of preparedness for climate impacts.

Beyond utilities and insurance, businesses across sectors face several short-term risks from wildfires, including business interruptions, labor shortages and reduced consumer activity due to evacuations or smoke which can affect urban centers not themselves touched by flames. Businesses may also face increased costs due to equipment and property damage or loss.  In the long term, recurring wildfires could decrease attractiveness of certain parts of Australia, which would reduce companies’ hiring pool and decrease tourism revenues.

Municipal Resources

Residents’ decisions to stay in a recovering area is largely affected by whether insurance companies choose to provide coverage or pull out after wildfires. This in turn, is a key factor in the viability of long-term development and the strength of cities’ tax bases. Faced with potential population loss, local governments may attempt to provide public insurance if private insurers leave a city or region, such as the National Flood Insurance Program (NFIP) in the U.S. However, as seen with the NFIP, this mechanism can lead to unsustainable development and a moral hazard, encouraging unwise economic decisions by shifting risks from the individual buying property, to the government and therefore the public.

The desire to help an area rebuild needs to be balanced against a forward-looking perspective on the new realities of climate change. As temperatures increase, droughts become more common and wildfire conditions become more frequent, climate change will make some areas no longer suitable for human settlement. In California some insurers have stopped offering wildfire insurance to certain fire-prone counties. After careful deliberation the state recommended the creation of a Wildfire Victims Fund to help pay claims to wildfire victims, while also supporting wildfire mitigation. However, this comes alongside recommendations to require home and community fire risk reduction standards, establish a development fee for new construction in the wildland-urban interface, and mandate that new development must be reachable by firefighters within a maximum amount of time.

The impact of wildfires on a city’s credit rating may also affect its economic prospects after an event. Issuers in Sonoma County were not downgraded after the 2017 fires, because of their strong credit quality, insurance coverage, commitment to rebuilding and long-term economic viability. The County has an emergency reserve fund, which helped make up the shortfall in property taxes for destroyed properties, assuaging any concern from rating agencies on their balance sheet post-disaster.

However, a Moody’s credit analyst noted that smaller, less well-resourced communities like those burned during the 2018 fires in rural Shasta County, will face less rapid rebuilding, which means less revenue and more difficulty repaying their debt. This highlights the need for proactive preparedness efforts, particularly as those municipalities in particular need of financing may see credit declines if they experience wildfire loss.

Hidden Costs: Health Impacts

Image Credit: NASA Earth Observatory/Aqua/MODIS

Wildfires’ impacts on human health can be long-lasting and widespread. While Paradise, CA burned down in 2018 San Francisco, about 200 miles away, had the worst air quality in the world. This led to school closures and business disruptions during the event, but its impacts are still being felt. Three to five months after Sonoma County’s 2017 fires there was a 20% increase in emergency room visits for breathing challenges, as well as a 20% increase in visits for cardiac problems three months after those fires. While populations are advised to stay inside to shelter from smoke, many evacuation victims do not have that option.

Suburban wildfire smoke is particularly dangerous because burning gas stations, buildings, cars and other man-made materials releases many toxins, along with tiny PM 2.5 particles. The long-term impacts of inhaling countless chemicals are not yet fully understood but will likely exacerbate the well-documented damage to lungs and hearts caused by PM 2.5 particles. As public health costs increase, municipalities’ expenses may rise and human productivity may decline, posing additional risk to economies and communities made fragile by wildfire.

Preparing for a New Normal

Recent attempts at risk mitigation highlight the challenges to improve prevention. In October and November 2019 over a million Californian’s lost power during multiple PG&E “Public Safety Power Shutoffs,” meant to reduce the risk of wildfire during “red flag” conditions, with high winds and warm temperatures. With less than a day’s notice in some cases, residents, businesses and schools around San Francisco’s Bay Area spent days without power. Elderly and those relying on medical equipment faced life threatening hardship, local businesses experienced significant loss, long-term, high-profile research was disrupted, and costs of the event were expected to be around USD2 billion (AUD3 billion).

Australia and California used to share firefighting resources since they didn’t need them at the same time, and firefighting contractors built their businesses around staggered fire seasons. Now, Australia and California fight fires concurrently, business models must shift and municipalities must reallocate resources.

As climate change increases the occurrences of wildfires across the globe, policymakers and communities will need to balance these considerations and invest in adaptation and resilience to limit the impact of future fires.

