RegTech Intelligence 
Add another category to the ever expanding list of risks posed to the financial sector with the new kid on the block: Climate Change.
Climate risk has now expanded beyond sheer physical damage to companies and their assets to encompass the risks posed by investments in fossil fuels and their rapidly declining value. In response to this, France has already established mandatory reporting for finance companies of their annual contribution to, and risk from, climate change; and they are not alone. British law also requires insurance companies to detail their exposure to fossil fuel investments, and every major exchange will soon be included under the mix with governor Mark Carney’s foot on the gas pedal.
With December’s official launch of the Financial Stability Board’s Task Force for Climate-related Financial risks, climate reporting is about to get serious on a global scale. The FSB was established in 2009 with the primary goal of identifying and mitigating potential stresses in the financial system, and with Climate Change they have identified what they believe to be the three major present and upcoming risks that threaten it today.
Physical Risk
Since 1980 the number of weather related losses has tripled, and costs resulting from these have jumped from $10 billion to $50 billion a year. A September report from the Bank of England details how insurers have suffered from this increase, and have begun to withdraw services from certain areas that have become more disaster-prone.
The main solution to tackling this is, rather than shying away from a problem that will only get worse throughout the century, insurers and other financial actors can play an active part in innovating around Climate Change. 2015 has seen a significant increase in weather derivatives being adopted by end-users to hedge weather-related occurrences, alongside an increase in catastrophe bonds that help to rebuild areas hit by extreme weather, rather than steering clear of them.
Climatewise is a partnership of insurers, brokers and risk modellers working together to help reduce the impacts of Climate Change through long-term investment and top-level responsibility for company sustainability. One member, Tokio Marine, based in Japan, has restored 8,200 hectares of mangrove forests in the coastal areas of seven countries, jointly contributing to offsetting their own carbon footprint while increasing the resilience of the areas to storm damage. These projects protect insurers as much as they do the victims of Climate Change, and open up markets rather than closing them down.
Speaking of new markets, one is also opening up in weather risk management. As weather-related terms such as El Nino (the strong reversal of Pacific currents that is now occurring more frequently, impacting weather patterns across the globe) appear more in financial conversations, it is becoming more important to understand which way the tides are turning – quite literally. Thousands of weather risk consultancies are springing up, and new products and services targeting actors such as energy providers (who rely on weather forecasting and hedging, particularly for renewable energy) are innovating around the physical risks of Climate Change.
David Whitehead, co-CEO of Speedwell Weather, which retained its title of Best Advisory/Data Service in this year’s Market Rankings, claimed “I don’t think any part of the world is not hedging weather risk now.”
Transition Risk
Now, not just insurers but also the entire buy-side face threats from the assets side of their balance sheet as well.
Enter the newest global trend: divestment. Compound that with the huge new mandate arising from the recent Climate Deal reached in Paris, and then have a serious look at the beginnings of a transition towards a low-carbon economy. Over $3.4 trillion US dollars have been divested from fossil fuels in total, and energy analysts at Barclays have estimated that the industry will face a $33 trillion hit to its revenues over the next 20 years.
Recently we have also witnessed a huge increase in the use of renewable energy, coming to the extent that it now poses a real challenge economically to fossil fuel use. There has been an 80% drop in the price of solar energy since 2000, and Mark Lewis, lead analyst at Barclays, said one of the main reasons for the recent Climate Deal being possible was because of the huge drop in costs for renewables since Copenhagen in 2009. With the more ambitious long-term temperature target and a clearer path to transition with five year reviews, Lewis said we can expect a tightening of climate policies over the coming decades.
This poses a huge risk to any portfolio currently invested in fossil fuels, as they are now losing their value. David Blood, co-founder of Generation Investment Management and former CEO of Goldman Sachs asset management, said that “for long-term investors, when they debate hold or divest coal or tar sands assets, the answer will be divest. It’s a no-brainer.”
Liability Risk
Liability risks are those that will arise from an increase in climate-related litigation. Liability insurance protects the insured from litigious action arising from Climate Change, such as failure to mitigate (for example, a company/government continuing to contribute to Climate Change through pollution), failure to adapt (such as the people of the Netherlands suing the government for not protecting them properly from rising sea levels), or failure to disclose/comply (a likely upcoming trend regarding the increase in mandated disclosure of climate risks written in legislation).
While this is indeed an area to be horizon-checking, particularly for insurers, it is also an area that yet poses a real tangible threat to the industry. Readers of the CFA institute financial newsletter were asked which type of risk is most critical for investors to consider. Among the 322 respondents, transition risk and physical risk each received 40%, while liability risk received only 20%. While it is a risk that could evolve adversely with an increase in climate legislation, it is still dwarfed by the very here-and-now dangers of the others.
Increasing disclosure
The upcoming risks pointed out by various financial market players have been picked up by concerned investors who want more information on their exposure to stranded assets. To date over 4000 companies have responded to investor demands by increased reporting. In the financial markets the mist is now clearing over climate disclosure, with increasing FIs reporting their climate performance of their portfolios and even setting portfolio targets through initiatives such as the Portfolio Decarbonisation Coalition established in 2014 by UNEP FI, CDP, Amundi and AP4.
However, one of the main issues picked up so far, particularly in the financial community, is the lack of consistency in reporting programmes, which have largely emerged on an ad hoc basis with little scope for comparison. The FSBs task force for climate related disclosure hopes to change this. On the 4th December the FSB announced that the task force would be established under the chairmanship of Michael Bloomberg, who spoke of its primary objective to increase the transparency of climate-related risks in the markets, which “will help make markets more efficient, and economies more stable and resilient.”
The first half of 2016 will see the determining of the scope and high-level objectives of the FSB climate task force, while the second half will focus on working up specific recommendations for voluntary disclosure principles. With this in mind, by the end of next year we may be looking at a robust framework for climate reporting, and an even bigger market for the low-carbon economy.