Climate risk - the need for data

Climate & ESG

As has been well-trailed, nothing has had a bigger impact on the environment than the cumulative effect of burning coal, oil and gas over the past two centuries of industrialisation. We are already at 1.1 degrees of warming compared to pre-industrial levels and the chances of capping this at 1.5 degrees are fast receding. The financial effects of this are beginning to crystallise, while the social impact of climate change is also becoming increasingly stark.

Extreme weather events and rising sea levels are causing significant social impact for current and future generations – witness wildfires, flash flooding and other extreme weather events. Some parts of the world are becoming unliveable and people are being forced to migrate to more temperate places. Anxiety about climate risk, especially amongst younger people, is growing too. Climate change presents social challenges on a huge scale.

The governance impacts from climate risk are also significant. Company boards, mindful of their fiduciary and statutory environmental duties, are setting net zero goals and interim targets to cut their own carbon emissions and those generated by their supply chain. Those companies that have overstated their environmental, climate and net zero credentials face spiralling legal actions for greenwashing. Greenwash litigation is now hitting from multiple directions, including activist law firms, activist shareholders, advertising standards regulators and other regulatory bodies.

The importance of metrics

With heightened awareness of ESG and increased scrutiny of climate-related claims, ESG – a UN-originated concept developed almost 20 years ago – has been coming under attack lately from various quarters. This is largely due to a perceived lack of consistency as to how companies’ ESG credentials are measured and tracked. This is important because ESG ratings are used by investors, and trillions of dollars in global investment are involved. ESG investment is big business and the associated metrics used to measure it need to be comprehensive and accurate.

Here is what Tesla said recently in its impact report: “Current ESG evaluation methodologies are fundamentally flawed. To achieve acutely needed change, ESG needs to evolve to measure real-world impact. Individual investors – who entrust their money to ESG funds of large investment institutions – are perhaps unaware that their money can be used to buy shares of companies that make climate change worse, not better”.

As all risk managers know, if you cannot measure a risk, you cannot possibly manage it. Metrics and measurements are fundamental for boards and managers, without which boards cannot make informed, proportionate decisions about their ESG exposures. Metrics – especially ESG ratings – may be a temporary Achilles heel of ESG and the call
for better metrics and consistency – for ESG reform – is growing louder by the day.

Climate risk metrics

This brings us back to climate risk – the most fundamental of all ESG risks. The good news on climate is that we have metrics galore, both for past greenhouse gas emissions and for future climate impacts.

One of those metrics is the predicted physical impact of climate change on specific, individual UK land, homes and commercial properties, based on core data from respected organisations, including the UK Met Office and the British Geological Society.

This data states that the number of UK properties at risk over the next 30 to 50 years from climate change is significant, if not alarming, as the table indicates:

Corporates, lenders, landlords and homeowners need to forward model scenarios involving potential floods, subsidence and coastal erosion in order to be able to assess climate risk for any property or land assets they own. Without analysis of this data and an understanding of t he level of risk, we will see a rise in t he number of stranded assets where properties are impossible to mortgage or insure, or where investment yield is reduced for investor landlords.

Climate risk and lenders

Lenders have a critical role to play in all of this. It has been estimated that, if they fail to manage their climate risks, lenders will be exposed to £225bn in credit losses in the UK arising from climate change by 2050.

A step-change occurred in the UK’s climate risk market regulation when the Bank of England / Prudential Regulation Authority released its Supervisory Statement SS3/19 “Enhancing Banks’ and Insurers’ Approaches to Managing the Financial Risks from Climate Change” (April 2019).

This required banks to assess their portfolio climate risks in terms of physical risks (resulting from a changing climate) and transition risks (risks arising as the economy moves from a carbon-intensiveness to net-zero emissions, such as policy, legal, technology, reputational risks).

For a number of banks, climate risk has now become a principal or tier 1 risk – in line with credit, market, treasury & capital, operational and reputational risk, and most lenders have identified real estate and retail mortgage lending as elevated risk sectors – requiring the development and implementation of sector-specific policies and, over time, climate-related lending targets.

It is also important that climate warming scenarios and time periods are aligned to the Bank of England’s stress test of the balance sheets of leading banks and insurers, so as to ensure consistency of approach and accuracy of data analysis.

Identifying assets at risk

As we move forwards and climate risk data becomes more accessible, stakeholders working across the real estate industry will more easily be able to identify assets or locations at risk, leading to more efficient use of funds and more effective decision making.

The availability of property specific climate data, such as Groundsure’s ClimateIndex™ analysis, is therefore important for property owners to screen their individual property or their entire portfolio to enable forward climate scenario modelling for flood, subsidence and coastal erosion risks. The collection, management and provision of these metrics is helping the real estate market to assess the principal physical risks arising from climate change and support more robust decision making for all stakeholders.

Author

Malcolm Smith, Chief Operating Officer – Groundsure

 
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