Audio Blog: Latest Innovations in ESG Investing

Colin Shaw at Sustainatopia discussing ESG investing
From left to right: Colin Shaw, Jason Escamilla, Catharine Banat, Megan Fielding, and Andrew Olig

Four Twenty Seven’s Director of Finance, Colin Shaw, was recently invited to be a part of a panel titled “Latest Innovations in ESG” at Sustainatopia on May 8th, 2017.

The panelists discussed the increasing awareness of investors in their options to invest responsibly, and breaking down the preconception that ESG investing sacrifices financial returns. Colin presented on the tools to used measure climate risk in financial portfolios, and the need that Four Twenty Seven sees for more climate data in order to better provide guidance to businesses for their risk management and adaptation planning. The other panelists included:

  • Andrew Olig, Regional Vice President of Calvert Mutual Funds
  • Megan Fielding, Senior Director, Responsible Investment at TIAA Investments
  • Catherine Banat, Impact Investing at RBC Global Asset Management
  • Jason Escamilla, CEO of Impact Labs

Listen to the entire engaging panel recording below.

Proadapt Symposium on Climate Risk and Investment

On April 20, 2017, Proadapt hosted the symposium “Climate Risk and Investment: Framing Private Challenges and Opportunities” a conference to discuss common challenges and emerging investment opportunities in climate resilience. Emilie Mazzacurati, Four Twenty Seven founder and CEO, joined the symposium to discuss what climate change means for the financial sector, and innovative ways that funding for climate-resilient projects can be achieved.

Emilie first spoke on the second panel of the event, “Climate Resilience and Emerging Tools for Financial Institutions”, highlighting the recent moves by financial regulatory groups and institutional investors to promote climate risk analysis and disclosure, as well as ways to overcome the challenges of translating climate data into business intelligence.

Joining Emilie on the panel was Wagner de Siqueira Pinto, executive manager of the Strategy and Organization Directorate of Banco do Brasil; Jerri Ribeiro, leader of PwC Brazil´s Risk Consulting practice; and Jennifer Burney, Assistant Professor at the University of California San Diego.

Later in the day, Emilie moderated a panel on “The Role of Blended Finance in Promoting Climate Resilience”, a lively discussion on methods to create new funding mechanisms to leverage public and philanthopic funding in order to raise private capital for environmentally-beneficial projects.

Speaking on the panel was Stacy A. Swann, CEO and Partner, Climate Finance Advisors; Joan Larrea, CEO of Convergence; Virginie Fayolle, Senior Consultant and the Climate Finance Lead, Acclimatise; and Stephen A. Morel, Global Energy Contractor, (OPIC).

Emilie capped the day at Proadapt by providing a few key thoughts on how she and Four Twenty Seven see the demand for climate resilience work in the future, including how companies are looking to see how climate data can be used to identify new opportunities as markets change.

Why BlackRock is Worried About Climate Change

This article was first published on the Huffington Post.

Why BlackRock is Worried About Climate Change

Climate Change: A Material Risk for Investors

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?

Economic and Financial Impacts from Climate Change

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.

Regulatory Pressures

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.

Energy Transition 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

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.

What Can Investors Do to Reduce Climate Risk Exposure?

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.

New EU Directive Requires Pension Funds to Assess Climate-related Risks

EU FlagOn December 8th, 2016 the EU adopted a new regulation regarding Pension Funds, the IORP II Directive — the successor of the Institutions for Occupational Retirement Provision Directive adopted in 2003. The directive’s main objectives are to enhance pension funds’ governance, risk management and supervision, and to facilitate cross-border activities.

A key feature of the directive is the consideration of environmental, social and governance (ESG) factors as part of pension providers’ investment. In particular, pension providers are now required to carry out their own risk assessment, including climate change-related risks, as well as risks caused by the use of resources and regulatory changes.

Moreover, the Directive explicitly allows pension funds to take into account ESG factors in investment decision-making, within the ‘prudent person’ rule. This comes as an important clarification as fiduciary duty is often cited by investors as a reason they cannot pay more attention to ESG issues in investment processes.

The implementation of the Directive

IORP II applies to all the 14,358 registered EU pension funds, among which 160 have cross-border activities.

