20 May 2019: Meeting the SDGs requires leveraging private sector finance and increasing investments in activities that can deliver benefits for livelihoods, climate, ecosystems and biodiversity. What is needed, stresses UN Assistant Secretary-General Satya Tripathi, is private sector leadership in a systemic change towards accounting for environmental externalities and greening business operations. Climate risk assessments enable informed investment decisions in that direction. They reveal that climate risk levels vary between sectors, both in terms of portfolio contributions to climate risks and exposure to risks, including policy risks.

This Institutional Finance Update informs of climate risk assessment study results and initiatives taken to act on climate-related risks to investment portfolios announced in May. It also highlights a study by the Organisation for Economic Co-operation and Development (OECD) and the World Bank on governments’ disaster-related contingent liabilities.

UNEP FI Issues Investor Guide for Climate Risk Assessment

In 2017, the industry-led Task Force on Climate-related Financial Disclosures (TCFD) presented voluntary disclosure recommendations to the G20. TCFD supporters currently manage almost USD 110 trillion in assets. To enhance understanding and adoption of the TCFD recommendations, the UN Environment Programme Finance Initiative (UNEP FI) conducted a pilot with 20 institutional investors throughout 2018-2019. In May, UNEP FI published the results in a comprehensive investor guide to scenario-based methods for climate risk assessment.

The pilot tests a ‘Climate Value at Risk’ (CVaR) for listed equities, corporate debt and real estate under several future scenarios. Unlike other methods, this measure considers physical and transition risk of climate change in an integrated manner, and examines a range of temperature pathways. On the physical side, the methodology examines the impacts of climate change on companies’ operations using business interruption as a proxy. On the transition side, it “explores policy risk – the cost for companies from meeting countries’ emissions reductions targets; and green opportunities – the profits for low-carbon technology companies earn from providing the means by which to reduce emissions.” The methodology then translates these physical and transition impacts through financial modelling into financial values. It further assesses portfolios against international climate targets “to give a temperature alignment” – the degree of warming associated with a specific portfolio.

Natural disasters have cost advanced and emerging economies around USD 1.2 trillion in damages and economic losses over the last decade.

Key findings of the report include:

• Investors face as much as 13.16% of risk from the required transition to a low-carbon economy (an approximate portfolio value loss of USD 10.7 trillion for the largest 500 investment managers);
• Utilities, transportation, agriculture, mining and petroleum refining sectors stand out as having high policy risk, with significant variation in climate risk levels between sectors;
• “Green” profits in a 2°C world are significant – approximately USD 2.1 trillion;
• Low-carbon technology opportunities help offset risk; and
• Governments’ delay in enacting climate policies that reduce greenhouse gas (GHG) emissions will come at a cost of USD 1.2 trillion.

The authors caution that corporate disclosure practice to date fails to provide risk assessments that are forward-looking and information at the level of the physical assets owned by a company such as facilities, plants and infrastructure. Explaining that risk exposure will manifest at the “asset level” more than at the level of companies as legal entities, the authors suggest TCFD recommendations improve data availability by asking corporate and financial institutions to disclose this type of climate-related data, including a company’s individual sensitivity and adaptive capacity.

To ensure comparability, the report suggests considering standardization and transparency requirements. Financial regulators could provide: a set of scenarios they would like investors to use in scenario-based analysis of their portfolios; and “thoughtfully-designed” transparency requirements of modelling methodologies. [UNEP Press Release] [SDG Knowledge Hub Guest Article on Governments and Corporates Driving Each Other Forward on Ambitious Climate Action]

European Investors Test Options to Align Portfolios with Paris Agreement

Many pension funds and asset owners recognize climate change as one of the largest systemic risks in their investment portfolios. More investors are making commitments to low-carbon investment, and show interest in aligning their portfolios with the goals of the Paris Agreement on climate change.

To identify some options, in May, the Institutional Investors Group on Climate Change (IIGCC) launched a project, together with a steering committee of leading European investors that includes AP2, Brunel Pension Partnership, Church of England Pensions Board, LGPS Central, PKA, and TPT Retirement Solutions.

Among others, the initiative will:

• Identify approaches and methods for aligning portfolios with the Paris Agreement;
• Explore feasibility of these for different asset classes and sectors;
• Test methodologies for alignment using real-world portfolios;
• Explore feasibility and opportunities for aggregation of alignment approaches at the portfolio level;
• Identify the financial characteristics of the portfolios and transition options in the context of wider financial risks.

[IIGCC Press Release] [UNFCCC News Article]

OECD, World Bank Publish Study on Governments’ Disaster-related Contingent Liabilities

During the annual OECD Forum in Paris, France, OECD and the World Bank released a joint report titled, ‘Fiscal Resilience to Natural Disasters,’ which presents results of a study comparing country practices in the management of the financial implications of disasters for government finances.

An estimated cost of USD 1.2 trillion in damages and economic losses in advanced and emerging economies resulted from natural disasters over the last decade. According to the report, this led to a surge in central government spending of substantial percentages of gross domestic product (GDP) for recovery and reconstruction.

The authors identify damages to public infrastructure assets and related service disruptions among the largest sources of the costs governments incur. To control their disaster-related contingent liabilities more effectively and improve resilience to fiscal risks, the report offers recommendations for governments in the areas of:

• Designing clear rules for post-disaster financial assistance;
• Establishing clear cost-sharing mechanisms across levels of government;
• Including the assessment of disaster-related contingent liabilities in fiscal risk management frameworks;
• Making risk reduction part of the framework conditions for co-financing disaster risk management measures; and
• Managing remaining fiscal risk through multi-pronged financial protection strategies.

[OECD Press Release]

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The SDG Knowledge Hub publishes monthly climate finance updates, which largely focus on multilateral financing and cover, inter alia, mitigation and adaptation project financing news and lessons, institutional events and news, and latest developments in carbon markets and pricing. Past IISD climate finance updates can be found under the tags: Finance Update: Climate Change; and Finance Update: Sustainable Energy.