This article was also published on The Fifth Estate and Which-50.

Natalie Ambrosio contributed to this analysis.

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Four Twenty Seven works with investors and businesses to provide portfolio hotpot screenings and real time due diligence with site-specific data on heat stress, water stress and other climate risks. Wildfire analytics are forthcoming. Contact us for more detailed analysis and site-specific data on climate risk exposure and its economic impacts.

Real Estate Climate Risks: How Will Europe be Impacted?

Introduction: Increasingly Severe Impacts

Extreme weather events driven by climate change are having severe impacts that are increasingly being seen across Europe. Between 1980 and 2017, weather and climate-related extremes caused approximately €453 billion of total economic losses. Among those losses, it is estimated that only 35% were insured. Climate change has a substantial impact on real estate markets. It can directly damage individual buildings, decrease their value or even lead to assets being rendered unusable. In Europe, floods from extreme rainfall and sea level rise represent a major threat to real estate markets. As climate change leads to more frequent and severe extreme weather events it is increasingly important for real estate investors to understand the climate risk exposure of key assets and prepare for impacts.

Assessing Exposure to Climate Change in Real Estate

To provide a view on physical climate-related risk for the real estate industry in Europe, Four Twenty Seven used a proprietary model that leverages global climate data to provide asset-level risk assessments to physical climate hazards. We analyzed the exposure of 20,816 retail spaces and 16,188 offices in Four Twenty Seven’s database of one million corporate facilities. The real estate sites are owned by over 900 listed companies, out of the 2,000 companies included in our database. We used our climate risk scoring methodology to assess each facility’s exposure to climate hazards, with a focus on floods, sea level rise and heat stress looking out to mid-century.  Flood risk and sea level rise are assessed with a precision of 90x90m. Heat stress is evaluated at a 25x25km scale.

We found that 19% of retail spaces and 16% of offices are exposed to floods and/or sea level rise, with floods representing the highest risk for both types of asset. Heat stress also presents significant risk to these facilities.

Inland Floods: A Major Threat for a Warming Europe

Floods are one of the most prominent risks for real estate in Europe. In most European cities, climate change is increasing the frequency and the intensity of heavy precipitation events, threatening urban infrastructure and increasing flooding.

Floods can inundate facilities directly, leading to disrupted operations and equipment damage and can also have indirect impacts on operations by damaging regional transportation, power and communication infrastructure. Fluvial and pluvial floods can increase costs associated with maintenance and repair of buildings, lead to higher insurance premiums, and reduce revenue due to business disruptions.

Figure 1. Retail spaces’ exposure to floods. A dot represents a city and its size represents the number of retail spaces in the city. The dot’s color represents the percentage of retail spaces exposed to floods, with red representing the highest percentage. Source: Four Twenty Seven

Floods also have wider impacts on real estate markets. For example, studies looking at the residential market in Germany and Finland show that properties in flood-prone areas are sold at lower prices compared to properties without flood risk.

Retail spaces in the United Kingdom are particularly exposed to flood risks, based on our analysis (Fig. 1). Climate change is likely to contribute to more events like the winter storms of 2015-2016 which resulted in around £1.6 billion of total economic damages in the United Kingdom. Over 20% of Edinburgh, Glasgow and Sheffield’s retail assets are located in flood-prone areas.

Figure 2. Retail spaces exposed to flooding in the Greater Glasgow area. A dot represents a retail space and the dot’s color represents its flood risk. Source: Four Twenty Seven

The amount of rain during heavy precipitation events in Glasgow (Fig. 2) is projected to double by 2030-2040 compared to 1975-2005. London is also exposed to surface, fluvial and tidal floods. In our analysis, London is the city with the highest number of retail spaces in flood-prone areas (Table 1). Its most exposed sites have a 20% probability of being flooded each year, and a 1% probability that the flood depth will be higher than one meter, based on Four Twenty Seven’s data.

Without adaptation measures at the site-level and the city-level, these assets will likely suffer from increasing property damages and potential business disruptions due to more frequent and severe rainstorms. For example, floods can reduce business at retail sites such as clothing stores when consumers may prefer to stay home or be prohibited from shopping by inundated infrastructure. Likewise, grocery stores and other retail sites may experience supply chain disruptions or damaged goods with impacts on sales and revenues.

