A typology of climate risk
I spent yesterday speaking at an excellent UK Finance conference on Climate Risk, Green Finance & Sustainability. For those of you not able to join us, the team tweeted a few snapshots as the day progressed on #UKFGreen. There was plenty of thought-provoking content but one thing that stuck out to me is that when someone mentions climate risk they can be referring to several starkly different categories of risk. Differentiating between these is vital to tailoring an appropriate response – and to pricing the risks of inaction. So here is my attempt at a basic typology:
Transition risk. The risks, often financial, faced by an organisations as they navigate the transition to a lower-carbon economy. For example, business models undermined by heavy regulation, or research and development spend to create more sustainable products.
Physical risk. Direct, physical manifestations of climate change that cause harm or loss. Including, but not restricted to, flooding, heatwaves, crop failure, and hurricanes.
Indirect risk. The after-effects of physical risks, not just clean-up costs and disaster relief but also world food price fluctuations, insurance premiums and debt pricing – amongst many others.
Systemic risk. The build-up of multiple physical and indirect risks. As a greater number of extreme weather events take place, systems that have been able to cope thus far will come under stress from multiple directions. For example, emergency systems dealing with both a major flood and a heatwave in close succession, or financial systems suffering shocks in several markets at once. The impact of multiple shocks is far harder to model and prepare for.
Reputational risk. My own specialism, on which I spoke yesterday. As climate change becomes more troubling for and understood by the general public, it presents an ever-larger threat to the reputations of organisations. A failure to take this seriously threatens the 87% of company valuations now made up of ‘intangible assets’.
Unfortunately for the fight to reduce carbon emissions, transition risk is far easier to both imagine and quantify than any of the others. It is easy to say that you cannot afford more R&D spend or that it is ‘impossible’ to reduce the emissions of a key manufacturing process. EY’s Gill Lofts showed us deeply troubling (though sadly unsurprising) figures recording the way in which annual reporting by companies significantly underestimated the impact of even the direct, physical risks of climate change – let along the more opaque, indirect ones.
For my part, I will keep explaining to the businesses the extreme reputation risks of not taking this seriously and I was excited to hear lots of discussion from financial institutions about their work to quantify physical and indirect risks – but we need to work much more swiftly if we want to make a real impact. Even Aviva, who are well-known and praised for their work in this area, confessed that their portfolio is currently consistent with more than a 3 degree rise in global temperatures.
I would love to hear what you think! Are these the categories you would choose? How can we raise awareness and understanding of the four categories that represent the downside of failing to adapt? And if you know anyone who needs help understanding the reputational risks of climate change, please send them in my direction on email@example.com