Climate risk is a new risk that is hardly quantified, sitting heavily on the books of financial institutions that are largely unaware of its magnitude and imminence.
In light of the United Nations IPCC report, half a million more people are at risk of serious flooding every year, and billions who are living on coasts will be exposed by 2050.
Upon evaluating 9 physical climate hazards and associated financial climate value-at-risk (CVaR) for 136 assets in Asia, Intensel Limited discovered that flooding could cause up to 62% of total portfolio loss by 2050. With 34% of financial assets across Singapore, Malaysia, Australia, Hong Kong, and China exposed to increased rainfall flooding, 29% in Australia and China are at risk of river flooding.
Considering that billions of dollars are being invested in infrastructure and real estate without proper climate assessments, DigiconAsia decided to find out more from finance veteran and climate tech entrepreneur Dr Entela Benz, Founder and CEO, Intensel Limited:
How should banks and financial institutions internalize and cost climate risk?
Dr Benz: There are 3 things that banks, and financial institutions must do to price climate risk:
1. Measure: Begin by choosing the right approach – quantifying their climate value-at-risk across time and scenarios from the ground-up, starting with assets/buildings in their portfolios. The key is to account for their existing building-level information and at minimum the right locations, and it is also important to have actionable insights at a granular level. To quantify risk, they need to rely on climate analytics providers, like Intensel, to get a comprehensive view across time, scenarios and multiple hazards.
2. Disclose: Financial institutions and asset owners need to then communicate and disclose their financial risks to regulators, investors and consumers, aligning with global frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD), ISSB (International Sustainability Standard Board). This will increase overall transparency and encourage ecosystem stakeholders and other institutions to do the same.
Most importantly, these financial institutions will be able to demonstrate that they not only acknowledge the climate risk as business/investment risk, but by measuring it, they are in good place to limit the exposure and/or profit from opportunities.
3. Integrate: With the new analytics (from above), financial institutions will need to assess how their balance sheets will be affected under different climate scenarios and across different hazards. They will then establish strategies to minimise their losses, liquidity, or credit risk. For example, they may wish to set lending limits in certain high-risk regions or implement climate resilience credits to encourage adaptation work for assets in high-risk locations. This is especially the case because future pricing of loans may also consider climate risk scores.
Just to give some real-world examples – there is a lot of climate risk for real estate investors today, but there is also a window to use climate insights to take advantage of new investment opportunities:
- Due diligence before acquisition will help them to avoid high-risk areas or lower their portfolio risk
- Asset owners and managers can also start engaging portfolio companies and building owners on their climate risks to mitigate against hazards at the building-level or to do in-depth hazard analysis
- They may also wish to divest the top 10-20% of portfolios that account for the largest fraction of climate-related losses
For the near future, how should financial institutions mobilize and adapt their finances for climate change?
Dr Benz: From a perspective of climate risk adaptation, financial institutions would have to adopt a proactive approach towards mitigating climate risk beyond aligning portfolios and operations with the Paris Agreement and Net Zero targets. The momentum on disclosures will rise further, but this should not be the sole focus or simply an exercise of ‘checking-the-box’. This means that they need to question how assets, or a portfolio can create value within organisations or communities, and/or further collaborate with regulators and policymakers to create an enabling environment.
Are banks, real estate and investment firms simply redirecting 90% for climate mitigation, all the while knowing that they’re locking in increasing economic and societal losses?
The economic and societal losses aren’t unknown, there have been reports on this for years. We know that flows to climate adaptation are a fraction of what we should be having (USD29bn versus USD160-300bn by 2030). The pace of increase is not keeping up with the risk related to climate change, as we’re just too late and too slow.
The major issue is the lack of discussion around climate adaptation planning, adaptation financing and implementation. We cannot adapt if we are not clear where and to what extent… due to the difficulty of quantifying a complex problem, quantifying the unpredictable.
The discussion needs to place greater weight on issues of climate adaptation and the interlinkage with mitigation. As global warming trend continues, so will the losses. The UNEP research shows that finance for adaptation falls short. The 2022 Adaptation Gap Report suggests that adaptation finance flows to developing countries are 5-10 times below estimated needs, and will need over US$300 billion per year by 2030.
How should nations protect the most vulnerable countries and communities, rather than saving “too big to fail” institutions with taxpayers’ money?
Dr Benz: Besides what’s mentioned above, I’d also like to add that there is a lack of analytical tools and good climate data, given the difficulties in obtaining data especially in parts of Asia, and nations need to start adopting climate analytic tools. Due to this lack currently, there is much weaker awareness or momentum around addressing losses and damages (compared to achieving low carbon economics and net zero targets), and policymakers and businesses have not acted as quickly as we should expect.
What are your thoughts on good governance and smart policies for climate mitigation?
Dr Benz: There are 3 main thoughts that I would like to highlight here – adaptation, resilience, mitigation (new tech):
- We need to increase awareness that we are running out of time for adaptation
- We also need to establish that adaptation and mitigation are complementary and not substitute
- Last, companies should be judged/assessed on their climate resilience frameworks
This can only be achieved via:
- Investments need to be directed into having high quality, granular data at the building-level that are then made available for climate science and risk researchers, as well as the broader community.
- We need to close this ‘data gap’ so that we can better quantify and project as accurate as possible the financial cost of climate change on firms and communities.
- We also need more firms – including real estate companies and developers – conducting climate risk analysis on their portfolio in order to de-risk their portfolios or to create new products/instruments – whether insurance or resilience credits – that price risks accordingly.
