When Mark Carney, in his role as chairman of the Financial Stability Board, spoke out on climate change the message was stark.
Climate change, we were informed, is considered as important a systemic risk as the failure of financial institutions. This duly resulted in the Task Force on Climate-related Financial Disclosures (TCFD), chaired by Michael Bloomberg. The appointment of such a significant figure was the catalyst for a collection of senior business figures to heed the call to action.
“Leadership on climate change has to come from the top.”
Yet despite the near-universal acceptance that the effects of climate change are already upon us, there are questions about how comprehensive the C-suite’s response has been. And without strategic leadership from the top, there is an argument that a lack of coordinated action could undermine the outlook for global business.
‘Leadership on climate change has to come from the top and we are seeing it in action,’ says John Scott, Head of Sustainability Risk for Zurich. ‘Unilever is one good example of a company that has made sustainability a core issue. The CEO, Paul Polman, has established its Sustainable Living Plan, which is more than a strategy: it’s their purpose as an organisation.’
‘The TCFD is a good framework for disclosure of climate change impacts on a business, but it’s not clear yet if all the current disclosures and strategic responses of companies are collectively enough to achieve the 2 degree goal of the COP 21 Paris Agreement”, says Scott. ‘Businesses have always had to change their strategies to respond to market conditions, but climate change is different in that the timescales of the most severe impacts are way beyond most strategic plans, in the order of decades. In these circumstances, scenario planning as recommended by the TCFD is an appropriate way to deal with such future uncertainty. The challenge is almost an ethical one to act now to prevent the “tragedy of the horizons” being borne by future generations.’
A tale of two scenarios
A new report published by Zurich, Managing the Impacts of Climate Change: Risk Management responses, posits two different climate change scenarios. In the first it assumes a failure to act on climate change, the second is at the other end of the spectrum: a 2°C compliant world, where measures are taken to make progress towards a low carbon economy, with the temperature rise from pre-industrial levels kept at or below 2°C by 2100.
While preparing for such diverse scenarios presents major organisational challenges, failure to do so is not a long-term option.
“Doing nothing is not an option.”
Andrew Voysey, Director of Sustainable Finance at the Cambridge Institute for Sustainability Leadership, insists that ‘All organizations need to carry out a scenario analysis in line with the TCFD findings. They need to ask themselves - how is my business model going to fare in a range of different scenarios?’
‘We have to accept that we face uncertainty and that the possible outcomes are really quite different. They give rise to different risks and opportunities but nothing is going to stay the same. So doing nothing is not an option.’
The first step for all businesses is to identify the broad business and strategic risks posed by climate change. Step two is to develop a granular view of the risks involved including, for example, individual locations. By using scenario and catastrophe modelling it is possible to determine the magnitude of risk and prioritize according to each company’s particular circumstances.
The final step, based on these findings, is to develop a mitigation strategy involving insurance and resilience. For those critical locations and regions defined as being at risk, a deterministic scenario-based loss estimate should be developed, based on detailed information regarding site vulnerabilities, both physical and organisational.
Once this has been completed there is the complex issue of disclosure. ‘Companies must identify how to disclose what their future may look like in different climate scenarios,’ argues Voysey. ‘That way the market can internalize that information, avoiding disruptive repricing moments in the financial market.’
A true understanding of the risks
Companies can mitigate against climate change risk employing a range of risk management tools and practices. A comprehensive assessment requires companies to look at the indirect effects of climate change. This includes risks connected to food and water shortages, deteriorating public health and the unreliability of infrastructure.
Carbon pricing should be considered as part of a company’s overall climate change strategy. In doing so, companies should also anticipate potential price increases over the coming years.
It is early days in terms of assessing how businesses will respond to the challenges of climate change. ‘Five years from now we will know a lot more about what is happening, especially regarding transition risks’ adds John Scott. ‘Ultimately, pricing of externalities, such as an adequate carbon pricing or removal of fossil fuel subsidies would help markets take decisions that drive low-carbon outcomes. However, in the current multipolar and multi conceptual world, it is difficult to see how globally harmonized policies on carbon emissions can be put in place in the face of trade wars and mercantilist attitudes.’
Hence the pressing need for the C-suite to step up and take the lead in untangling one of the most complex and urgent problems facing the world today.
Evolving the culture from the top
Amar Rahman, Principal Risk Engineer for Zurich, says: ‘One of the most common problems I encounter is the disparate awareness and perception of natural hazard risks in general and climate change issues in particular. For many people these risks are intangible.’
‘When embedded in the organization‘s risk culture, Total Risk Profiling (TRP) is a powerful management and communication tool,’ adds Rahman. ‘It supports all levels of the organization in achieving consistency in defining a common risk appetite across the organization and implementation of resilience measures.’
"For many people these risks are intangible."
It is certainly not all doom and gloom. With good leadership companies can take advantage of the opportunities presented by climate change. According to a 2017 report by the International Finance Corporation (IFC), addressing climate change could create a $23 trillion investment opportunity by 2030 in emerging markets alone. In more developed countries, renewable energy is creating jobs twice as fast as any other industry. Whichever way you look at it, the old adage is true: fail to prepare, prepare to fail.
- Through the TCFD, there is a clear blueprint for how to deal with the issue if physical climate risk
- Use scenario planning and catastrophe modelling to clearly define potential future risks
- Tackle disparate awareness and the perception that natural hazard risks are intangible, while integrating climate change into strategic decision making
- Build a carbon pricing policy, engaging stakeholders from top to bottom of the organization
- Establish a rigorous, practical disclosure model
- Businesses must take three critical steps:
- Step 1: Identify the broad business and strategic risks posed by climate change
- Step 2: Develop a granular view of the risks involved using scenario and catastrophe modelling
- Step 3: Establish a mitigation strategy involving insurance and resilience