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ESG is now old paradigm when climate might flood your site or damage your buildings

Riverside in Perth, Western Australia. Photo by Josh Spires | @drone_nr on Unsplash

Ratings agency Moody’s Corporation’s recent acquisition of Four Twenty Seven, a Californian company that measures the physical risks of climate change, signals a step change in how markets price risk related to climate heating.

The acquisition includes data, intelligence and analysis relating to physical climate risks. If Moody’s uses its full potential some serious repricing could be about to take place.

Four Twenty Seven has built one of the most comprehensive databases on the exposure of assets such as bonds and stocks to climate change, according to Bloomberg.

It assesses sites and “their exposure to heat stress, floods, wildfires, hurricanes and other extreme events that become more frequent as the climate changes, and figuring out how vulnerable the company’s suppliers and consumers are to the same phenomena given their predicted frequency,” reported Bloomberg.

“Before regulatory and reputational hazards even kick in, there’s the danger that fields and mines will be flooded, buildings ruined, supplies disrupted; in that sense, for example, a concentration of assets, especially in disaster-prone areas, should be a warning sign to investors.”

It’s part of major shift under way in how markets are pricing climate change risk – from something that’s largely reputational to something that’s very much material and financial, Bloomberg said.

“The science is increasingly unequivocal and precise. No, it’s not about normally changeable weather or any kind of natural climate cycles; the change is happening because of human activity, and it’s unprecedented in the last 2000 years.

“This means the old paradigm of discussing climate change as part of so-called ESG (Environmental, Social and Governance) risks is inappropriate.

The Carbon Market Institute’s (CMI) chief executive officer John Connor agrees.

Connor was CEO of the Climate Institute for 10 years before a two-year stint working on climate issues for the Fijian government. He keeps a close eye on the investment side of climate risk.

The awareness of risk beyond environmental social governance issues into material risk is moving swiftly, he says.

Significant developments include central banks raising questions about financial stability in relation to climate change, with the Reserve Bank of Australia deputy governor Guy Debelle warning climate change could cause financial shocks if not planned for appropriately.

Financial regulators have also come out strongly. Back in March, the Australian Prudential Regulation Authority called on entities to “move from gaining awareness of the financial risks to taking action to mitigate against them”. The Australian Securities and Investments Commission has also indicated it will supervise regulated financial entities on how they are managing climate change risk.

Connor says more companies are reporting against the Task Force on Climate-related Financial Disclosures (TCFD) than ever before.

Companies such as Rio Tinto are moving out of coal, and other companies in the climate hot seat are reshaping their portfolios.

In the built environment, Connor has observed some positive movements in new builds, with many of the big players setting climate goals.

This still leaves “massive problems in terms of legacy assets”. However, along with this comes growing exploration of sustainable materials.

Addressing climate change risk almost mandatory

Chief executive officer of the Responsible Investment Association Australasia (RIAA), Simon O’Connor, says Australia’s finance sector is moving to an almost mandatory consideration of climate risk.

He says this is driven by a range of factors, not least the strong stance taken by regulators.

They have all assessed the state of play and are saying there’s been “some activity but it’s too little and not adequate”.

O’Connor says there’s now an expectation that listed companies will not just disclose but will also provide evidence that they are managing climate change risks.

“It’s not going so far to make it mandatory to disclose against TCFD but it’s their preferred standard.”

He says their posturing is “as close as you can get without it being mandatory… you could interpret that it’s pretty much mandatory.”

Investors, not just institutional investors, are starting to disclose their risk. However, they need better disclosure from the companies they invest in before they can realistically disclose their own exposure.

But O’Connor says there is some “really good reporting” emerging.

“The trend is only moving in one direction and that is towards greater disclosure and greater action around risk, and it is changing really rapidly.”

What’s ESG’s role?

ESG must remain at the foundation of these reforms, says CMI’s Connor.

“If we’re not building healthier, more equitable communities than these reforms may become precarious,” he says.

“It’s still important to have those as a focus, but we are now looking at a quantum leap for the greatest repair job in human history.

“The prism needs to shift, it’s not just sustainability anymore. We’ve moved beyond that because things are so stuffed. We’ve got to move to regeneration, we need to repair.”

RIAA’s O’Connor sees the recent clamour to address climate change risk as part of a maturing focus across the ESG spectrum. Other ESG issues such as modern slavery are also seriously impacting markets.

“What climate change does is highlight how financially significant these ESG issues are and only strengthens ESG investing.”

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