Navigating climate risk in times of change
The growing market for climate-resilient projects will open up new veins of economic opportunity for developers and investment managers who can successfully demonstrate their commitment to combatting climate change.
In recent years, many companies and investors in the US have come to recognize the critical role that mitigating climate risks to their assets, organizations, and investments plays in achieving lasting resilience. With the Biden administration’s pledge to fight the climate crisis by “building back better,” climate risk and resilience have been elevated to national priorities. The growing market for climate-resilient projects will open up new veins of economic opportunity for developers and investment managers who can successfully demonstrate their commitment to combatting climate change. But with climate-risk reporting standards, like TCFD, still evolving, it can be challenging to determine how best to do this.
We invited a group of Arup resilience and finance experts to discuss the state of climate-risk and resilience reporting today, where climate-risk reporting frameworks and regulations appear to be headed in the future, and how they are helping their clients navigate the changing terrain. Jonathan Yates leads Arup’s Transaction Advice business in New York and has more than 25 years’ experience advising infrastructure clients in both the public and private sector. Ibrahim Almufti is a design, risk, and resilience thought leader who works in Arup’s Advanced Technology + Research group. Heather Rosenberg is Arup’s resilience leader in the Americas and has spent 20 years leading sustainability and resilience projects for organizations ranging from local governments and real estate investment firms to transportation authorities and social justice organizations.
There was initially a lot of concern that the pandemic was going to put the climate crisis on the backburner. Has that been your experience?
Heather Rosenberg: If anything, the pandemic has opened people’s eyes to climate risk in new ways. It’s one thing to be told that everything in the social, environmental, and economic ecosystem is interconnected. It’s another thing to see this principle in action, as we have during COVID-19. We can now see clearly how a catastrophe in one area creates all kinds of cascading effects.
Ibrahim Almufti: I agree that climate risk is top of mind for many of the clients we’re talking to these days. We’ve seen huge demand from organizations looking to better understand their climate change-related risks, both at the asset level and the operational level.
Jonathan Yates: I think the COVID-19 pandemic has really underscored the importance of making your organization resilient to a broad range of risks, including climate-related risk change. Many of the investors we work with have built resilience by diversifying their portfolios and they have largely avoided major problems as a result. Instead of having the bulk of their assets wrapped up in, say, the aviation industry and taking a major hit when demand shrank, their portfolios were diversified and resilient.
What is transition risk?
Any financial or economic risk related to transitioning to a less polluting, cleaner-energy economy.
Transition risks can vary widely, depending on the project, context, and sector and can cover anything from the economic implications of changes in climate and energy policy to the costs associated with implementing low-carbon technologies.
What is transition risk?
For instance, a developer that is looking to build luxury condos on the Florida coastline over the next 15 years could face transition risks, such as:
- Increasingly strict energy performance codes and requirements for decarbonization and electrification
- Increasing costs of materials and equipment over time due to implementation of carbon pricing
- Opportunity to differentiate by providing zero carbon options where few similar products currently exist
For the uninitiated, can you clarify what TCFD is?
Ibrahim: TCFD, or the Taskforce for Climate-related Financial Disclosure, provides guidance on how to make disclosures related to climate risk. TCFD recommendations cover both physical risk and transition risk. So TCFD is about understanding how climate-related hazard events might impact an organization’s assets and business, as well as how the transition to a low carbon economy might impact revenues over time.
What are some common challenges clients face when it comes to climate-related reporting frameworks, like TCFD?
Heather: Climate-risk reporting is still evolving, which means there’s still a lot of confusion out there about how best to do it. With a variety of frameworks and little in the way of regulation, it can be difficult for organizations to determine which reporting mechanisms are going to be the best match for their internal needs and which ones provide the information most relevant to their investors.
We find that to drive change, it’s often necessary for our clients to use a variety of metrics and reporting tools. Using a combination of strategies allows them to track the information they need, so they stay on the right track and avoid green washing. But to do this you need strong leadership and focused implementation over time.
Jonathan: The investors we work with often run into issues because they’re trying to meet competing goals. On the one hand, they want to use climate-risk tools to de-risk investments and meet their shareholder’s expectations. On the other hand, they need to stay competitive. And these two goals aren’t always easy to reconcile.