Member States (EU countries) have until January 13, 2019 to transpose IORP II into their national law, which was published early January in the Official Journal of the European Union. According to current projections, the implementation deadline should therefore fall before Brexit, an important fact considering that the UK accounts for 50 percent of the EU occupational pension fund sector, followed by the Netherlands (33 percent).

A new risk assessment covering climate-related physical risks

The risk assessment is to be carried out every three years or after any significant change in the risk profile of the pension funds “in a manner that is proportionate to their size and internal organization, as well as to the size, nature, scale and complexity of their activities”.

The assessment must cover “new or emerging” risks, “including risks related to climate change, use of resources and the environment, social risks and risks related to the depreciation of assets due to regulatory change”.

The Directive’s preamble invites EU member states to use the Principles for Responsible Investment (PRI) as a reference for ESG and climate change-related reporting requirements and states that “the relevance and materiality of environmental, social and governance factors to a scheme’s investments and how they are taken into account should be part of the information provided by the scheme under this directive”.

While physical impacts of climate change are not mentioned in these terms, the inclusion of risks related to climate change, use of resources and social risks clearly point to the inclusion of physical impacts, in addition to regulatory and energy transition risks. National transpositions might provide more explicit guidance.

Beyond compliance considerations, pension funds are particularly exposed to climate risks given their long-term investment profile. The longer an asset manager’s time horizon, the more climate-related risks increase. As pension funds also tend to be particularly risk-averse, taking into account climate-related risks is crucial for effective risk mitigation. In 2015, the Economist Intelligence Unit valued the average expected loss as a result of climate change across scenarios as $4.2tn in financial assets.

Considering that EU pension funds now manage more than €2.5 trillion ($2.65 trillion) in combined assets, the assessment of physical climate risks will require considerable effort to access raw climate data at asset level, select appropriate indicators, and interpret the output.

Climate-related regulatory efforts gaining momentum

The adoption of this new climate risks mandatory disclosure at EU-level follows the adoption of an pioneering climate risk reporting law for asset managers and asset owners in France, discussed in a previous post, and occurs almost concomitantly with the release of the Task Force on Climate-related Financial Disclosures (TCFD) Phase II Report discussed  in a policy brief and a webinar.

European central banks and financial regulators are increasingly aware of the threat to financial stability of sudden market adjustments caused by climate-related risks. The concern is that the scale of impacts would pose a systemic risk to the financial system as a whole. A growing number of public institutions are paying attention to this issue including De Nederlandsche Bank; the Bank of England; Finansinspektionen; the SEC and the ESRB.


Four Twenty Seven helps investorsFortune 500 companies and government institutions understand how to quantify and monetize climate change impacts on operations as well as social factors that affect their value chain. 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.

 


You can find the full text here and the impact assessment made by the European Commission here

A handbook by Lane, Clark & Peacock on the IORP II

 

TCFD Key Recommendations for Climate Risk Disclosure

The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) is an industry-led task-force established at the December 2015 G20 summit for improving voluntary financial disclosure of climate-related risks. Eight months after the release of its Phase I report (discussed  in a policy brief), the TCFD published a comprehensive set of recommendations on December 14 in its Phase II report. The recommendations provide detailed guidance for companies on how and what to integrate in their financial climate risk disclosure. These recommendations are categorized into four different components: Governance, Strategy, Risk management, and Metrics.

Core Elements of Recommended Climate Risk Disclosures

Governance

The first set of recommendations relates to the organization’s governance for addressing climate-related risks and opportunities.

At the board-level, TCFD report recommends disclosing how and how often is the board informed about climate-related issues, whether it integrates them when reviewing, guiding, monitoring the organization’s activities, and how it oversees progress against goals and targets for addressing those issues.

At the management-level, the TCFD suggests disclosing whether the organization has assigned climate-related responsibilities to management-level positions, what those responsibilities entail and how they are reported to the board. Just as for board-level, the report also invites organizations to describe processes by which management is informed about climate-related issues and how it monitors them.

Strategy

The second set of recommendations covers how climate-related issues may affect an organization’s businesses, strategy, and financial planning over the short, medium, and long term.