England, Scotland, Wales and Northern Ireland all have a Climate Change Adaptation Program. The English program pledges to construct additional hard defenses and to support communities and businesses in increasing their properties’ and investments’ resilience.

Table 1. Cities with the highest percent of retail spaces exposed to floods, out of those cities with over 70 retail spaces. Source: Four Twenty Seven

Sea Level Rise: When Beach Front No Longer Means Value

Several recent studies have found that there is potential for severe sea level rise if certain tipping points are reached. For example, East Antarctica is warming faster than previously expected, with immense implications for global sea levels. According to opinions gathered from experts, there is a possibility of sea levels rising to two meters by 2100 under a 5˚C scenario. Without coastal adaptation investment, it is estimated that annual damages, due to storm surges and king tides, could reach up to almost €1 trillion by the end of the century in Europe.

The real estate industry is at the front line of sea level rise risk. Properties can suffer from severe damages leading to maintenance and repair costs. Even if a facility itself is not permanently inundated, it may be rendered unusable if its closest rail and road infrastructure experience chronic disruptions. Sea level rise can also have far-reaching market impacts such as increasing insurance costs and higher local taxes to fund adaptation efforts. The perception of sea level rise risk can also impact an asset’s value. For example, French coastal properties suffered from substantial damages after coastal flooding caused by storm Xynthia in 2012. At the Ile de Ré, a touristic French island close to La Rochelle, material losses had a longer-term effect on the real estate market. Home prices dropped in the most exposed part of the island. Fields previously sought after by developers became classified as non-constructible areas after the storm.

Figure 3. Corporate offices’ exposure to sea level rise. A dot represents a coastal city and its size represents the number of offices in that city. The dot’s color represents the percentage of offices exposed to sea level rise, with red representing the highest percentage. Source: Four Twenty Seven

Our assessment found that corporate offices are highly exposed to sea level rise in Europe (Fig. 3). Increasing floods and chronic inundation from sea level rise can affect employee commutes, with implications for business continuity at offices. Assets in Ireland, France, Sweden and the United Kingdom have particularly high exposure.

Copenhagen is highly exposed to sea level rise, with 81% of its offices exposed to coastal flooding. In its Climate Adaptation Plan, the city acknowledges that it will be at high risk of flooding in 2040, stating that if no adaptation measures are undertaken, sea level rise will cause “unacceptable” damage. An asset’s risk to sea level rise will be largely driven by regional adaptation efforts to prepare for flooding from higher tides and storm surge.

Copenhagen has defined a long-term adaptation strategy, including the creation of green infrastructure and flexible spaces that can be inundated during high tides, such as sports fields and parks. The city also constructed dikes and quays to protect it from up to 2 meter storm surges. However, the construction of hard protective infrastructure is leading to very high expenditure for local authorities, which can have impacts on local taxes and the strength of other government services. Adaptation policies may also affect building permit requirements and add restrictions to real estate development. Dublin is the city with the highest number of corporate offices from our database exposed to sea level rise (Table 2). This exposure is concentrated in Dublin’s business district (Fig. 4). Floods in the business district can impact the transportation system, electric grid and telecommunications networks, which all impact local businesses.

Figure 4. Corporate offices exposed to sea level rise in Dublin. A dot represents an office and the dot’s color represents its sea level rise exposure. Source: Four Twenty Seven

Dublin is aware of its risk and has developed a 2019-2024 adaptation plan that budgets the construction of new flood defenses and includes a flood risk management strategy. Property managers and real estate investors can engage with the surrounding community to support these regional resilience-building efforts that will also mitigate the risk to their own assets.

Table 2. Cities with the highest percent of corporate offices exposed to sea level rise, out of those cities with more than twenty corporate offices. Source: Four Twenty Seven

Heat Stress: Shattered Records Becoming the New Norm

Heat stress is a growing concern for Europe. The region experienced two recording-breaking heat waves within two months during summer 2019,  affecting public health, hindering productivity and contributing to train delays, with implications for economies across the continent. The decade from 2009-2018 was the warmest on record, with temperatures around 1.7°C above the pre-industrial level in Europe.

