Climate risk is the defining issue of our generation, but it is the velocity of climate change which will have the greatest and most profound impact upon our lives. Climate risk is a long-term science-based, non-diversifiable risk, impacting and affecting all industries. To the corporate world, climate risk is a balance sheet risk, a profit and loss risk and more importantly a reputational risk. The risk requires firms to think about assigning a set of comprehensive roles and social responsibilities/values that can be measured up and be accountable to mitigate the challenges posed. Through climate change, one sees the interconnectedness of emerging risks, with the current pandemic, a manifestation of both the velocity and acceleration of this risk, ushering in a change transformation of both thought, word and deed.
Business Model Changes
COVID 19 is a dress rehearsal for climate change, a harbinger and abstract of what is in store down the road. The current pandemic is an agent of change, causing disruption and requiring firms to adapt their business models to accommodate these changing circumstances. Such a change can be seen in the realm of stress testing and scenario design, (which are the common tools used to identify, measure, quantify and review enterprise risks both known and unknown), with the data provided by COVID 19 adding more realistic data and testing parameters to the emergence of climate change. Stress testing and scenario design have been around for a while but what has changed in this pandemic is the need to repurpose/enhance existing models, whilst at the same time, overlaying and incorporating new thinking and parameters. Common issues such as data quality, information technology and risk management have had to be structurally addressed to ensure that the resultant output of these test results is both meaningful and transparent to its many users. The pandemic has asked questions on the gathering, collection and frequency of data utilized, requiring, and enhancing data sets which can be introduced and populated for climate change modelling.
COVID 19 has ignited and obfuscated the current climate change debate, with politicians from all walks of life, trying to distract and manipulate the debate for short term considerations .This political uncertainty is amplified by the fact that firms operating in multi jurisdictions , will have to cater to the differing lenses and perspectives of a constantly changing central government policy. If the way out of the current pandemic comes in the form of a green viral, it may be that the corporate world needs to take the initiative, striving to do what is right, leading to greener pastures.
Firms have now been forced to plan to include climate risk within their portfolio of risks, with a framework that includes the five pillars of governance, risk management, strategy, pricing and metrics. The lynchpin of this framework, is governance and this is evidenced by company boards driving and dictating the change, rather than senior management; setting a whole new sense of social and commercial responsibility, the likes of which have never been seen before. Moreover, boards now have had to educated at short order with many turning to colleagues from the insurance industry who have a wealth of experience in forecasting and dealing with the long-term implications of climate. It is becoming self-evident to boards that firms very existence is wrapped up in the way they approach climate risk and the efforts needed to improve their continuing viability, sustainability and resilience. This Climate change DNA is invoking for the few who walk this path, a strong culture of compliance and governance focusing on quality returns and maximizing the customer experience.
Many firms have been forced to disclosure their efforts by means of written narrative in their financial reporting. The quality of their disclosures will be under the microscope with stakeholders alike, looking to see that the words have been translated into concrete actions. Boards and senior management will be watched with eagle eyes on how they behave with any discrepancies, the subject of litigation and social media scrutiny. The messaging will be all important and could be part of the sustainable company brand. The requirements need to comply with the above measures are exacting, with financial institutions now needing to monitor their customers green efforts and behavior by means of covenants and warranties. The covenants and warranties are far reaching extending to both funding and investment decisions, in terms of research and development and capital expenditure. Lending firms are becoming more closely identified with their customers and their borrowing policies, a reflection of their climate corporate governance. This gives the opportunity for lending firms to position themselves as “green” role models and brand their lending accordingly. The more astute firms will take this onboard with performance tables being designed and produced indicating the applicability of climate risk standards, enabling the corporate world to be benchmarked against one another.
Above all, climate risk must be thought of as a commercial risk, the institutions that embrace these changes and adopt, reinforce corporate values which can be a game changer in terms of reputation and culture. Those institutions that adopt a higher purpose with a climate moral compass are likely to experience anecdotally a more coherent and collective culture. This culture change can be seen as a competitive advantage, but it must be remembered that there are costs associated with the introduction of this climate change vision. Embedding this change transformation requires a sustainable reengineering in terms of business practice and models, demanding investment in different skills sets and training.
Mankind is watching and the question is, do you want to be the shepherd or the sheep, the choice is yours?