The 2018 Global Risks Report, released during the World Economic Forum in Davos earlier this year, highlights the fact that climate-related risks have grown in prominence over the years. The report indicates that risks related to extreme weather events, natural disasters and failure of climate change mitigation and adaptation are all rated as part of the top five global risks, in terms of likelihood and impact.
These results are not a surprise. We have seen governments ramp up their efforts to mitigate climate risks for some time now — both on the global level (e.g., through Paris Agreement commitments) and the local level (e.g., China emissions trading scheme). However, there is a growing accountability on businesses to address climate-related risks.
This is fueled by regulatory developments, increasing shareholder resolutions, legal action, recommendations made by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) and, perhaps most importantly, investor demands. Investors are increasingly seeking more nonfinancial information to assess the long-term value creation potential of portfolio companies.
Businesses, therefore, should be better informed on how they are managing their climate-related risks, including climate-related financial risks. In doing so, they may be able to respond better to growing demands from investors and create sustainable, long-term value.
This article discusses why greater transparency is warranted on the impact of climate risks and the opportunity that disclosure can bring.
Financial sector is driving greater disclosure of climate risks
The financial sector considers that climate change risks (including both physical and transition risks) represent a systemic financial risk to the economy (including sudden loss of asset values), which is not being adequately addressed by businesses. This aligns to EY’s annual investor survey that shows stranded assets remain a concern for the majority of investors.
And this sector, including the investors and the asset managers who represent them, are often growing impatient. This validates what investors are telling us, globally, in our investor survey that more than one in four investors indicate an expectation of dramatic improvements in organizations’ disclosures on climate risks and how they are being managed.
But even regardless of this, investors are already considering climate risks in their decision-making and taking action. Sixty-two percent of them reported decreasing their holdings, or monitoring holdings closely, due to stranded asset risks. Examples of more direct investor action on climate change include the US$1 trillion Government Pension Fund of Norway, also known as the Oil Fund, which controls 1.5% of all global stocks. It announced a plan in November 2017 to completely divest from oil and gas (after having already sold most of its coal stocks).3 And in December 2017, the World Bank announced it would withdraw from financing upstream oil- and gas-related investments after 2019.
Beyond the financial sector, other influencing factors are leading to better management and disclosure of climate-related risks, including:
- Increasing shareholder requests for businesses to report on climate-related financial risks and activities to transition to a low-carbon economy
- Stock exchanges and securities that have the ability to encourage or mandate better climate disclosure in listings
- Credit-rating agencies beginning to consider climate risk as part of sovereign credit ratings
This has all sorts of ramifications for businesses impacted — including valuations of assets and liabilities, capital raising and financing (as shown in Figure 1 below). These shifting market dynamics are not only impacting assessment of risks, but also generating opportunities and opening up innovation and disruption.