Figure 5. Retail spaces’ exposure to heat stress. A dot represents a retail space and the dot’s color represents its heat stress risk. Source: Four Twenty Seven

Our analysis shows that offices and commercial spaces throughout Europe will experience heat waves that are 21 days longer on average compared to 1975-2005. Based on Four Twenty Seven’s data, Southern Europe is expected to experience the highest increase in the duration of heat waves, with projections showing an additional month of temperatures above the 90th percentile every year in Madrid (Fig. 5). Heat waves will also bring higher temperatures, with an 8% average increase in maximum temperatures by mid-century, and over 10% in Paris, for example. This will manifest in cities experiencing climates typically associated with locations significantly further south. For example, a recent study noted that “Madrid’s climate in 2050 will resemble Marrakech’s climate today, Stockholm will resemble Budapest, London to Barcelona.”

The urban heat island effect and worsening air quality will exacerbate the impacts of increasing average temperatures in many European cities, with implications for human health and economies. Heat stress can create new cooling needs for buildings and thus increase operations costs at real estate assets. This is particularly true for assets such as data centers and retirement residences, with significant cooling needs. Extreme heat can also affect consumer behavior, reducing the desire to window shop outside, for example, but increasing the visitors to air-conditioned facilities such as shopping malls. In the long run, increasing average temperatures could have indirect effects on real estate markets as consumer preferences shift.

To reduce their vulnerability, many cities are adapting to extreme heat by increasing green spaces and the use of reflective materials to reduce the albedo effect, for example. Property managers can model on-site adaptations after these examples, while also contributing to wider regional efforts that reduce the urban heat island effect to preserve public health and economic activity.

Conclusion: Understanding Risk to Build Resilience

Real estate assets are already experiencing the impact of extreme heat and floods across Europe and the real estate industry will continue to be impacted by climate change in the near-term. There is an urgent need for resilience-building across assets to ensure business continuity and reduce financial losses. Understanding asset risk is an essential first step towards building resilience. Asset owners and managers can leverage asset-level risk exposure data, alongside awareness of regional adaptation efforts, to improve the resilience of their assets and engage communities around shared resilience priorities.

[1] This analysis does not capture coastal flooding for areas further than five kilometers inland from the coast. This limitation may under-represent risk in coastal-adjacent, low-lying areas that extend inland like Amsterdam.

Download the analysis.

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Four Twenty Seven’s ever-growing database now includes close to one million corporate sites and covers 2000 publicly-traded companies. We offer equity risk scoring and real asset screening services to help investors and corporations leverage this data.

Factsheet — Financial Climate Risk Regulation in the European Union

July 29, 2019 – 427 FACTSHEET. Regulation on climate risk in Europe is likely to have a rippling effect across markets globally. There has been key legislation in the past few months, with more action on the agenda. Staying up-to-date on these developments will provide early indications of regulatory action to come. This factsheet on regulatory developments in the EU provides key background to the EU’s sustainable finance agenda, outlines key actions and highlights upcoming dates to remember.

Since establishing the High-Level Expert Group on Sustainable Finance (HLEG) in 2016, the European Union (EU) has positioned itself as a leader in sustainable finance. It has made rapid progress on integrating climate change into its financial sector, simultaneously addressing it from several angles, including risk disclosure, green bond labels, a taxonomy for adaptation and mitigation, and risk management oversight directives. As global financial actors operate, and are regulated, in Europe, EU regulations are likely to propel a development in best practices for addressing climate risk that reaches beyond the EU. Likewise, regulators and financial actors across the world are watching carefully as EU regulation may influence their own action. This factsheet, Financial Climate Risk Regulation in the European Union, summarizes the EU’s stance on the financial risk of climate change, notes key regulatory players and highlights recent and upcoming regulatory action applicable to financial markets.

Key Takeaways

  • The EC completed several milestones from its Action Plan in June 2019, including publishing updated nonbinding guidelines for incorporating climate risk into the non-financial reporting directive and releasing the Technical Expert Group report on a taxonomy for activities that contribute to climate adaptation and mitigation.
  • In April 2019, the European Parliament and Council agreed on text for regulation on disclosures relating to sustainability risks and investments, explicitly stating that climate change demands urgent action.
  • The European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority have provided technical advice on proposed changes to oversight requirements, suggesting that sustainability be explicitly integrated into risk management, operations, investment strategies and governance.
  • The European Banking Authority will spend two years assessing environmental, social and governance risks and their management in the banking sector. The assessment will be used to develop a draft amendment requiring “large institutions” to disclose their risk and the disclosures will be required three years after the regulation is implemented.

