Select Page

Fundamentals of Climate Risk Management

by | May 15, 2022 | ESG

Introduction

Climate change is a major worry due to the severity of the potential consequences and the uncertainty associated with climate change estimates. There has been an upsurge in concern in recent years about how we can anticipate, assess, and control the threats linked with climate change. The Planet’s surface temperature has risen at an unprecedented rate in recent decades, posing hazards to life, ecosystems, and the economy. More warming is unavoidable, according to climate experts, during the next decade and most likely after that. Climate risk management refers to the actions and strategies used by individuals, organizations, and institutions to support climate-resilient decision-making. Its mission is to encourage sustainable development by maximizing the positive benefits of climate change solutions and reducing negative consequences across the whole range of geographies and sectors that may be affected by climate change.

Every day, we see the consequences of climate fluctuation and change. Extreme weather and climate change have a negative influence on integration and development and future development progress. It is a development issue with immediate ramifications for hunger, poverty, war, water shortages, infrastructure integrity, sanitation, illness, and survival.

Climate Change Risk

Climate risk assessments are based on a rigorous examination of the implications, likelihoods, and reactions to the impacts of climate change, as well as how social restrictions determine adaptation alternatives. Climate change consequences are expected to worsen in the future decades, despite mitigation measures, because the climate system is no longer keeping within a fixed range of extremes.

The evolutions in the climate system make estimating hazards more difficult. Applying existing information to comprehend climate risk is made more difficult by significant variances in regional climate forecasts, an increasing number of climate model findings and the requirement to pick a suitable collection of future climatic scenarios in their assessments.

While climate change affects all countries, studies find that the poorest countries may be more vulnerable since their climates are typically closer to harmful physical limits. They also rely more on outside labour and natural capital, and they have fewer financial resources to adjust fast. One example of how poorer nations may be more exposed to climate risks is the risk connected with the impact of increased heat and humidity on workability.

In the face of these difficulties, policymakers and corporate leaders will need to put in place the appropriate tools, analytics, processes, and governance to correctly assess climate risk, adjust to risk that has already been locked in, and decarbonize to avoid additional risk accumulation.

Climate Change Risk Management

Climate risk management is a broad word that refers to a method of making climate-sensitive decisions. The strategy aims to improve long-term development by lowering the vulnerabilities associated with climate risk. CRM includes techniques that attempt to maximize good and minimize negative results for communities in sectors such as agriculture, food production, water management, and health.

Early-response systems, dynamic resource-allocation rules, strategic diversification, financial instruments (such as climate risk insurance), infrastructure design, and capacity building are all examples of potential climate risk management activities. A climate risk management approach, on the other hand, tries to optimize possibilities in climate-sensitive economic sectors, such as farmers who use favourable seasonal forecasts to enhance crop yield.

CRM combines the two research streams of Climate Change Adaptation (CCA) and Disaster Risk Reduction (DRR) into a framework for sustainable development.

Comprehensive Climate Risk Management seeks to address and mitigate the negative consequences of climate change by averting climate risks through reduced greenhouse gas emissions, reducing climate risks through adaptation, and risk management or managing residual climate risks through instruments such as climate risk financing or transformative measures. CRM is a concept that includes the following mutually reinforcing phases and should be established with the cooperation of stakeholders from all industries and scales.

Fundamentals of Climate Risk Management

Climate Change to Financial Risks

By the year 2100, climate change will have put roughly 2% of the world’s financial assets in danger. In the worst-case scenario, up to 10% of global financial assets might be in danger by 2100. Such is the magnitude of the disaster that we should be prepared for and we must increase our preparations right now.

Climate change will force significant structural changes in the global economy. Such fundamental developments will obviously have an influence on banks’ balance sheets and operations, resulting in both dangers and opportunities. While coastal mortgage portfolios may be subject to the physical effects of climate change through sea-level rise and floods, enormous quantities of cash and new financial instruments will be required to fund the shift and finance climate resilience, boosting demand for bank services.

