Are You Evaluating Physical Risks Linked to Climate Change?

Physical Risks from Climate Change
May 05, 2020

Government agencies and investors are now requiring businesses to report a new metric in light of climate change: the cost of potential physical damage.

These physical risks include weather-related events, such as property damage due to a tornado or wildfire, as well as subsequent issues such as disruption of global supply chains or resource scarcity.

According to GreenBiz’s “The 2020 State of Green Business Report”, in 2018, 80% of insured losses were due to weather-related events.

As this is likely to continue or even increase, investors and insurers want to know more about the physical impacts to businesses now and going forward.

To help, the international Financial Stability Board initiated the Task Force on Climate-related Financial Disclosures (TCFD) in December 2015.

Chaired by Michael R. Bloomberg, the TCFD helps businesses develop recommendations for voluntary climate-related financial disclosures that provide information for lenders, insurers, and investors. This increased transparency on climate-related risks promotes more informed financial decision-making.

Just last month the group topped 1,000 global private and public supporters, demonstrating there is a trend to building a more resilient financial system through climate-related disclosure. Supporters include corporations, government ministries, central banks, regulators, stock exchanges and credit rating agencies.

In the interest of full disclosure, however, TCFD asks companies to conduct scenario analyses based on different assumptions about the future and the impact across their businesses, including operations, supply chains, customers and markets. Companies that participated in the survey said that they found the scenario analysis difficult. However, this trend is not going away.

Physical reporting does not confine itself to just looking at the headquarters of a company. Rather it looks at a company holistically, asking about the global physical risks to the company.

For example, some questions that might be examined:

  • Where are all the assets of a business located worldwide?
  • Where are the suppliers located?
  • How may end markets change during a crisis or even in the near future?
  • How may consumer demands change?

The GreenBiz report lists many examples of why this knowledge and disclosure are important.

First, there is a direct relationship on corporate credit ratings. Lauren Smart writes in the report: “An analysis by S&P Global Ratings identified 299 cases in which the impact of extreme weather or other climatic or environmental factors resulted in or contributed to a corporate rating revision, or was a significant factor in S&P Global Ratings’ analysis. In 56 of these cases, climate-related risks had a direct and material impact on credit quality, resulting in a rating, outlook or CreditWatch action or notching of the rating; nearly 80 percent were negative in direction.”

And perhaps one of the most recent examples of climate-related risk was in the United States when Pacific Gas & Electric (PG&E), the utility servicing northern and central California, was linked to the deadly fires in 2017 and 2018. The company had to file for bankruptcy after losses nearly equaled the company’s market value.

A physical risk analysis is more than just a disclosure for disclosure’s sake. By understanding where the risks are, a company can develop better mitigation strategies and protect itself against future climate change impacts.

Author

Laurie Toupin