Weekly round-up- August 1-5

Weekly round-up: August 1-5

August 1, 2022

The top five climate risk stories this week

1)Worst-case climate scenarios “dangerously underexplored”

Extreme climate change outcomes are “under-studied and poorly understood,” a group of scientists have warned. 

In a paper published Monday, they argue that a “Climate Endgame” research agenda is needed to explore the worst-case outcomes of catastrophic global warming. These include famine and undernutrition, extreme weather events, conflict, and diseases — what the scientists call “the four horsemen” of a climate apocalypse. 

“Climate damages are likely to be nonlinear and result in an even larger tail of [low-probability, high-impact extreme outcomes]. Too much is at stake to refrain from examining high-impact low-likelihood scenarios. The COVID-19 pandemic has underlined the need to consider and prepare for infrequent, high-impact global risks, and the systemic dangers they can spark. Prudent risk management demands that we thoroughly assess worst-case scenarios,” the paper says.

The bulk of climate risk analysis to date has focused on lower-end warming because of the 2 °C threshold popularized by the 2015 Paris Agreement, and because of a bias in climate science to “err on the side of least drama,” the scientists claim. However, the current global emissions trajectory is set to cause warming of between 2.1°C and 3.9°C by 2100. In addition, even lower levels of anthropogenic warming could push certain earth systems past crucial “tipping points” that cause sudden, irreversible changes. These could, in turn, accelerate the build up of greenhouse gases in the atmosphere. For example, Arctic permafrost could thaw unleashing huge amounts of sequestered methane and carbon dioxide.

Analysis of extreme warming impacts and how they could disrupt ecosystems, geopolitics, and the global economy is needed to inform “robust decision-making” and remedy “naive risk management”, the scientists say. Their proposal for a dedicated research program on “Climate Endgames” is intended to fix this blindspot, they add.

2) Climate risk management found wanting at Australian firms

Almost one-third of financial institutions overseen by Australia’s prudential regulator do not consider climate risk as part of their strategic planning, new data shows.

A climate risk self-assessment survey, compiled by the Australian Prudential Regulation Authority (APRA), was distributed in March to gather information on how banks, insurers, and superannuation funds are adopting the agency’s guidance on climate-related financial risk management.

Sixty-four entities responded. Only a “small portion” said they have thoroughly integrated climate risk across their risk management systems and practices. One-fifth said they have no formal process to identify climate risks, and almost one-quarter admitted they don’t have any metrics to gauge their climate risks.

However, the survey also showed that there is “reasonable cross-industry alignment” to APRA’s guidance, particularly in the areas of climate governance and disclosure. Four out of five boards, or board committees, said they oversee climate risk on a frequent basis, and 77% said they have had training in climate risk.

“Climate change and the global response to it are creating financial risks for banks, insurers and superannuation trustees, whether it be the physical damage from floods or bushfires, or asset price volatility as consumer and investor demands evolve,” said APRA Deputy Chair Helen Rowell.

“The survey findings indicate that most survey participants are taking this issue seriously, however they also underline that this remains a relatively new and evolving area of risk management, especially with regards to setting metrics and targets,” she added.

3) New ESG rules for EU funds enter into force

Changes to European retail investor protection rules that came into effect Tuesday require financial advisers to factor in the sustainability preferences of their customers when selling investments products.

The regulations are part of an update to the European Union’s Markets in Financial Instruments Directive (Mifid II), a wide-ranging rulebook for securities markets, investment intermediaries, and trading venues. Advisers will now have to accommodate the sustainability preferences of their clients by offering them products that: i) invest a minimum proportion in environmentally sustainable investments as defined under the EU’s Sustainable Taxonomy; ii) invest a minimum proportion in sustainable investments as defined under the EU Sustainable Finance Disclosure Regulation (SFDR), or iii) consider “Principal Adverse Impacts” on sustainability factors.

Mifid II also imposes new reporting requirements on asset managers. Such firms must now distribute ESG-related data for all products sold in the EU by fund distributors and insurers. This information has to be provided in a standardized European ESG Template (EET), which contains 580 data fields in total — although not all of these are relevant for every sector or geography. Many of these data fields also refer to the EU Sustainable Taxonomy and SFDR.

Complicating implementation of the Mifid II rules is that key planks of the EU Sustainable Taxonomy and SFDR have yet to be enacted. This has led to patchy and inconsistent ESG reporting by fund managers, which in turn has made it hard for financial advisers to ensure they are properly honoring clients’ preferences.

A report from fund data giant Morningstar found that conflicting interpretations of the two incomplete regulatory frameworks “have led asset managers to adopt different approaches to the calculation of sustainable investment exposure and taxonomy alignment, rendering it impossible to compare products directly.”

4) Extreme weather events can overwhelm risk management

Risk management strategies do not reduce the impacts of climate-driven natural disasters that repeatedly hit the same locations, an academic study has found.

In a paper published in the journal Nature, researchers examined 45 areas where an extreme flood or drought has occurred twice. For each pair of events, they compared the severity of the disaster, the population’s exposure, the vulnerability of the area, the impact in terms of deaths and economic damage, and any risk management strategies in place — like early-warning systems, reservoirs, or levees. 

This analysis found that the impact of the second disaster in each pairing was greater than the first in all but two cases in which it was the more extreme event — regardless of the risk management undertaken, or the degree to which exposure and vulnerability had lowered over time. The researchers say this implies that “investments in managing risk and curbing vulnerability following one severe event might not make a society sufficiently adaptive to reduce the risk from unprecedented subsequent events, which are increasing in a changing climate.”

The paper further argued that certain risk management strategies — like managing flood risk through levee construction, or drought risk by improving irrigation — can backfire, since they “incentivize people to settle in floodplains or start new agricultural activities in drought-prone areas,” increasing the size of the at-risk population.

5) Top CFOs share advice on ISSB standards

Chief financial officers from major banks and insurers have called for changes to the International Sustainability Standards Board’s (ISSB) two proposed reporting rules.

The CFOs of Bank of America, NatWest, and Manulife were among 86 finance heads to sign a letter to the Board describing how it could improve its sustainability- and climate-related disclosure standards. The executives were convened by Accounting for Sustainability, a nonprofit set up by the Prince of Wales to marshal finance leaders in support of a sustainable economy.

“Moving forward, it will be essential that the ISSB is agile. It must respond to real world feedback on the practical application of its standards, and incorporate evolving risks and opportunities associated with social and environmental factors,” the letter said.

The CFOs listed six goals the incoming standards should strive for:

  • Alignment with “relevant existing and emerging sustainability reporting standards”;
  • Clarity on the application of materiality “recognizing that investors may need disclosures on broader social and environmental impacts to assess risk and inform investment decisions”;
  • Agreement on “clear definitions and guidelines” to help reporting entities disclose in a “transparent, consistent and comparable manner”;
  • “[T]he necessary time and provisions” for entities to “put in place appropriate processes, controls and technology”;
  • Integration with financial reporting standards; and
  • Inclusion of “the broad set of environmental, social and economic issues” that influence decision making.

Sixteen asset owners and other financial institutions — including Alecta, Brunel Pension Partnership, and University Pension Plan Ontario — signed an accompanying statement which emphasized the importance of decision-useful data on environmental and social impacts to investors. This statement also commended a “double-materiality approach” to sustainability reporting that “will give investors earlier insights into likely financial and business impacts, and provide the information we need to deliver on our own net zero and broader sustainability commitments.”

The consultation on the ISSB standards closed on July 29.