Read the Factsheet.

Read Four Twenty Seven’s other Factsheets on Financial Climate Risk Regulation.

Factsheet — Financial Climate Risk Regulation in France

July 29, 2019 – 427 FACTSHEET. In 2015 France laid the groundwork for legislating climate risk disclosure with Article 173 of its Energy Transition Law, mandating that publicly traded companies and asset managers report on their physical and transition risks from climate change. Building on its track record as an early mover, France’s financial regulators are now actively involved in national and international endeavors to frame climate risk as a financial risk and determine the most effective response.  Staying up-to-date on these developments will provide early indications of regulatory action to come. This factsheet on regulatory developments in France provides background on France’s sustainable finance agenda, outlines key actions and highlights upcoming dates to remember.

France’s Art. 173 helped build support for the Taskforce on Climate-related Financial Disclosures recommendations, prompted firms to begin disclosing climate-related risks early and set an example for other nations considering regulation on climate risk disclosure. Since this landmark legislation, French financial regulators have become engaged on addressing financial risks from climate change and the Banque de France was a co-founder and provides the Secretariat for the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), which is focused on propelling the transition to a low-carbon and sustainable economy. By providing the Secretariat for the NGSF, the Banque de France identifies itself as a key player in international efforts to address climate risk. This factsheet, Financial Climate Risk Regulation in France, summarizes France’s stance on the financial risk of climate change, notes key regulatory players and highlights recent and upcoming regulatory action applicable to financial markets.

Key Takeaways

  • Banque de France was the first central bank to release an assessment of its climate risks in line with the TCFD and Art. 173, aiming to set an example of best practice for the French financial sector.
  • ACPR’s fall 2018 survey of the French insurance sector found that disclosures in Art. 173 reports varied between firms and lacked reporting on long-term climate strategies and yearly progress. ACPR made suggestions for insurers to improve their climate risk management based on this review.
  • In summer 2018, ACPR surveyed its banking sector on banks’ climate risk management, identifying “advanced institutions,” larger banks with ample resources that have integrated climate into risk management, and “wait-and-see” institutions, which are largely domestic, retail-oriented banks still focused on a corporate responsibility approach to climate change.
  • France’s stock market regulator, AMF, released a report asserting that climate change has been identified as a financial risk, it is still not sufficiently assessed by the market, and the regulator’s role is to inform and raise awareness on the topic.

Read the Factsheet.

Read Four Twenty Seven’s other Factsheets on Financial Climate Risk Regulation.

 

Factsheet — Financial Climate Risk Regulation in the United Kingdom

July 29, 2019 – 427 FACTSHEET. The Bank of England’s views on climate risk provide an indication of how the broader financial sector will likely approach the issue. The Bank propels this conversation by framing issues and convening stakeholders around the challenges and uncertainties of climate risk. With the integration of climate change into its insurance stress tests, the Prudential Regulatory Authority (PRA) has shown that the Bank’s declarations are starting to influence regulatory requirements. Staying up-to-date on these developments will provide early indications of regulatory action to come. This factsheet on regulatory developments in the United Kingdom (UK) provides background on the Bank of England’s approach to climate risk, outlines key actions and highlights upcoming dates to remember.

The Bank of England has been on the forefront of acknowledging climate change as a material financial risk since before it was commonly discussed in the financial sector. Its Governor Mark Carney coined the term the “tragedy of the horizon” in 2015 referring to the economic risks of climate change. Since then, the Bank has become known for emphasizing climate change as an urgent threat to financial stability and financial regulation in the UK is beginning to reflect this stance. Paying close attention to developing perspectives at the Bank will help prepare financial actors for future regulatory changes to come. This factsheet, Financial Climate Risk Regulation in the United Kingdom, summarizes the UK’s stance on the financial risk of climate change, notes key declarations and highlights recent and upcoming action applicable to financial markets.

Key Takeaways

  • The PRA included scenarios for physical and transition climate risks in its “Scenario Specification, Guidelines and Instructions” for life insurance and general insurance stress tests released in June 2019.
  • In April 2019, Carney announced that banks and insurers will be “expected to embed fully the consideration of climate risks into governance frameworks, including at board level.” This was followed by a supervisory statement outlining these expectations and asking firms to have preliminary plans by Oct. 15 2019.
  • In May 2019, the PRA’s working group of insurance industry experts released a framework for assessing the impacts of physical climate change in the insurance sector and is seeking feedback by Nov. 22 2019.
  • The PRA and Financial Conduct Authority (FCA) developed a Climate Financial Risk Forum, including banks, insurers, asset managers and other financial stakeholders, that will promote capacity building and knowledge sharing for responding to financial climate risks.

