June 10, 2020

By Katherine Monahan

 

Every good business or investment decision is based on sound data and analytics that help determine the greatest return over time. Of course, not all factors affecting costs and benefits can be predicted, so a certain degree of risk is always present in the Canadian economy – and the financial sector is skilled at integrating these risks into decision-making frameworks.

But financial actors have been slow to recognize how climate change presents material risks and how these risks continue to accelerate. In part, this is because of the uncharted nature of climate change. But we can also pinpoint more tangible barriers.

The Bank of Canada has only recently begun to examine climate-related risks. Last month, they published scenario analysis for the first time acknowledging there are “significant economic risks from climate change and the move to a low-carbon economy”. Examples of progress in the private sector include BlackRock, the world’s largest asset manager, which confirmed in January that it will make climate change central to its investment strategies.

But these types of initiatives can only be replicated if financial actors have the right data and analytics to support climate-related risk analysis.  The Task Force on Climate-Related Financial Disclosure (TCFD) points to transparency gaps, particularly in financial reporting, that are impairing the decision-making abilities of investors and financial institutions. Meanwhile, corporates argue that they do not always have the data needed to provide this transparency.

Although a wide range of voluntary reporting standards are available, and ample climate and energy data exists, the financial sector is hampered by challenges around comparability, reliability and accessibility of this data. The resulting knowledge and information gaps lead to market failures, where climate risks and opportunities are not well captured, slowing progress on the low-carbon transition, and leaving Canada’s financial system vulnerable to the risks of climate change.

The challenges around climate-related data and analytics was one of the clearest needs identified by the Expert Panel on Sustainable Finance. In their 2019 final report, they called for the establishment of a Canadian Centre for Climate Information and Analytics (C3IA) as an authoritative source of climate information and decision analysis to help fill these gaps.

At a high level, climate change presents two types of risks to the finance sector:

 

1) Physical risks from climate change

The accelerating frequency and intensity of acute climate events can destroy infrastructure and cause disruptions to supply chains and workers’ health. More chronic pressures from a changing global climate means that past trends are poor indicators of the future.

Financial consequences from climate change are already being captured through insurance claim data. Canadian insurers are now facing claims on natural catastrophes of at least $1 billion annually, up from an average of around $400 million annually a decade earlier. Likewise, the Disaster Financial Assistance Arrangements, managed by the federal and provincial governments, has paid out $5 billion in post-disaster assistance since 1970, with over half of this amount paid in the last five years.

As a direct example, the large California utility company PG&E’s bankruptcy was widely touted as the first “climate change bankruptcy in the United States”, with shareholders losing more than $20 billion. Wildfires, that swept its service area in 2017 and 2018, were aggravated by extremely hot, dry conditions. Several articles noted that “it might be the first climate change bankruptcy, but it won’t be the last” and pointed to areas like coastal real estate that could see values fall as climate change accelerates.

 

2) Transitional risks and opportunities from climate change

The transitioning nature of energy and climate policies can increase costs for higher-emitting industries or practices, while creating opportunity for lower-carbon technologies and other alternatives.

The European Union’s legislative framework to decarbonize the building sector, for example, means that the commercial real estate sector could face costs to comply with minimum energy-performance requirements for their existing buildings, increasing transition risk for the sector.

Yet there are opportunities related to transitions too. The EU policy will also cause an increase in demand for low-carbon buildings and related technologies as well as all the related skills in design and construction. Financial actors can position themselves to leverage these changes to investment and consumption patterns.

 

The Challenges around Data and Analytics

Although the importance of these risks and opportunities are increasingly clear, there are increasing calls for more granular and comparable data in order to integrate risks into business, investment and insurance-related decisions.

This includes elements such as:

  • Better tools to judge exposure to physical risk; such as more granular mapping of physical risks to different asset classes;
  • Better tools to support forward-looking scenario analysis and stress testing;
  • Better understanding of the carbon intensity of assets and practices within investment portfolios, as well as business supply chains;
  • More consistent taxonomies around what constitutes “green” or “transition-aligned” assets or practices.

Recognizing, reporting and tracking climate-related risks and opportunities is a fundamental building block to sustainable finance. Improvements around these types of data and analytics would:

  1. Help build resilience to physical risks;
  2. Improve the quality of climate-related risk disclosure;
  3. Leverage investment capital towards low-carbon technologies and solutions.

Canada’s pathway to reducing greenhouse gas emissions and building resilience to climate change will ultimately depend on the allocation of capital. Making smart decisions around the allocation of capital demands robust and trusted data and analytics.

Katherine Monahan

Senior Research Associate