Assessing climate risk can be challenging: it is highly uncertain, sometimes difficult to quantify, and difficult to hedge against, because of the systemic and pervasive nature of climate risk. The issue is complicated because there is still more to be done on the corporate side regarding climate risk. The 2021 EY Climate Risk Disclosure Barometer, which examines more than 1,100 companies across sectors, found that not all are undertaking a climate scenario analysis, and those that do are inconsistent in their approach. The research shows that only 41% of the organizations assessed have disclosed whether they conduct scenario analysis to examine the likely scale and timings of particular risks and prepare for the worst-case outcomes.
Furthermore, the research shows that corporate decarbonization is central to investors’ investment decision-making, with 86% of respondents saying that investing in companies that have aggressive carbon reduction strategies is an important part of their strategy. Making progress toward net zero and decarbonization will likely require companies to produce a robust approach to scenario planning, and investors to engage closely with organizations on their strategies:
- Companies should undertake robust scenario planning to help understand the potential implications of a range of climate outcomes and stress-test the current risk management and strategy processes within their business.
- Investors should engage with companies on the need to recast their organizational strategies to incorporate decarbonization and ESG factors. They should also determine a forward-looking view of decarbonization strategies.
While the transition toward a net zero carbon economy presents significant material challenges, efforts by national governments to encourage the transition could also be an opportunity for investors. Ninety-two percent of investors surveyed said they had made an investment during the previous 12 months because they saw that target benefiting from the green recovery.
However, this opportunity could become a victim of its own success. With a potentially limited supply of suitable green investments achieving high sustainability scores from ratings providers, there is a risk of a market bubble: 76% of investors surveyed said the “shortage of supply in suitable green investments will lead to some investors overpaying for green assets, creating the risk of a market bubble.” As we explore in an article on the role of investors in financing the green recovery, there are also other factors that could dampen some of the concerns over a market bubble: the sheer volume of finance likely required to achieve renewables goals and the significant amount of equity capital that will likely need to flow to those organizations in emissions-intensive sectors.