TCFD recommends organizations state what they consider to be the relevant short-, medium-, and long-term horizons, according to the nature of their assets / infrastructure, then identify the specific climate-related issues that could have a material financial impact on the organization for each time horizon and by distinguishing between physical and transition risks. According to the report, the risks and opportunities should be assessed by sector and geography when appropriate, and the methodology used should also be described along with the assessment.

Based on the above recommended disclosure, TCFD suggests disclosing as a first step how identified climate-related issues have already impacted the organization’s:

  • businesses, strategy and financial planning
  • products and services
  • supply chain and/or value chain
  • adaptation and mitigation activities
  • investment in R&D
  • operations, by types and location

As a second step, the report recommends assessing how the organization’s strategy is likely to perform under various climate-related scenarios and how what actions are subsequently taken to mitigate risks and take advantage of opportunities.

Risk management, metrics and targets

The last sets of recommendations relate to how the organization identifies, assesses, and manages climate-related risks, including the metrics and targets used.

The TCFD suggests disclosing the processes implemented within the organization for assessing the potential size and scope of identified climate-related risks, for managing those risks (be it through mitigation, transfer, acceptance or control) and for prioritizing them. More specifically, the organization should explain how materiality determinations are made.

According to the TCFD, organizations should consider providing the key metrics used to measure and manage those risks, especially metrics associated with water, energy, land use, and waste management where relevant, as well as the organization’s internal carbon prices. All metrics should be provided for historical periods to allow for trend analysis, along with a description of the methodologies used to calculate them.

Moreover, the TCFD recommends setting climate-related internal targets, such as those related to GHG emissions, water usage, energy usage, etc., but also efficiency goals, financial loss tolerances, or net revenue goals for products and services designed for a low-carbon economy. Targets description should detail whether the target is absolute or intensity based, time frames, key performance indicators and methodology used to assess progress against targets.

Examples of climate-related risks and their potential financial impacts

The report provides examples of physical and transition risks, along with their potential impacts on the organization’s finance.

Examples of climate-related risks and their potential financial impacts

The main challenge ahead: Identifying risk at asset-level

The process of scanning assets for physical climate risk exposure will require considerable effort and challenges, from accessing raw climate data at asset-level, to selecting appropriate indicators and time frame, and interpreting the output while accounting for climate data’s unique complexity and sources of uncertainties.

To support corporations and investors looking to identify hotspots and quantify value at risk in their portfolio of assets, facilities or across their supply chain, Four Twenty Seven has developed a suite of enterprise applications that provide rapid, cost-effective screening across portfolios of 10,000+ assets.

Learn more about CREST, our Climate Resilience Support Tool for corporate climate risk management, and our climate data analytics services for financial institutions.

Art. 173: France’s Groundbreaking Climate Risk Reporting Law

National Assembly, Paris, FranceIn the fall 2015, in the run up to COP21, 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 now famous Article 173.

The reporting obligations set out under Article 173 and its implementing decree have potentially far-reaching implications, requiring institutional investors to report on the integration of both physical risks and ‘transition’ risks caused by climate change on their activities and assets.

Whom Does Article 173 Apply To?

Article 173 addresses publicly traded companies, banks and credit providers, asset managers and institutional investors, the latter being listed as insurers, pension or mutual funds and sovereign wealth funds, with differentiated reporting obligations depending on their size and nature.

The law applies to French companies, meaning that French subsidiaries of large financial groups are potentially subject to requirements that do not apply to their parent companies.

What Must the Climate Change-Related Reporting Include?

A comply or explain approach

The law provides investors with broad flexibility in choosing the best way to fulfil the objectives, based on a comply or explain approach. It does not impose any specific method, giving leeway to find the reporting methodology suiting best the investment portfolio, for example reflecting specific asset classes or subsidiaries. However, investors must provide information and justification on the methodology used. They are encouraged to draw from current best practices. An assessment of the implementation will be carried out after two years, at the end of 2018, and the best-in-class approaches will be promoted.

Differentiated requirements

Banks and credit providers will be subject to regular stress tests including a climate change component.

Publicly traded companies’ annual reports must disclose the financial risks related to the effects of climate change, the measures adopted by the company to reduce them and the environmental impact of the company’s activities and of the use of goods and services it produces.

Asset managers managing funds below 500 M€ and institutional investors with balance sheets below 500 M€ must report on the implementation of their ESG policies.

