Climate risks are here to stay, so managing the credit implications is simply common (financial) sense
Written by Jon Williams, PwC partner and Member of the FSB Task Force and Stephanie Chang, PwC Assistant Director
Climate change presents risks that are not only being felt today, but will continue to generate both physical impact and low carbon transition risks that could affect companies’ financial performance. Climate policy such as a carbon tax could drive up production costs, while physical climate impacts have the potential to disrupt supply chains. Technological responses to combat climate change could shift demand curves for established markets, and energy policies that favour renewables could leave the value of carbon emitting assets impaired.
Figure 1: Decarbonisation pathways from the PwC Low Carbon Economy Index 2016
As the providers of financial services and capital to companies exposed to such climate risks, financial institutions including banks, asset managers, and insurers are increasingly trying to come to terms with how such risks could transfer to them and ultimately to those whose interests they manage. This necessitates a broadening of the traditional scope of risk management to adapt to the fundamental changes to markets and business models wrought by climate change.
The challenge for the financial sector is that climate-related reporting has historically evolved around environmental metrics such as greenhouse gas emissions or water use. These are useful measures in some instances, such as working out the direct implications of a carbon tax, but may be of limited use in others, for example in trying to understand the implications of changes to the demand for conventional cars and electric vehicles. A further limitation is that such reporting tends to be backward-looking.
The Financial Stability Board (FSB) recognises that without the right disclosures, the financial sector will not have access to the information necessary to make well-informed lending, investing, and underwriting decisions. And if climate risks aren’t well understood and correctly priced, the financial system may be prone to abrupt market corrections. In other words, pricing in climate risk allows decisions to be made based on more complete information, and enables risk functions to move from gatekeepers to strategic business partners.
In response to this, Mark Carney, as Chair of the FSB, established the Task Force on Climate-related Financial Disclosures (FSB-TCFD) which has recently launched their recommendations for improved reporting. We have developed a short summary for business leaders.
At the very least, the recommendations will mean that reporting the financial impacts of climate change will be on the board agenda, as they consider the mid to long term implications of climate risks on their business, strategies and financial performance, for example through the use of scenario analysis. The recommendations are due to be finalised by mid-2017.
Widespread uptake of the recommendations will mean that financial institutions will have access to consistent, comparable data which will aid risk management and disclosure at the financial institution level. A key challenge for financial institutions will be to assess current processes and systems for collecting and analysing such data, and consider how such enhanced information can be best incorporated into existing risk management and financial reporting frameworks.
Those who act first will be best placed to capture the arbitrage while others get their houses in order to price in climate risk. Appropriate pricing of risk should mean that capital is deployed in ways that make financial sense for businesses – including the capturing of climate-related opportunities. Is this perhaps a situation where the planet and profits do not have to be at odds?
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