Climate risk – A new normal

The past two full years – 2017 and 2018 – were the most costly back-to-back years on record for weather-related disasters say insurance companies, with economic losses exceeding $650 billion. Moreover, 2018 was the fourth costliest year on record for weather-related events, even though there were no events on the scale of hurricanes Katrina in 2005, and Harvey, Irma and Maria in 2017.

Experts believe 2018 represents a ‘new normal’, when a large number of relatively small natural disasters added up to substantial losses. 

Trying to ascertain how many of these events are the result of global climate change, and how many would have happened regardless, is extremely challenging, but historical data can certainly be applied to show that the frequency of severe weather events has increased in recent years.   

Investment firm Schroders estimates global economic losses from climate change could reach $23 trillion per year in the long term if action isn’t taken. That’s almost four times the impact of the 2008 financial crisis.

But for individual firms, trying to quantify the risk of physical climate change on their assets, infrastructure, businesses and supply chains is no easy feat. While many firms are used to managing weather risk on an annual or seasonal basis, managing the long-term, ever-increasing effects of climate change requires a very different approach. It is something many firms are grappling with now, not least because shareholders and investors require greater transparency on it.

This report explores how corporates – and the banks that invest and lend to them – are approaching this new discipline. It also examines developments in disclosure – particularly those stemming from the guidelines of the Task Force on Climate-related Financial Disclosures.

However, climate risk is not just about the economic losses caused by severe weather events, rising sea levels and higher temperatures. It is also about trying to understand how the transition to a low-carbon economy might affect businesses. Firms involved in the production of fossil fuels will be particularly affected by policy efforts to reduce carbon emissions and curb demand for the highest-polluting fuels.   

Several banks have already started to model transition risk in their investment and lending portfolios although, again, this is a discipline in its infancy (see page 12).

While there are many different approaches to modelling this risk, most agree that the long time horizon and the sheer number of variables and possibilities mean that a scenario approach makes most sense. 

There is also widespread agreement that assessing and managing climate risk will require the co-operation of enterprise risk and business risk managers, but it will also require them to work alongside environmental and social responsibility teams. While climate risk is identified as a top risk at many firms now, it needs to move beyond the level of public relations and ethics to a quantifiable business risk that can be communicated in a transparent and standardised way.  

We hope this report provides invaluable information to companies as they embark on this journey. As ratings agency Standard & Poor’s noted at last year’s UN Climate Change Conference: “Climate change has already started to alter the functioning of our world.”

 

Climate risk – Special report 2019
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