Asset managers managing funds above 500 M€ and institutional investors with balance sheets above 500 M€ are subject to extended climate change-related reporting obligations (besides their ESG policies). Those obligations are two-fold:

  1. Assessment of the portfolio’s exposure to climate change-related risks, including both physical risks (physical impact of climate change) and transition risks (impact of the transition to a low-carbon economy).
  2. Assessment of the investor’s contribution to meeting the international and national low-carbon goals, including the low-carbon targets set by the the investor itself and the actions taken to achieve these targets.

While Asset management companies have to report separately on each of the above 500 M€ funds they manage, institutional investors must provide a consolidated reporting on their assets.

Note that institutional investors may have a commercial relationship with asset management companies via dedicated funds and/or management mandates. Therefore, asset management companies may be directly or indirectly affected by Article 173, via their institutional investor clients. The terms and conditions of access to ESG information required by institutional clients to meet their own Article 173 reporting obligations are to be defined in the contractual relations between them and the asset management companies involved.

Though investors are free to choose which exact data to report, the implementing decree suggests including the following information:

  • The consequences of climate change and extreme weather events on the assets
  • Changes in the availability and price of natural resources
  • Policy risks related to the implementation of national and international climate targets
  • Measures of past, current or future emissions of GHG (both direct and indirect)

As mentioned above, all assessments must come with an explanation and justification of the methodology used.

As of now, 60 institutional investors are subject to the latter reporting requirements.

The Assessment of Climate Change-Related Physical Risks

What really makes Article 173 groundbreaking is the reporting obligation on climate change-related physical risks. The inclusion of physical impacts of climate change in a financial risk analysis is in line with the industry-led Task Force on Climate-related Financial Disclosures (TCFD) recommendations report, released on December 2016 and discussed in a policy brief and a webinar.

While traditional climate-related reporting focuses mainly (if not exclusively) on the impact of the organization’s activities on climate change, the French Energy Transition Law is truly pioneering as it also emphasizes the impact of climate change on the organization’s activities and assets. This new focus meets the demand of investors for enhancing financial risks assessment through taking better account of climate-related risks.

A Ripple Effect

The French government is hoping for a ripple effect, both internationally and on a national level, across the investment value chain. The service providers of eligible investors are already considering how to enhance their ESG and climate reporting practices in order to meet their clients’ demands and comply with the law.

Moreover, climate-related regulatory efforts are gaining momentum. Article 173 is expected to be the first of a series of national equivalent regulatory frameworks among the G20 countries. The TCFD was established shortly after the Law passed, at the December 2015 G20 summit, and explicitly offers its guidance for compliance with Art. 173.

In March 2016, the Dutch central bank DNB announced it was taking steps to monitor and mitigate climate risk. Last November, the European Union has issued a directive requiring all EU-based pension funds to assess for climate change risk.


Four Twenty Seven helps investorsFortune 500 companies and government institutions understand how to quantify and monetize climate change impacts on operations as well as social factors that affect their value chain. 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.


Documents
A handbook on Article 173 published by the French SIF

By Delphine Ly, Climate Analyst at Four Twenty Seven

Audio Blog: Private Sector Perspectives on Climate Resilience

The Inter-American Development Bank in partnership with Four Twenty Seven and the Global Adaptation and Resilience Investment (GARI) Working Group held a panel discussion, “Private Sector Perspectives on Climate Resilience”, on Monday, November 14th in Marrakesh, Morrocco as a side event to the proceedings at COP22. You can listen to a recording of the full discussion here.

 

Bringing together thought leaders from the private sector and international financial institutions, the panel examined challenges and opportunities facing private actors in the arena of climate resilience. The panelists provided insights into the latest developments in technology, finance and the entrepreneur community on how the private sector can turn climate risks into opportunities and contribute to greater social and economic resilience.

From left to right: James McMahon, Emilie Mazzacurati, Amal-Lee Amin, Jay Koh, Mari Yoshitaka discuss climate resilience

Panelists

  • Amal-Lee Amin, Chief Climate Change and Sustainability Division, IDB
  • Emilie Mazzacurati, Founder and CEO, Four Twenty Seven
  • Jay Koh, Founder & Chair, Global Adaptation & Resilience Investment Working Group (GARI)
  • James McMahon, CEO, The Collider
  • Mari Yoshitaka, Chief Consultant of Clean Energy Finance Division, Mitsubishi UFJ Morgan Stanley Securities

What Brexit Means for Climate

Reposted from The Huffington Post, The Blog, view it on HuffPo HERE.