Read the Factsheet.

Read Four Twenty Seven’s other Factsheets on Financial Climate Risk Regulation.

Scenario Analysis for Physical Climate Risk: Equity Markets

In this second installment of our blog series of scenario analysis, we focus on how investors can start exploring impacts on portfolios of listed equities/fixed income with existing climate risk analytics. The series provides our current reflections on how corporations and financial institutions can integrate physical climate risk into scenario analysis. The first installment, on foundations, focuses on important characteristics of climate science that affect how climate data can be used to inform scenario analysis for economic and financial risk. A forthcoming post will discuss scenario analysis at the asset level for real asset investments and corporate facilities.

Scenario Analysis Serves Different Purposes

Scenario analysis serves different purposes for real asset investors and for equity or fixed income investors. When looking at a single real asset, scenario analysis can be used to inform very concrete decisions regarding the asset, working directly with the asset operator: whether and what flood protections to put in place, insurance requirements, anticipated impacts on operational costs from water and energy consumption, etc.

In contrast, for an equity or fixed income portfolio, investors’ influence on the resilience of the underlying asset (e.g. a corporation or a sovereign entity) is much more limited. In a previous publication we discussed the importance of shareholder engagement with corporations as a key channel for investors to help raise awareness of rising risks from climate change, and encourage companies to invest in responsible corporate adaptation measures. Investors, however, would be hard pressed to run scenario analysis on individual portfolio companies themselves, and disclosures from corporations on scenario analysis remain weak and fragmented.

Meanwhile, prudential authorities in Europe have been signalling expectations that insurers and banks perform scenario analysis on their portfolio to examine potential impacts of climate change, to understand how different climate-driven outcomes might prevent the insurers and lenders from meeting their financial obligations. Most recently, in April, the Bank of England Prudential Regulatory Authority (PRA) released a proposed set of specifications for scenario analysis that includes some simplified assumptions on climate impacts on financial portfolios.

In this piece we examine how available climate risk analytics can be leveraged to inform early attempts at developing stress test assumptions and simulate potential outcomes on investment portfolios aligned with the relative exposure of corporations by sectors and by regions.

Climate Risk Analytics for Equities/Fixed Income

We leverage our data on corporate physical risk exposure to determine what assumptions can be made in this type of early stress test. In this piece, we analyze the climate risk scores for 1730 of the largest companies in MSCI All Country World Index (ACWI). This physical risk assessment is based on the exposure of the underlying database of about a million facilities globally.

We score each company on three components of physical climate risk: Operations Risk, Supply Chain Risk and Market Risk.

427 Methodology Chart
Figure 1. 427 indicators for physical climate risk exposure in corporations (equities/fixed income)
  • A company’s Operations Risk is based on its facility-level exposure to hurricanes & typhoons, sea level rise, floods, extreme heat and water stress. The analysis also considers the sensitivity of different types of facilities. For example, manufacturing plants with their high energy demands are more sensitive to extreme heat than offices.
  • Supply Chain Risk is based on the risk in countries that export commodities that the company depends on and a company’s reliance on climate-sensitive resources such as water, land and energy, based on its industry.
  • Market Risk is based on where a company’s sales are generated and how its industry has historically been impacted by weather variability.

Scores are normalized, with 0 being the least exposed and 100 being the most exposed. (For more details, please refer to our previous report Physical Climate Risk in Equity Portfolios as well as our Solutions page)

In line with considerations of relevant time horizons and of impacts being locked in over the climatic short term (detailed in Part 1), our standard equity risk score data considers projected climate impacts in the 2030-2040 time period under a single RCP scenario, RCP 8.5 (the worst case scenario, also known as business as usual), but leverages several climate models.

From Climate Hazard Exposure to Financial Impacts

Studies of how physical climate hazards translate into financial impacts at the company level are scarce. While a growing body of research explores the complex relationships between climate hazards and economic impacts, which vary by sector and by region, academic research on the relationship between climate events and corporate/stock performance, at scale, is still limited. Our approach focuses on leveraging what can be estimated in a robust, data-driven way: relative exposure of companies to climate hazards.

