Getting physical climate risk right will take time, but we must start the process now
Standard Chartered Bank
For those who allocate capital, pricing physical climate risk is a serious challenge. There are many moving parts, and the task of unpicking them all can seem daunting. But like any big task, the key is to take it step by step, do what we can, and accept that all we can do is lay the groundwork for future iterations.
Standard Chartered Bank provides capital to businesses of all sizes. Naturally, we are exposed to the physical impacts of climate change on our borrowers’ businesses, and need to understand how to direct capital to those who demonstrate that they will deploy it to create resilience and minimise climate impacts.
But at present, it remains a challenging task.
Firstly, we have much better information from some countries than others. We operate across Asia, Africa, and the Middle East. The state of corporate disclosure in those countries is not as advanced as in markets such as the UK or other European countries.
Secondly, not all companies have the resources to dedicate to the task. Smaller companies struggle in particular, having less time to think about climate change issues and less capacity to act.
Thirdly, we have to grapple with the complex question of how climate change alters assets’ risk profiles compared to the weather risks with which we are already familiar. Does it imply an increase in frequency or magnitude of the disruption? How does the effect differ in different parts of the world? What is the likelihood that any impact will be mitigated, both in terms of the firms’ ability and willingness to do so? Fourth, once companies have taken steps to mitigate that risk, we must
take a view on the chance that those steps will be effective. We have to consider how well our existing credit risk assessments take into account borrowers’ efforts to mitigate their exposure to physical climate risk, and if not what tools we need to achieve this.
Fifth, if any given borrower were to experience climate-related disruption, would it hurt their cashflow and when? Would it hurt their repayments? A disruption might not affect their short-term repayment because they may well take shortterm steps to generate cashflow. Distress to the business may not become apparent until further down the line. In other words, the increased likelihood of catastrophic weather events can play out in unexpected ways over unexpected time periods.
All this adds up to a risk profile which is dynamic, multilayered, and complex.
As a bank, there are measures we can take. For the last eighteen months, for example, Standard Chartered Bank has been working with Oxford University to research the potential physical and transition climate risk exposure of our energy utilities clients. We have used spatial mapping techniques to look at the physical risks to which each of their individual plants are exposed, enabling a conversation on how they can be mitigated at quite a detailed level.
We’ve also worked with the United Nations Environment Programme for Financial Institutions. Sixteen different banks have come together to look
at how best to model physical climate risks and opportunities, and develop a common industry framework to do so in future.
As part of the TCFD, Working Group 2, which I chair, will focus on identifying metrics which corporations can include in their financial disclosures on how they are improving climate resilience right along their value chains, for example at their facilities, or via their suppliers or customers.
The aspiration is consistency of disclosure from clients. If that were achieved, banks, insurers, and investment managers would be able to make capital available to those who have the data to demonstrate that they are more resilient to physical impacts.
But there is a long way to go. Even if we solve the data issue and the modelling issue, we will only then begin to be able to quantify the effects on any individual borrower. However, I do not think that we should be discouraged. The first step is to build the foundations. This is an inherently multi-step task, with refinements to approaches coming over time.
We must be humble enough to recognise that we will make mistakes. These will be refined and improved by all those who pick up the baton and take this work forward in future. It would be a mistake to let the perfect be the enemy of the good. We are learning as we go. Our work is foundational, and foundations are necessary.
Ultimately, our work will bear fruit. We should see, and know, that that capital is being directed to the right places and those who manage their climate resilience and identify opportunities will benefit.