Climate risk: a more positive approach pays dividends

As the world grapples with the impacts of climate change, organisations are racing to keep up with new environmental, social and governance (ESG) disclosure requirements and climate risk analysis methodologies. But what separates those ahead of the curve from those that are lagging? The answer lies in leadership and capability.

In recent years, ESG concerns have become increasingly prominent across every industry, with climate risk taking centre stage. Despite growing awareness, many organisations have been slow to embark on their climate risk journeys.

The emergence of new standards for global ESG and climate risk reporting and mandatory reporting requirements, however, means organisations need to act fast to establish effective climate risk analysis and reporting methodologies. A step-up in management capabilities and in-house functionality will be essential to success in meeting the requirements, and can also provide a springboard for growth.

Regulators in many jurisdictions worldwide have mandated climate risk disclosures in line with the Task Force on Climate-Related Financial Disclosures. New standards for global ESG and climate risk reporting will likely follow. Mandatory reporting on risks and balance sheets is also on the horizon, though not yet enacted. Elsewhere, formalised standards, such as those from the International Sustainability Standards Board (ISSB) in Australia, which become effective in 2024, follow global regulatory trends seen in the US and the UK, driving the market towards mandatory reporting.

Richard Yee, KPMG

Richard Yee, practice leader, general insurance actuarial and data analytics at KPMG Australia, who is leading the deployment of the firm’s climate risk solution across the Asia-Pacific region, notes two other drivers that have focused attention on this issue.

“The Covid-19 pandemic was a pivotal moment,” he says. “While not directly related to climate change, the severe disruptions to every industry worldwide caused by the pandemic put the similarly calamitous implications of climate change into stark perspective.”

Yee also highlights events such as the intense bushfires in Australia in 2019–20 – which were then followed by seasons of heavy rainfall – as the kind of environmental disaster to really make the physical impact of climate change hit home. “These headline-making events acted as a wake-up call for all industries to put an action plan in place.”

Much of the messaging on climate risk has been shaped by the 2015 Paris Agreement on climate change, where regulators from across industry sectors set up frameworks for how to manage climate risks and achieve specific climate goals by limiting temperature rises and reducing greenhouse gas emissions.

Energy companies have been among the first movers in climate risk mitigation, addressing the transformative impact of energy transition and the global move to net-zero emissions on their industry. Market participants are seeing increased regulation and scrutiny on their activities and, as such, have implemented teams and strategies to steer the transition to the new world economy.

Energy firms must prepare regulatory submissions to demonstrate their capital spend and risk mitigation strategies for the next 30 to 50 years. These pricing submission documents require them to plan for different climate change scenarios, and demonstrate how they will manage this risk in the long term, the capital expenditure required, and the impact on customers and on energy distribution. How that cost is passed back through customers is also a key consideration.

Management capabilities and in-house functionality

Elsewhere, it has been slower to progress in the response to new regulatory standards such as those set by the ISSB. Yee points to organisations that are less mature in their climate risk strategies – those that are just beginning to establish dedicated teams. “One of the key challenges for smaller firms is that few have a dedicated budget to establish in-house teams, and so they may look to outsource this function,” he says.

The market has also been unable to establish consistent reporting models and solutions that can be used across industries, which means a range of capabilities remains in evidence. In-house solutions require significant investment to gain specialist skills, particularly in economic modelling and climate modelling. Despite these cost barriers, there can be advantages to building these in-house functions – particularly if the organisation is able to own the intellectual property for their solution and customise the analysis to their business.

That said, even organisations that have a strong in-house team often seek independent opinions, such as through audits, to ensure they are on the right track with their risk modelling. One advantage is that these service providers can share advice and examples from a broad range of industries, therefore offering their clients a more holistic view of how others are managing climate risks.

For those looking to keep control of the process in-house, there are some key skills and technological capabilities an organisation must develop to keep ahead of the curve, and these mainly come down to data.

Data collection is of the utmost importance, says Yee – but so too is how you use that data and having the technology and know-how to assess it through data science. Purely objective data must be used if you are to build effective models, examine risks and make better-informed decisions on your portfolio.

Climate modelling is another essential skill, which Yee describes as capturing key data to assess the resilience of your assets through a climate lens, and showing where you should be investing to make your assets more resilient to climate risks.

Opportunities in climate risk

Monitoring and mitigating climate risk is not simply a matter of defence, but one of opportunity and growth for an organisation. “You’re not just defending against climate change,” explains Yee. “You’re also looking for opportunities within your portfolio, and there can be big opportunities for growth in this environment”.

Among financial market participants, such as fund managers or the superannuation sector, investees want to be assured their investments are channelled towards net-zero companies or those that are making strides in their environmental strategies.

Yee sees this as a key opportunity for firms to show leadership in this space. “Companies that are able to authentically measure the climate change risks in each individual listed asset, company or bond, and demonstrate to their investees that they’re on the path to net-zero can potentially get higher enhanced returns while following the requirements of their investees and the vision and strategy outlined by these companies,” he says.

Forward-thinking perspectives

Emphasising the positive aspects can also have a galvanising effect on stakeholders, says Yee, an important message for firms struggling to make climate risk integral to an organisation’s operations. “People might see it as a standalone activity but, to make it truly successful, you need your major stakeholders to understand your approach, how it fits with the company strategy, and make it part of the business so that, at each level, you are able to incorporate it into the operations. When you can come up with new strategies and view them as opportunities, it’s easier to get the whole team on board,” he adds. That cohesiveness is integral to the model’s success.

Yee goes on to explain that, in the past, climate risk solutions only focused on identifying the risks, but now the technology is available to integrate that data to measure, quantify and model the risks. The advantage is that an organisation can now project different risk scenarios and see the impact on their balance sheets. Modelled numbers and data help to bring these risks to life – it creates a more cohesive plan of action for an organisation and provides an enhanced way of reporting and meeting stakeholder requirements.

About Climate IQ

KPMG Climate IQ is a risk assessment tool that streamlines an organisation’s climate risk disclosure reports, taking into account global climate scenarios, climate financial risks and stakeholder demands, and provides a holistic framework to execute a clear and forward-looking climate risk strategy. The tool offers assistance at various stakeholder levels – allowing for climate risk analysis and reporting needs across different teams – engages the board and provides a clear rationale for decision-making on critical scenarios to help organisations achieve operational excellence as part of their risk strategies.

Sponsored content