Image courtesy: Free Range Stock, photographer Daniel J Schreiber “London Landscape"

BOTTOM LINE

  • In the short run, Brexit means, at the very least, delays and complications in the process towards the ratification of the Paris Accord.
  • The financial volatility caused by the referendum’s outcome could distract the worlds’ financial regulators and have a negative impact on current efforts to better regulate climate-related financial disclosures.
  • Looking ahead, the incoming Eurosceptic government in the UK is unlikely to make climate change its priority, depriving global climate negotiations from a leader and political engine towards more ambitious GHG cuts.
  • In a worst case scenario, a full-blown global economic crisis would set back investments in clean energy, cut budget for both mitigation and adaptation efforts, and fuel further discontent from the middle-class and the unemployed.
  • Over the long run, a possible “contagion” effect enabling populist victories in upcoming elections in the US, Spain, France or Germany over the next 12 months could further hamper the enactment of effective global climate policy.

ANALYSIS

Political Implications: Impact on the Paris Accord

The only certainty regarding the impact of Brexit on climate policy comes from the extensive political uncertainty and financial volatility the referendum outcome has triggered. As the political debate turns towards the process for the UK to exit from the EU and deepening internal tensions between the UK and the “pro remain” constituents within Scotland and Northern Ireland, this uncertainty will at a minimum cause a temporary slowdown of the ratification process of the Paris Accord.

The ratification process was already expected to be long and complex for the EU. Each country has to approve the ratification domestically before the EU as a whole ratifies the accord. In the context of such a lengthy process, we think it is highly unlikely the lame-duck Cameron government would stick its neck out and push for a rapid ratification of the accord in the next three months, before its scheduled October departure. It is unclear how the UK will affect the EU ratification process during the two years preceding Britain’s formal exit from the EU.

This leaves the next government in charge of a possible ratification. Leading candidate for British Prime Minister, Boris Johnson, and the UK Independence Party leader Nigel Farage, who are credited with driving the success of the Leave vote, both do not believe in or prioritize climate change, casting a shadow of uncertainty over whether the UK might actually ratify the Paris accord at all.

However, the Paris Accord requires the ratification from 55 countries representing 55 percent of global emissions to come into forces. A refusal from the UK to ratify would send a negative signal but a single country representing 2 percent of global emissions would not bring the global process to an end. While the UK has historically been a driving force in global and EU climate negotiations, we expect the new UK government will at best be a follower, at worst a laggard and opposing force in global climate policy.

Beyond Britain: The Rise of Populism

While the direct political implications of the referendum on UK climate policy are quite predictable, we cannot rule out a potential ripple effect on the willingness from other countries to ratify the Paris accord. More generally, the UK vote signals that current populist trends in the world’s largest economies – U.S., France, Germany in particular – could bring a deep reshuffling of cards for climate policy. Populists parties are typically lukewarm, if not outright opposed to climate policy and global agreements, as illustrated by the so-called Trump Trajectory in the U.S.

A rise in climate-sceptic governments could bring to a halt the progress brought about by the Paris accord and set us back toward a high carbon emission pathway. At this point in time, however, we believe most governments have a robust understanding of the seriousness of the issue of climate change, and will do their best to proceed with the accord ratification and with meeting their targets.

Financial Implications: Impact on Efforts to Regulate and Price Climate Risk

A very immediate impact from Brexit-induced financial volatility and risk of recession will be felt on efforts to better understand, regulate and price climate-related risks on financial markets. The very institutions and individuals that have been leading this effort globally – the Financial Stability Board and its Chair, Mark Carney, who is also the Chair of the Bank of England, as well as to some extent the Securities and Exchange Commission in the U.S., are going to be entirely focused on preventing a complete collapse of the British economy and a global recession. This will necessarily cause distraction away from the recent efforts to push climate change higher on the agenda of financial decision-makers.

