CLIMATE RISK
R&C: Could you provide an overview of the key climate risks facing businesses?
Plochan: When talking about the impact of climate risk, it is important to make a distinction between corporates and financial institutions (FIs). We also need to make a distinction between the physical impact and the transitional impact of climate change. For corporates, there is a physical risk resulting from climate change that would impact their operations. For example, a farmer who grows cotton is dependent on water supply and is therefore exposed to changing patterns in rainfall that may reduce water supply. That is a physical impact. In terms of transitional impacts, if we continue the example, the farmer is also exposed to any changes in government climate change policy related to the transition to a low carbon economy. Such measures may introduce penalties for water-heavy plant production, such as cotton production, and that would impact the farmer’s revenues. As for FIs, a range of corporates that may experience financial instability due to climate change are included in their portfolio playbooks, both current and long, which exposes FIs to the impact of climate change on their borrowers. So climate change risk manifests as increased credit risk in FIs’ portfolio books. But there is a separate dimension for FIs: they are also exposed to the physical impact of climate change on their own operations. For example, a facility containing data servers may flood due to heavy rainfall. In terms of transitional impact, FIs may suffer penalties for financing heavily polluting projects. In this sense, operational, strategic and reputational risk for FIs can be a manifestation of climate change risk. There is a taxonomy introduced by the Network for Greening the Financial System (NGFS), an organisation formed in 2019 that contains 60-plus central banks and regulators, which drafted a number of guidelines on how banks and financial institutions should respond to climate change risks.
Jan-Mar 2020 Issue
SAS Institute Inc.
Standard Chartered Bank