When did climate risk first become a reality for your business?
Catastrophic events like wildfires, hurricanes, floods, drought and ice storms spell disaster for citizens, communities, wildlife and the surrounding environment. They’re also having a devastating impact on companies, wreaking havoc on supply chains, disrupting manufacturing, holding back food production and preventing delivery of essential services.
However, less well known is the concept of transition risk. As the world transitions to a low carbon economy, this can result in many new risks, including transition risks, which companies need to understand quickly. Transition risk can manifest itself in many different ways including the following:
- Changes in policy and regulation which will impact companies in every industrial sector (e.g. carbon taxes)
- Changing consumer sentiment with strong preferences emerging for green and low carbon goods and services
- Changing consumption habits including food and transport preferences
- Public protests such as the Gilet Jaunes in France
- Changing technology solutions
This list is by no means exclusive.
One estimate suggests climate change could cost the world’s leading companies a staggering US$1 trillion between 2019 and 2024, according to the CDP.
In the KPMG 2021 CEO Outlook Pulse Survey, climate change risk was considered the fifth biggest risk to growth over the next 3 years. Acknowledging the threat of climate risk by companies is one thing. Knowing how to size this risk, and adapt and thrive, is another.
KPMG, along with global law firm Eversheds, recently polled senior executives from 500 of the world’s leading companies for our survey Climate change and corporate value: What companies really think. Three-quarters of leaders surveyed admit they need to improve their ability to deal with climate change risks, yet a key finding from this report is that many companies believe that they lack the skills and expertise to pursue their net-zero carbon objectives. This is a serious problem which needs to be overcome if we are serious about getting to net-zero by 2050.
Why is climate risk so important?
There are a number of reasons that climate risk is a critical issue for companies:
- In the first instance, failure to recognize, measure and disclose climate risk may ultimately lead to problems with both debt and equity investors, as there is increasing awareness of the reality of climate risk from these stakeholders and the impact on their own investments.
- For the financial services industry, regulators are paying very close attention to climate risk and insist that it is properly addressed by those institutions under their prudential supervision.
- Ultimately, climate risk needs to be seen as a financial risk because it can impact business models, long term cash flows and profitability. In turn, this can impact the way assets and companies are valued, ultimately leading to the spectre of stranded assets.
Investors are also demanding clear metrics for the climate risks (and opportunities) faced by businesses, along with documented action plans, as part of a coherent strategy.
Forty percent of respondents to The Time Has Come: The KPMG Survey of Sustainability Reporting 2020, say their organization reports on the financial risks of climate change. This is likely to increase significantly.
The funding dilemma
The issue of mobilization of finance is central to the fight against climate change. Various initiatives are underway to encourage the reorientation of capital from non-sustainable to sustainable investments. This includes initiatives such as the EU Taxonomy, the recently announced Glasgow Financial Alliance for Net-Zero (GFANZ) and also the Network for Greening the Financial System (NGFS) comprising of central bankers from all over the world.
The assumption that debt and equity capital will likely continue to be freely available for companies is a dangerous assumption in a climate-focused world. As a result of the various initiatives I mention above, together with overall market sentiment, companies who do not address the question of climate risk may ultimately find that accessing capital will become more challenging. On the other hand, companies who face up to climate risk and begin implementing net-zero strategies should find that, in time, access to capital to support this work may be easier.
As we begin the countdown to COP26 in Glasgow this November, it should be clear to everybody that standing idly by on the climate question is no longer an option. The world has now begun to accelerate to a low carbon society and it is critical that public and private companies recognize the reality and become part of the solution.
A board that’s knowledgeable on climate risk, and committed to addressing this challenge, can help shift a company from a protective stance, to embrace the genuine opportunities of the low carbon future. This can convince investors, asset managers and ratings agencies to place their trust – and their capital – in the business.