Assuming the world’s financial leaders are successful in preventing a global recession and the volatility of financial markets continues, we expect the discussion to resume and allow the recommendations from the Task Force on Financial Climate-Related Disclosure to garner the attention needed from global financial regulatory bodies.

However, if Britain’s decision to leave the EU were to cause continued turmoil on financial markets around the world, leading to a major recession, the impacts on climate change policy could be extensive, and mostly negative. Recessions in general are bad for the environment because jobs and financial volatility typically take precedence on the political agenda over environmental regulations and climate policy, often perceived as putting added burden on the economy. A global recession could lead to budget cuts and increased contention over energy and climate budgets, and otherwise lead to a scale back of efforts to reduce emissions.

Financial instability also means a setback for investments in clean energy, with financial flows likely to flock towards safe havens (U.S. bonds, gold) and away from riskier investments.  Expectations of trade financing faltering, credit spreads narrowing, emerging markets assets under serious stress and a worse-than-expected earnings season, impacting equity valuations all point to less money for adaptation in developing countries and a further slowdown in renewables investment levels.

Conclusion

The UK’s decision to leave the EU puts both financial markets and climate policy to the test. Financial markets were still slowly recovering from the second greatest recession in the history of modern markets, and this is where the main uncertainty stands at the time of writing. Short term volatility may bring distractions but unlikely to drive a meaningful change of course away from greater climate risk disclosures. If continued economic turmoil materialized, it could slow down investments in clean energy and put climate and environmental issues on the back burner once again.

By Emilie Mazzacurati and Camille LeBlanc

Image courtesy: Free Range Stock, photographer Daniel J Schreiber “London Landscape”

 

Redefining Climate Risk

Comment Letter from Four Twenty Seven to Task Force on Climate-Related Financial Disclosures. (Download full letter here)

May 23, 2016

Dear Chairman Bloomberg,

Four Twenty Seven, Inc., a climate resilience research and advisory firm, is pleased to submit this letter of comment for your consideration and to help inform the work of the Task Force on Climate-Related Risk Disclosures (TCFD) during Phase II.

We commend you for the important work undertaken by the TCFD and your deliberate efforts to engage practitioners and stakeholders in providing input along the way. Providing guidance around climate risk disclosures is a critical step not only to help ensure financial markets will not be blindsided by predictable risks, but also to ensure that investors send the appropriate price signals to the decision-makers for the underlying assets – from corporate boards to public officials and real estate owners — thus providing an incentive to better prepare for and adapt to the physical impacts of climate change.

Our comments stem from years of working closely with Fortune 500 corporations to help them understand climate change impacts, quantify risk and monetize costs. We anticipate this type of analysis will need to become widespread for corporations to comply with the forthcoming guidance from the TCFD, and wanted to share our lessons learned from our past work.

Our comments, detailed below following the questionnaire structure, center around two key takeaways:

  1. The need to redefine climate risk to better account for direct and indirect risks related to the physical impacts of climate change. Regulatory, technology or transition risks are by no means confined to greenhouse gases, and focusing a disclosure framework only on extreme weather events and direct physical impacts would be deeply misguided. It is critical that corporations understand, address and disclosure their exposure to risks and opportunities related to transition risk due to:
  • Regulatory changes driven by climate change (e.g. changes in underground water regulation, permitting, zoning, etc.);
  • Costs and revenues associated with finding and deploying adaptive technologies to improve corporate resilience, mitigate risk exposure and promote more efficient resources use;
  • Costs associated with capital expenditure, retrofitting or moving facilities, infrastructure and other critical assets out of harm’s way.
  • Costs and revenues associated with increasing the company’s adaptive capacity, ranging from increased legal and insurance costs to investments in human capital, supply chain risk management, engagement with local governments to support climate adaptation efforts, and other public-private partnerships.
  • Macro-economic and financial risk for property owners, market risks for certain products, etc.

 

  1. The need to incorporate climate data into decision-making processes and provide vulnerability assessments at the asset-level for both corporations and investors.
  • Corporations need to utilize fully the wealth of climate data and projections that are available, and leverage sophisticated techniques and models to incorporate uncertainty into their decision processes.
  • Climate risk analysis must be performed at the asset-level, even if the final disclosures do not include all the asset-level data, and should rely on common standards, assumptions and scenarios to enable comparison across assets and across markets.
  • Risk assessments should be subject to third-party verification to ensure they are complete and cover all the material risks.