If TCFD, or other climate-risk disclosures, reveal significant physical or transitional risks that impact the overall value of the investment, then this could be reflected in the bid price, jeopardizing their ability to compete. A lot of what we do during a due diligence assessment is help clients strike the right balance between managing climate risk and responding to the realities of the competitive marketplace they operate in.
Ibrahim: Just to piggyback off what Jonathan said, part of the issue for the clients we work with is that today’s investors vary a lot in their sophistication. Some want a high level of detail on how a company is mitigating their climate-related risks. But a lot them still treat climate-risk reporting as a box to check. So where do you draw the line between too much disclosure and not enough?
Heather: Yes, because right now that line is not drawn for you. Unlike reporting frameworks like GRESB that provide a standard set of questions for organizations to address, TCFD is more of a broad mandate: You should address physical risk to your assets and transition risk related to changing markets, and you should disclose that to your investors. This is great, in theory, but there’s no real consistency in the way it’s applied, which makes TCFD a relatively blunt instrument. All companies are really required to disclose at this point is information on their processes for risk assessment and mitigation, which is just a small part of the story.
Do you see any effort to address these challenges?
Heather: My sense is that things are changing rapidly. A few years ago, I worked with GRESB to integrate climate-risk and resilience reporting into their reporting system. The GRESB Resilience Module we developed consisted of a voluntary set of questions. It was designed to run for three years and in each of those years, GRESB adapted the module to align with TCFD.
We’re now working with them to digest the lessons learned from the Resilience Module and think through which metrics can be brought into the core system going forward.
What is GRESB for those who don’t know?
Heather: GRESB (the global ESG benchmark for real assets) is an ESG-reporting system specifically targeted at the real estate industry. The scope of ESG (environmental, social, and corporate governance) is quite broad, but up to now GRESB and other ESG-reporting frameworks have primarily been used to report on environmental performance.
So integrating TCFD into GRESB will allow companies to use an ESG-reporting framework to capture information on both sustainability and climate risk. Will doing that help allay confusion about how TCFD should be applied?
Ibrahim: It’s a step in the right direction. It’s also indicative of a larger trend toward incorporating some level of climate-risk reporting into corporate sustainability reporting. The Sustainability Accounting Standards Board is also working to integrate TCFD so the market is beginning to align.
We’re also starting to see more government regulations around TCFD and climate risk. The UK is beginning to require alignment with TCFD for some companies and New Zealand will require compliance starting in 2023. I think it’s just a matter of time before we see similar regulations emerging in the US.
Jonathan: We’ve definitely seen growing interest in TCFD among our clients and the more rigorous and standardized the framework gets, the stronger its foothold will become, I think.
The other issue that often crops up in our work with investors is that TCFD disclosures are entirely voluntary. They aren’t subject to external audit in the same way that the finances of a company would be audited on the basis of international financial reporting standards, which means those wishing to invest capital have to undertake some of their own due diligence.
American investors have raised billions to put into projects with the right set of sustainability and resilience criteria, but it can still be quite hard to identify and vet those projects effectively. What they’re looking for now is a robust framework they can be confident offers a comprehensive and accurate picture of long-term resilience.
It sounds like it will take time for TCFD and other climate-risk reporting tools to reach full maturity. In the meantime, how are you helping clients ensure that they’re adequately addressing climate-related risks to their physical assets and overall business model?
Heather: A big part of our work is helping clients set priorities and identify which actions and reporting frameworks will provide maximum return on their investment. In other words, which climate-risk “product” or combination of products will do the best job of enhancing performance, managing risk, and improving transparency.
In some cases, our clients are choosing to report across multiple frameworks to better convey different aspects of their portfolio performance.
Jonathan: I think Arup is uniquely positioned to help investors who run into issues related to climate-risk disclosure, because we understand how to structure a successful project-finance or mergers and acquisitions transaction, and also have a deep understanding of how to integrate resilience in the built environment. When a client needs to find ways to optimize a project’s whole-life cost, we can work with our in-house infrastructure and design specialists to find the right technical solution.
Ibrahim: We’ve been working with a lot of clients who want to go beyond the TCFD-type guidelines and truly understand their risks in terms they can grasp. I think our multidisciplinary knowledge enables us to help our clients better understand the complexity of the climate-risk hazards they face and to find the right path forward for their organization.