Opinion: Measuring climate risk and its importance

Global awareness of the dangers posed by climate change has probably never been greater than today. The impact from a heating planet is being felt around the world. According to a report by NGO Christian Aid, the top ten most impactful extreme weather events in 2022 cost more than $168bn in damages combined.

Against this backdrop, political willingness to implement policies that reduce greenhouse gas emissions, and thereby limit global warming is growing. But even as companies around the world are setting targets to reduce their carbon footprint and align themselves to climate targets, the path to net zero is not without risk. Indeed, few companies are looking closely at how the mounting pressures to decarbonise are leading to costs and reputational risks for companies in sectors where emissions are hard to abate.

Within the financial community, this is referred to as transition risk. At the same time, the growing impact from extreme weather events will gradually lead to higher economic costs, reinforcing the need to invest in climate adaptation strategies. Although “loss and damage” financing was part of the official COP27 agenda for the first time, most companies do not yet consider how these so-called physical risks will affect them.

What measuring climate risk means for companies in the UAE

For UAE-based companies in our dataset, climate physical risks are projected to increase, on average, only mildly over the course of the century.

In 2030, UAE-based companies will face a 58 per cent chance of being affected by climate physical risks. Individual companies could face much higher risks, however, depending on their geographical footprint throughout the world.

For some UAE based companies, the chance of being affected by climate physical risks in 2030 is as high as 80 per cent. Savvy investors will want to be hedged against both transition risk and physical risk, while maintaining good investment returns. To do this well, investors need to address three fundamental challenges.

Understanding the challenges

The first challenge is to understand how companies are exposed to climate risk. To determine a company’s exposure to climate-related risks investors need non-financial data, unlike for traditional types of financial risk. For transition risk, for example, key factors to take into account include a company’s carbon footprint and its transition plans. Such data is not traditionally reported by companies, and to help investors plug that gap vendors have developed models to estimate emissions, and solutions to understand whether companies are on track to achieve net zero targets.

Another challenge to consider is how to derive the potential impact from climate risk. As climate change is unprecedented, forward-looking data and models are needed to capture the future financial impacts from climate risk and give plausible predictions of how climate policies, energy technologies and the physical environment could evolve.

Finally, there is the question of how to incorporate climate risk assessments into investment decisions. Given that climate risk assessments rely on non-traditional datasets and models, questions arise around how to use the insights from such assessments in actual investment decisions. For example, how should longer term climate risks be factored into shorter term investment strategies? How should different future scenarios be weighted so as to allow for probabilistic impact metrics, such as a climate value-at-risk?

In light of these challenges, the task of incorporating climate financial risk in investment decisions can feel overwhelming. This is where climate risk data and tools need to be integrated into investment decision-making processes. To make strategic climate-informed decisions, it is crucial to understand how company performance could be impacted across a range of scenarios.

However, thanks to increasingly reliable data and insightful analytics, climate risk management is set to become business as usual.

The writer is the head of climate for Core Product Sustainable Finance Solutions, Bloomberg LP.

Also read: Climate change: The GCC’s role in this equation