As the United Nations Climate Change Conference (COP26) convenes, the financial dimensions of this century’s most fundamental issue are coming into focus. The need to incorporate climate risk into financial decision-making and commercial strategy, as well as disclosing on these in a complete and transparent manner, is emerging as a central challenge for businesses the world over. A new kind of thinking is called for: one that can accurately frame the financials of climate risk and provide robust evidence bases to investors, employers, customers and supply partners, as well as to governments and regulators.
Financial impact and risk associated with climate change will be a fundamental part of the debate at COP26. Regardless of whether the Paris Agreement goal of limiting global average temperature rise to no more than 1.5°C above pre-industrial levels is met, climate change is here, and has the potential to disrupt every segment of the global economy. With the world already experiencing extreme impacts, climate risk has moved decisively from being an outlying concern to a crucial planning issue for business, with regard to both adaptation and the need to meet emissions reductions commitments.
Curbing carbon emissions and limiting global temperature rise will cost trillions in private finance, but the benefits will dramatically outweigh the initial costs. With some effects of climate change already irreversible, adapting and building resilience is crucial. “Every financial decision needs to take climate into account,” the COP26 goals emphasize.
In response, we are seeing fundamental shifts in financial markets, with increased investor attention and the emergence of investor-led climate change reporting standards and legislation aimed at protecting and improving the stability of the global economy. In line with this, there is also an urgent need for effective assessment and disclosure of climate-specific risks, enabling businesses to properly factor them into decision-making as well as disclosing their progress.
Integrating climate risks into traditional business risk approaches demands a new kind of analytics. Many of the risks are long-term, uncertain, changing and difficult to quantify compared with other components of commercial risk management. There is a need for companies and their auditors to become fluent in this emerging risk landscape. Some are aware of the new and potentially decisive risk dimension associated with climate change, but have yet to codify it in disclosures or in corporate strategies. However, responding to this challenge means businesses are able to plan, adapt, and transition towards a net zero economy, while providing investors and insurers with greater clarity and therefore confidence, in their long term viability.
The 2021 report by the Intergovernmental Panel on Climate Change (IPCC) has shown that inaction isn’t an option. With global temperature rises on course to far outstrip the main Paris Agreement target, climate change is already affecting every region on earth, evident in the increased frequency and severity of extreme weather events. In the face of this unique challenge, failure to take steps to ensure resilience will likely present a future liability.
We at AECOM advocate a three-tiered approach: ensuring that the outcomes of climate risk assessment are reflected in strategic thinking across all aspects of an organization; identifying and embracing the competitive opportunities that, for many businesses, this change in strategy can offer; and achieving accurate and meaningful climate assessment, monitoring and disclosure.
A proactive investment stance
There is an opportunity to demonstrate proactive thinking and efforts to a world which increasingly values real climate action. The Pew Research Centre has been tracking attitudes to climate change since 2013, and the latest surveys indicate a huge growth worldwide in the view that climate change is a major threat. A study released in September spanning 17 advanced economies found that overall 72 percent of citizens were concerned that climate change would harm them personally, with significant upward trends in almost all countries surveyed. This deep shift in public sentiment parallels the changes we have noted in investor priorities, and makes a powerful case for climate proactivity as a competitive advantage.
There is no doubt that this decade is the one for accelerated climate response and action. The world’s largest economies, including the U.S. and China, as well as the European Union, have set carbon reduction targets for 2030, targets that are increasingly being incorporated into the investment mandates of asset managers. Every demonstrable climate-positive action that companies take reduces the cost of capital and future financial risk.
Applying emerging standards to disclose climate risk
Demand from investors increasingly requires companies to account on reporting and forecasting climate-related risks that lie outside traditional risk analysis. Of the available climate reporting guidelines and initiatives to enhance disclosure and mitigation of climate-related financial risk, the Task Force on Climate-Related Financial Disclosures (TCFD), created by the G20’s Financial Stability Board in 2015, has risen to the fore as a go-to framework for financial climate risk, becoming part of the regulatory framework in several countries, including the EU.
