The World Economic Forum in 2020 reported that the leading threats to businesses today are extreme weather events, natural disasters, and the failure to mitigate and adapt to climate change. Southeast Asia, in particular, has been identified to be one of the most vulnerable regions in the world to climate change; as a consequence, businesses and society in this part of the world are facing unprecedented climate risks.
The Asian Development Bank had predicted that the region risks experiencing larger economic loss compared to any other area in the world. In fact, new analysis suggests that the impacts of climate change in Southeast Asia may be larger than previously estimated, possibly reaching 11% of gross domestic product by 2100.
Southeast Asia, as the world’s fourth-largest economy, has seen rapid economic growth and urbanization over the last decade. The population is expected to reach 795 million by 2050. Many of these people live in cities concentrated in low-lying coastal areas, which puts communities and industries at risk. For instance, having the world’s second largest coastline, Indonesia risks nearly 60% of Indonesia’s population and 80% of its business from rising sea levels, storm surge, and inundation. The world’s second largest city, Jakarta, is experiencing such rapid urbanization that land subsidence is accelerating (recorded subsidence of 25cm at some areas of Jakarta compared to an average rate of 5-10cm). With Indonesia predicted to attain climate departure (stage where climate change damage is irreversible) by 2029, the knock-on impacts of climate change on its population and cities would be immense and financially crippling. And the recent floods of 2019 may be seen a precursor of things to come.
Climate risks are present in Malaysia in the form of:
a. Physical risks from extreme climate events, which include storms, heavy rain, flooding, drought and associated wildfires, and heat waves. It is hard to predict the changing intensity, frequency and concentration of these events such as clusters of typhoons.
b. Transition risk where the ‘unknowns’ about how the world will evolve towards a low carbon economy in terms of public policy, regulation, actual temperature change, social expectations and technological developments makes it difficult to measure or price. And, given the slow progress on transition, the potential for a panicked, forceful policy response in a few years’ time — sparking a disorderly transition — is increasing.
c. Liability risk - recent estimates suggest that there have been close to 1,000 climate change related class action lawsuits filed in 25 countries. Rhode Island in the U.S., for example, filed a suit that alleges 21 companies knowingly contributed to climate change and failed to adequately warn citizens about the risks posed by their products. Law suits are creating concerns for companies’ insurers.
The climate related risks faced by small-medium enterprises (SMEs) in Malaysia remains primarily due to a lack of awareness and understanding of how the impacts of climate change can affect their business continuity and prosperity. For example, it has been predicted that as polar icecaps melt, the occurrence of flood events will increase in severity. The Malaysian National Hydraulic Research Institute (NAHRIM) has estimated that from the 1970s to 2007, the intensity of rainfall duration has increased approximately 30%, while sea level has risen between 2.7 to 7.0 mm per annum (between 1993 to 2010). At the same time, the incidences of droughts have increased the risk of water stress in the country.
Translated, this means: without adequate preparation, there is increased risks of business disruptions in frequency and duration. For example, based on our experience, severe flooding events had resulted in the disruption to the inflow and outflow of staff, materials, products for a week, resulting in financial losses. During drought situations throughout the country, our clients had reported the necessity to purchase water to ensure the continuation of business operations, resulting in unplanned cost impacts. We frequently advise our clients to prepare for the impacts of climate change – principally in flood or drought events locally, and if businesses are receiving goods from abroad via shipping lines, our clients are advised to ask – what is the impact to business on a severe storm event?
For many financial institutions (both banks and insurance sector), with each occurrence of climate related incidences in both frequency and impact, the sector increasingly recognizes that the mid- to long-term outlook on climate change carries some massive risks (for example, recent bushfires in Australia have an estimated cost of A$4.4B, while the financial costs of the December floods in Jakarta have yet to be quantified. In Malaysia, the financial costs of floods have been estimated at RM100 million annually). It is expected that in mitigating the impact of climate risks, measures put in place may impact the ability of many companies to access capital and insurance.
SME Risk Mitigation
Hence it makes good business sense for SMEs to move beyond traditional risk management that tends to focus on each risk separately, which often limits the focus to managing uncertainties around physical and financial assets. Instead, a better way would be to take a holistic and coordinated approach that optimizes risk management performance.
The holistic and coordinated approach enables SMEs to be in a position to navigate risks in a rapidly changing world paradigm. The advantages of good risk management are manifold: enhanced comprehensiveness of risks identified, reduced potential blind spots in the business and better forward-thinking and preparedness to manage risks in the long run.
Risk Elimination or Optimization?
For many SMEs, risk management is practiced in various forms within its day-to-day business activities, but most remain largely informal and unstructured. Companies should calibrate their risk management framework according to their scale and nature of operations. There is no one-size-fits-all approach.
Good risk management should never be about adding more layers of controls and processes in place without due consideration of costs and efficiency. Risk management is not about eliminating risks but about risk optimization. Companies that do not understand their risk profile and actively manage their risks may find themselves suffering from the effects subsequently.
An effective risk management framework should thus seek to support the management in making informed decisions, balancing risks and opportunities when making key decisions. It will provide key stakeholders with the right information on both risks and opportunities to support cost-benefit analysis, as well as to cover all angles when making investments or strategic decisions.
To put it simply, we believe business leaders in the SME sector must start asking the following questions:
1. How robust is our business under differing climate-related scenarios?
2. Are climate-related issues considered in our strategy discussions?
3. Do our risk management and governance processes consider climate change?
4. Are our non-financial KPIs sufficiently informing climate-related financial risks and do we properly use them to manage risks?
5. How flexible are our investment commitments to adapt in a timely manner to the energy transition?
6. How are we quantifying climate-related risks?
7. How can we assess the potential materiality of climate-related risks against other more traditional considerations?
8. Are there climate-related opportunities for us to exploit?
9. Can we differentiate our offering to investors by taking industry-leading positions in our response to climate change?
10. Can we use existing joint venture frameworks at both a national and international level to demonstrate our commitment to, and expand our understanding of climate-related risks and opportunities?
Understanding climate-related risks and building them into daily business financial management is a challenging affair. Nevertheless, as every good leader knows that within every risk lies great opportunities