Our analysis of global corporations shows the relative exposure of industries to climate related risks across all three dimensions: operations risk, market risk and supply chain risk (Table 1). This table shows the sectors with the highest exposure, including manufacturing, infrastructure (utility, energy, transportation), and industries with high dependency on natural resources (food, apparel).

Table 1. Industries most exposed to physical climate risks . Source: Four Twenty Seven.

Services, not shown in the table, are not only less exposed, they’re also far less sensitive to changes in climatic conditions, with the exception of the financial sector, which holds the risk of all the other sectors in its investment, lending or insurance portfolios. Note that real estate is not included in this analysis, but data on regional exposure in that sector can be found in our white paper on climate risk in real estate.

These differentiated impacts by sectors can lay the foundations for a stress test, as industry risk levels can be used to set initial assumptions on sector-wide impacts. Following the example set out by the Bank of England’s PRA, for example, investors could assume that sectors with high exposure might see a 10% or 20% drop in value, whereas sectors with medium exposure would see half of that impact. These assumptions are not intended to substitute for financial impact modeling, but provide a shortcut to test how a portfolio might perform under climate-driven duress.

Drivers of Exposure to Physical Climate Risk

While some sectors overlap with those examined in scenario analysis exercises for transition risk, such as utilities and energy, other sectors with high exposure are not typically included in scenario analysis, like tech manufacturing or pharmaceuticals. Understanding the nuances of the risk pathways in each sector and their relative exposure to different hazards is critical to refining assumptions and developing models that can quantify value-at-risk by sector with some accuracy.

Manufacturing companies in the tech sector rely on complex value chains that can be interrupted by extreme weather events, particularly in Asia, which is a region highly exposed to typhoons and extreme precipitation. They also often produce expensive and water sensitive products using costly machinery and can incur costs and damages from extreme events on site.  Pharmaceuticals are particularly exposed because of the prevalence of their manufacturing in water-stressed regions (India, California) and regions highly exposed to hurricanes & typhoons. For example, damaged manufacturing sites in Puerto Rico had rippling impacts on pharmaceutical operations globally during Hurricane Maria in 2017. Pharmaceuticals is also one of the groups with the most weight in the MSCI ACWI, making this exposure particularly significant (Fig 2).

Figure 2. The average company risk score by GICS Industry Group, with Operations Risk on the y-axis and Market & Supply Chain Risk on the x-axis. Red represents those industries with the highest exposure, green represents those with the lowest exposure and the size of the bubble signifies an industry’s weight in the MSCI ACWI.  Source: Four Twenty Seven.

In the utility sector, the nature of the exposure is very different from that observed in transition risk analysis: carbon neutral power generation can be as exposed as thermal generation – for example due to water stress or floods for hydro facilities. In addition, utilities rely on expensive equipment, such as cables, poles, fuel storage and pipes that are often exposed to severe weather and sensitive to extreme conditions. Their operations are also resource-intensive, relying heavily on energy and water for cooling. They can experience operations disruptions during peak energy demands or due to equipment damage during storms.

The exposure of the automobiles & components sector has been illustrated by recent flooding in Japan. Automobile companies rely on manufacturing processes and machinery that can be interrupted due to flooding or hurricane damage, but their reliance on employee labor also makes these companies vulnerable to the wider regional impacts of extreme events. For example, during Japan’s extreme flooding in July 2018, Mazda was forced to halt operations at some of its facilities that were not physically damaged themselves, because its employees could not travel safely to work.

Conclusion

Climate change calls for a better understanding of impacts of physical hazards on financial markets, which remains a topic largely unexplored. Yet as regulators push insurers and banks towards the integration of climate scenarios into stress testing, robust, data-driven views on the relative exposure of sectors or regions provide a helpful foundation from which to explore the potential impacts on equity and fixed income portfolios.

Over time, better data will become available as academic and industry providers develop models that capture the nuances of climate impacts on different industries and geographies, but also as companies make a concerted effort to disclose better data on their past and anticipated financial exposure to extreme weather and climate-related events.

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Four Twenty Seven’s data products and portfolio analytics support risk reporting and enable investors and businesses to understand their exposure to physical climate risks across asset classes.