The TCFD offers extensive guidance on recommended disclosures in the areas of governance, strategy, risk management, metrics and targets, as well as principles for effective disclosure and advice on assessing resilience across a range of scenarios. While businesses can use such guidelines to understand the kind of things they need to report, deciding what is material and how to accomplish meaningful climate risk disclosure remain big challenges for individual organizations. However, this is where the real value lies.
Our team at AECOM supported Tate & Lyle PLC, a global provider of ingredients and solutions for the food, beverage and industrial markets, to align its climate-related disclosures to the TCFD recommendations and to effectively disclose climate-related risks and opportunities through the company’s annual reporting processes. We conducted a gap analysis of Tate & Lyle’s corporate disclosures across the four TCFD thematic areas (governance, strategy, risk management and metrics and targets) to assess how well-aligned existing indicators were. Key stakeholders within Tate & Lyle, working in areas such as enterprise risk management, investor relations, sustainability programs and reporting, procurement, commercial and manufacturing, were interviewed to understand current processes and procedures across all aspects of the organization.
Part of the process was also undertaking a climate-change risk assessment for Tate & Lyle, considering the physical and transition risks and opportunities associated with its operations, as well as for key suppliers and markets. A review of climate-change projections and trends, relevant policy, legislation and industry progress informed the assessment. Workshops were conducted with key personnel from a range of functions to build capacity and understanding of these issues and explore the extent to which some of these may have already been experienced. A key outcome was to help Tate & Lyle to better integrate climate risks and opportunities into its current enterprise-wide risk management framework. We formed a road map and action plan for improved alignment to TCFD with the recommended next steps and suggested timelines for Tate & Lyle.
“The TCFDs are important to help businesses like Tate & Lyle improve their understanding of long-term climate-related risks and opportunities. But to take meaningful action, we needed to start with a better understanding of what matters most,” said Rowan Adams, Executive Vice President of Corporate Affairs. “With the support of AECOM, we have not only developed a road map and action plan for improved alignment to TCFD, but also engaged our organization in finding new and innovative solutions to the climate-related challenges we face.”
Understandably, many organizations have not yet met these challenges. The TCFD says that corporate disclosure of climate-related financial impacts remains low, despite a policy statement from the International Accounting Standards Board that climate risks should be treated as material financial risks, and moves by some governments to legislate reporting requirements. Investor-led groups such as the Principles for Responsible Investment initiative have responded enthusiastically to the emergence of new climate impact financial reporting guidelines, but the corporate response has not always matched this interest. A recent statement signed by 567 investors representing $46 trillion in assets urged governments to implement mandatory reporting requirements in line with TCFD recommendations to ensure disclosures that are “consistent, comparable and decision-useful.” In June this year, G7 finance ministers also called for greater coordination on mandatory disclosures, and there are signals that an international agreement may be forthcoming.
Embedding climate-related financial risks into strategic thinking
The slow uptake of analysing and reporting on climate-related financial risk underlines the difficulty of the task. A key challenge is that climate risks do not fit the template of other financial risks.
The TCFD touches on this when it says that climate risks are “non-diversifiable.” They are not amenable to conventional risk management, which works on the basis of risk isolation and mitigation on easily manageable timescales. At AECOM, we recognize that it is difficult to align climate risk with traditional risk measures, and that is why it is so important to bring an enhanced risk awareness into a company, building engagement and understanding from the board level down.
The time for this change is now. The world has already been through a period where companies have had to respond very fast to risk scenarios that were once thought highly unlikely. Yet the speed and flexibility of response that organizations have shown through the coronavirus pandemic have readied them to meet other extreme risks.
Our experience is that many companies have the ambition to innovate around climate action. There are clear competitive opportunities in products, processes and at a deeper level in becoming different kinds of businesses. The challenge is converting the ambition into action.
Meeting that challenge means understanding and quantifying climate-related financial risks, mitigating them, and harnessing opportunities. This will be the road for successful firms to 2030 and beyond.
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