Seeing through the 2 degree C lens

What will Australia be like if global mean temperatures rise by 2˚C or more? Evidence suggests that there will be increases in extreme weather events, sea-level rises and more extreme bush-fire seasons to name just a few increased challenges.

There may also be opportunities from changes in weather and rainfall patterns for some areas. Ultimately all organisations will need to assess the impacts of these changes on their business or operations. What impact will it have on your customers? What will they need and want, and how will you respond? Where and how will you generate sales and deliver service? What does it mean for your assets now and in the future? Your costs, your profitability and returns to shareholders? And will your need for capital increase?

This all means that organisations will need to view the world through this 2˚C lens. The Paris COP21 Agreement is ratified and countries are starting to implement irrespective of any changes in the US stance. The agreement focuses signatories on keeping the global mean temperature rise below 2˚C, and that includes Australia – and doing this will be a challenge

Seeing through the 2 degree C lensGlobal and local disclosure requirements
The global Financial Stability Board’s Taskforce on Climate-related Financial Disclosure (TCFD) recently published recommendations for the disclosure of this information. Companies will need to think through and disclose the systemic effects of climate change on their finances and operations so that they can answer the question of what their business will look like financially under a 2˚C world or other scenarios.

In February 2017, APRA announced that it too will be asking questions of insurers and banks on what these temperature rises will mean.

The two main risks are physical and transitional which APRA describes thus:

  • Physical risks stem from the direct impact of climate change on our physical environment – through, for example, resource availability, supply chain disruptions, or damage to assets from severe weather.
  • Transition risks stem from the much wider set of changes in policy, law, markets, technology and prices that are part of the now agreed transition to a low-carbon economy.

At Deloitte we assist clients assess these impacts including modelling and developing scenarios to consider impacts on their organisations of 2˚C world taking into account exposure to both physical and transition risks.

For physical risk we can assess companies’ exposure to weather related events, such as coastal erosion or flood, on property portfolios – both those owned directly and indirectly, e.g. by a bank through its home loan portfolios. There are of course a number of challenges, including access to the right data and models of climate change and physical damage.

For the first time significant improvements in geospatial modelling using cloud computing, improved climate data, and property data have made these types of stress tests feasible.

While insurers have been looking at this issue for many years, their models only extend to the next 12 months. We have had to go back to the drawing board to redesign models from the ground-up to look at longer time horizons like 10 years and more.

While that may seem a long time out, banks have already written home loans up to 30 years so are exposed to potential climate related losses. Banks will also need to think through how this new information impacts responsible lending, and how best to engage with their customers over this.

For transition risks, companies need to drill down into their investment portfolios to assess their exposure to investments in high carbon intensity industries. Widespread adoption of the Financial Stability Board’s TCFD recommendations, will make this process a lot easier for investors. But in the early stages understanding the supply chain and the exposure to climate risk is a complex challenge, as well as how to communicate the results to all stakeholders.

As the regulator APRA begins to look through this 2˚C lens, the world changes in sometimes unexpected ways, bringing new challenges for banks and insurers.

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