The Gift Of Physical Climate Risk Assessment
By Natalie Ambrosio Preudhomme 22 December, 2020
It's challenging but not impossible to manage climate risks as Four Twenty Seven's Ambrosio Preudhomme shares their new Application
In a year as unprecedented as 2020, it sometimes seems as if nothing is “normal.” However, as the holidays approach, the annual reporting season also draws near and this annual tradition will persist. With the COVID-19 pandemic shining light on the importance of preparing for tail risks, many financial actors are putting increased commitment in preparing for another such risk – climate change.
Physical climate risk is already here & causing significant impacts…
However, at the same time, physical climate risk is already here, causing significant impacts, from sea level rise decreasing real estate values, to floods disrupting commutes and supply chains, to heat waves and wildfire smoke threatening human health.
…UK & NZ to mandate climate risk reporting with EU & Asia considering to follow
The UK and in New Zealand have both announced plans to mandate climate risk reporting, with financial regulators across Europe and the Asia-Pacific also actively considering such measures. More thorough and comparable assessment and disclosure of these risks, will help increase transparency, contributing to more accurate pricing of risks, and thus in turn will help foster a resilient financial system.
As reporting time comes near, many banks, investors and businesses may be looking for not only the right tool to leverage, but also how to take their climate risk assessment to the next step, not just complying with regulation, but really taking action to mitigate their risks and build resilience.
Emerging best practices for physical climate risk disclosure include disclosing the number of facilities exposed to specific hazards, the costs of past extreme weather events for the company and the activities of facilities exposed to each hazard, which can inform how sensitive operations are to climate hazards.
Four Twenty Seven’s application goes beyond compliance to drive real mitigation & resilience actions
For real estate investors, banks or corporations, Four Twenty Seven’s (an affiliate of Moody’s) Physical Climate Risk Application (Application) helps inform disclosure metrics such as those. It allows users to assess exposure to floods, heat stress, hurricanes & typhoons, sea level rise, water stress and wildfires at the asset and portfolio levels. The data compares historical baseline conditions with projected future conditions to mid-century, providing a view on both absolute and relative risk.
By leveraging global climate models and other environmental datasets, the application provides a science-driven, forward-looking view on risk exposure. Portfolio summary statistics provide a snapshot of exposure, with key metrics such as percent and total assets exposed to each hazard, as well as average exposures. This can feed directly into risk disclosures.
While detailed, asset-level information on the underlying drivers of risk for each hazard, as well as benchmarks may be too much detail for risk disclosures, it’s invaluable information to inform risk management internally. The Application’s real-time scoring for any asset globally allows asset owners and banks to quickly incorporate physical climate analysis into their due diligence processes for new acquisitions or loans.
Company Climate Risk Scores comprise operations, supply chain & market risks
For example, some users set internal thresholds for exposure and require further due diligence for any assets that receive “High” or “Red Flag” scores for specific hazards. Deal teams may be tasked to investigate asset-specific features that would make it more resilient to certain climate hazards, such as freeboard above base flood elevation, onsite power generators, or water efficiency measures.
Meanwhile, when it comes to reporting the risk of a portfolio of companies, there is more to consider. Central banks such as the Banque de France and Bank of England and institutional investors have leveraged Four Twenty Seven’s Company Climate Risk Scores for mandatory or voluntary climate risk disclosure. These Company Climate Risk Scores are composed of operations risk, supply chain risk and market risk.
Operations risk captures climate risk to business activities, based on the exposure of their underlying assets to physical climate hazards. To date Four Twenty Seven has mapped and scored over 1 million corporate facilities globally associated with over 2,200 of the world’s largest publicly listed companies. Market risk captures exposure to climate change in countries that a company depends upon for its revenues, as well as its sensitivity to weather volatility. Likewise, supply chain risk captures climate risk in countries a company depends upon for its inputs, as well as the resource demand of a company.
Investors leverage this granular data for reporting, benchmarking & portfolio risk management
Investors leverage this granular data for reporting, benchmarking and portfolio risk management. Understanding how many of an investee companies’ facilities are at risk to key hazards, and assessing which sectors hold the most risk in a given portfolio informs shareholder engagement and risk balancing. It is important to emphasize that the impacts of climate change on companies and assets will depend both on how sensitive their operations are to the hazards to which they are exposed, as well as to any resilience measures they’ve put in place.
For example, manufacturing facilities will be more vulnerable to heat stress than offices, due to their high energy use which can expose them to brownouts during peak energy demands, as well as increasing energy costs. Likewise, construction, mining and other outdoor activities will be vulnerable to reduced labor productivity during increasing heat events.
Meanwhile, while flooding can have rippling regional impacts, individual facilities can build preparedness by removing water-sensitive equipment from the first floor among other mitigation techniques. Businesses also have an opportunity to support regional resilience efforts, for example to make transportation corridors less vulnerable to flooding, which will also reduce disruptions at the facility due to commute or supply chain disruptions.
“It’s challenging but not impossible, to assess, disclose & manage [climate] risks”
Understanding physical climate risk exposure is an essential first step to engaging with investees or loan clients on the resilience-measures they may require to mitigate their risk. It’s challenging but not impossible, to assess, disclose and manage risks. Before signing off for the holidays, perhaps embrace this season of gift-giving to consider what your next steps might be toward building a more climate-resilient economy.
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