Download Four Twenty Seven’s Comment Letter (FourTwentySeven_PhaseI_CommentLetter) for our detailed analysis on climate risk reporting.

Policy Brief: The Evolving Regulatory Landscape of Financial Climate Risk Disclosure

This Four Twenty Seven Policy Brief provides a summary of key findings from the Task Force of Climate-Related Financial Disclosures Phase I Report and highlights issues of interest to reporters and users of financial disclosures within corporations from the financial and non-financial sector.

What is the Task Force on Climate-Related Financial Disclosures?

In December 2015, the Financial Stability Board created a Task Force on Climate-Related Financial Disclosures (TCFD). The industry-led Task Force, chaired by Michael Bloomberg, is mandated to make recommendations for improving voluntary financial disclosure of climate-related risks. This coordinated international effort comes after investor advocacy organizations, like Ceres, have called attention to the poor quality of climate risk disclosures in financial filings (10-K management disclosures) and the lack of enthusiasm from the Securities and Exchange Commission in enforcing its 2010 guidance on climate change disclosure.

The Task Force released its Phase I report on April 1st. The report provides a high-level review of the existing landscape of climate-related disclosures, establishes fundamental principles for effective disclosures, and defines the scope and objective of the Task Force’s work through 2016. The report comes on the heels of an SEC ruling that ExxonMobil must include a climate change resolution on its annual shareholder proxy at the request of shareholders including the NY State Pension Fund.

Why is this Important?

The ultimate goal of the TCFD is to enable financial market participants to incorporate considerations on climate risks and opportunities into investment, credit and insurance-underwriting decisions, as well as to increase investor engagement with boards and management with respect to corporate climate risk management. This portends momentous change for the most exposed sectors. Over time we believe that the impact of the report has the potential to mainstream climate risk analysis and disclosure reporting requirements across all financial asset classes – equity, commodities, real estate, bonds – and will force a focus on climate resilience for all underlying assets – corporations, energy, agriculture, real estate, cities, and more.

Improved financial disclosures on climate-related risk will enable more informed decision-making within the financial markets and yield positive impacts for the economy. A higher standard on financial disclosures will also enable “appropriate pricing and distribution of risks throughout markets” and reduce financial instability by lowering the risk of an abrupt change in asset values (“transition” risk).

Just as the ultimate goal of the FSB and the G20 is to avoid another major financial crisis, In our view, the Task Force embodies the best climate change financial policy architecture that will promote market efficiency in a context of scientific uncertainty and information asymmetry. While the Task Force recommendations will not be binding, they come at a time when market authorities and financial regulators are looking to gain a greater understanding of climate change impacts on financial markets, and the Task Force recommendations will constitute a critical reference point for consensus on climate risk disclosures, and facilitate international standardization of requirements.

The Current Landscape of Climate Risk Financial Disclosure

The Task Force report finds that current climate risk financial disclosures are fragmented and incomplete, with a lack of agreement on what constitutes materiality. Most disclosures consist of boilerplate language that does not provide decision support or even useful information to investors. They also fail to acknowledge an organization’s specific risk profile and exposure to climate risk. Finally, most disclosures pertain to climate information in general and not to climate-related financial information.

The TCFD report highlights in particular the lack of comparability across disclosures due to ad hoc reporting practices, which prevents analysis of possible systemic risk in financial institutions’ portfolios and in financial markets at large. These findings are consistent with previous reports from Ceres and from the Sustainability Accounting Standard Board (SASB), as noted in their Technical Bulletin on Climate Risk from January 2016.

Proposed Principles for Effective Disclosures

The Task Force lays out seven fundamental principles for effective disclosures:

  1. Present relevant information.
  2. Be specific and complete.
  3. Be clear, balanced, and understandable.
  4. Be consistent over time.
  5. Be comparable among companies within a sector, industry, or portfolio.
  6. Be reliable, verifiable, and objective.
  7. Be provided on a timely basis.

While these principles are fully aligned with general principles of financial disclosures and with previously established climate disclosure framework, notably from the Climate Disclosure Standard Board, they raise a number of practical challenges when applied to climate risk disclosure. Climate science continues to evolve, as does global climate policy, making it difficult to be “consistent” over time. Climate impacts touch businesses and the economy well beyond the walls of any given corporation, but accounting for these indirect risks in a “specific and complete” manner is extremely challenging. An accepted methodology to measure and quantify climate risk will go a long way towards ensuring that disclosures meet these principles, and that the information is “comparable among companies.”

Looking Ahead: Phase II Scope of Work

The Task Force will seek to establish guidance as to what needs to be reported, in what format, and for what purpose.

Climate-Related Risks and Opportunities

The first challenge the TCFD will take on is defining what qualifies as climate-related risks and opportunities. In the framework outlined in the Phase I report, the TCFD echoes the common dichotomy between “physical risks” (e.g. extreme weather events) and carbon-related “non-physical” risks (e.g. carbon regulations, cost of low-carbon technology, asset liability, etc.). In our view, this framework is bound to evolve to better account for the breadth of regulatory, technological, market/economy, and reputational impacts directly related to climate risks and opportunities, including for example: changes in zoning laws, cost of adaptive technologies, changes in commodity pricing, etc.

Governance

Second, the Task Force will ensure climate-related risks and opportunities are considered in the broader context of the reporting entity’s strategic management. The Task Force will encourage disclosures pertaining to the governance process, specifically how boards and executive leadership consider and approach climate risks and opportunities.

Entities: Preparers and Users

Third, the Task Force will develop recommendations for reporting by non-financial companies – mainly publicly-traded corporations – as well as by financial intermediaries, investors, and asset managers that may be exposed to climate change in their portfolio. While recommendations will likely focus on companies above a certain size, they may also apply to privately-held corporations. In the financial sector, the Task Force intends to emphasize risks associated with underlying loans and investments in companies, and possibly into real estate investments as well.

The Task Force is also interested in better understanding how the climate-related disclosures will be used and by whom. The objective is that disclosures be provided in a format such that users across the entire financial value chain can integrate climate risk metrics into existing risk assessment, portfolio analysis, asset allocation, and other financial decision-making processes.

Information to be disclosed

Finally, the Task Force will give particular attention to the information being disclosed. This information may include both quantitative and qualitative disclosures, providing “consistent and comparable data and metrics” to be aggregated across portfolio.Screen Shot 2016-04-04 at 12.01.32 PM

For quantitative metrics, an established accounting system exists for carbon accounting, but no such common methodology is available for physical and indirect impacts of climate change, especially not across a broad range of sectors and asset classes. The Task Force will need to balance the conflicting needs between finding a lowest common denominator metric that can be used across sectors, and disclosing data and metrics that provide relevant insights into sector-specific risks. The Task Force may encourage greater use of scenario and sensitivity analysis to support forward-looking assessments of risks and opportunities.

For qualitative disclosure, the Task Force will consider governance, transition strategies, priorities, and processes. This indicates that companies with a vision and plan for greater climate resilience, together with well-supported Key Performance Indicators showing progress towards established resilience milestones, will be better positioned to protect shareholder value.

Next Steps

The Task Force will be working on Phase II elements through the end of 2016 and will deliver its recommendations to the FSB in December 2016, with a finalized report expected in February 2017. The Task Force intends to integrate and leverage stakeholder input throughout the process and is currently inviting feedback through May 1st in the form of a detailed questionnaire on its website. The questionnaire solicits structured feedback on reporters’ and users’ needs, scope and definition of climate risks and best practices.

The regulatory landscape of climate risk disclosure is evolving rapidly. Corporations and investors will be well advised to stay current on legal and policy changes related to climate change risks, and to deepen their understanding of climate change science and its impacts on their business. While climate change presents a wide array of direct and indirect impacts, many of these impacts can be forecasted and managed. Businesses able to take in new knowledge on climate change will be able to stay ahead of the curve, manage regulator and investor expectations, protect their value, and capitalize on opportunities.

Learn more about how we are helping corporations adapt to their climate risk.

Reference Documents

TCFD Phase I Report

SEC Commission Guidance Regarding Disclosure Related to Climate Change

Ceres Cool Response Report

SASB Technical Bulleting 2016-01