Climate catastrophes create “physical hazards” that have a direct influence on our society and have the ability to harm the economy. People will grow more reliant on insurance to pay the expenses of damage to their homes and automobiles if these incidents become more common.

As the number of weather-related insurance claims increases, insurance firms have more money to pay out, raising everyone’s premiums. If businesses and households are uninsured, they may be forced to pay the price themselves. In both circumstances, the consumer pays more money.

Meanwhile, authorities are starting to take action, and investors, clients, and civil society are seeking action, adaptation, mitigation, and transparency on the issue.

Businesses have handled climate change via the prism of Corporate Social Responsibility (CSR). With rising financial stakes, more external demands, and new rules, the traditional CSR strategy is no longer adequate. Climate change has become a financial concern for banks and must be managed as such.

Climate Risk Regulators and Expectations

There has been a continuous increase in regulatory and supervisory activity in recent months to monitor these climate-related systemic risks and analyze their influence on global financial stability. This is accompanied by an increase in climate awareness among major financial firms. With other developed countries catching up worldwide, it may continue to look to EU and UK financial authorities as a model.

The organization intends to increase its attention on climate-related disclosures in public and corporate filings and to uncover any major gaps or misstatements in issuers’ disclosure of climate risks under current standards.

Climate regulatory exercises focus on the resilience of financial institutions to climate change; nevertheless, the volume and breadth of climate-related exercises vary greatly among jurisdictions. Modelling climate-related hazards are still in its early phases of development. Nonetheless, precise climatic scenarios are provided, and the results are consistent and comparable.

Financial institutions’ awareness and disclosures about how they handle climate risk will grow. In 2022, there will be no fines or additional capital requirements, but the data will be utilized to drive choices (regulatory expectations, risk management) and define best practices.

Climate Risk Measurement

You can not manage things; you can not measure. When we talk about climate risk management. Measuring the extent of climate risks is a vital process. Climate change poses numerous and difficult-to-quantify threats to human and environmental systems. Now, research has developed a composite indicator of global climate risk that may aid in tracking progress in tackling climate change.

Because climate change causes both short-term and long-term changes in social and economic situations, a risk assessment technique must go beyond just evaluating changes in the nature, amplitude, or frequency of physical occurrences. To put it another way, the human and societal consequences of climate change are more significant in the long run than the actual physical changes to the climate. Individuals and society are affected by the consequences of these changes, not the changes themselves.

Within the wide scope of risk assessment, it is feasible to conduct evaluations ranging from qualitative to numerical in nature. As uncertainty diminishes, so does the usage of analytic and numerical tools, and so does the capacity to comprehend the system under changing conditions.

The natural hazards-based method of climate risk measurement begins by characterizing the climatic hazard(s), which may be written as:

  • Risk = Probability of a climate danger × Vulnerability

The vulnerability-based method begins with characterizing vulnerability in order to provide criteria for assessing risk, such as the possibility of surpassing a critical threshold.

  • Risk = (Probability of exceeding one or more vulnerability criteria)2

Measuring Climate Risk n Detail

Climate Risk Assessment

There are two basic techniques for measuring climate risk: natural hazards-based and vulnerability-based. These methods are mostly determined by whether the initial emphasis is on the biophysical or socio-economic aspects of climate-related risk. In other words, is the focus on climate risk or on socioeconomic outcomes? These two techniques complement one other and can be developed individually or together.

Natural hazards-based approach: This approach to climate risk assessment begins by characterizing the climatic hazard (s). In general, the hazard is fixed at a specific level and is used to evaluate changing vulnerabilities over space and/or time. For example, a flood of a certain height or a storm with a certain wind speed may become more often over time, raising the risk.

Vulnerability-based approach: Fixing the vulnerability level enables the size and frequency of climate-related hazards that contribute to the vulnerability to be diagnosed. According to Carter et al., this is the “inverse approach” (1994). While this approach is frequently utilized in other areas, it has not been widely employed for analysing climate change risks.

The policy-based approach and the adaptive-capacity approach are two further approaches:

  • Risk assessment approaches may be employed in the policy-based approach, where:
  1. A new policy is being developed and evaluated to see if it is resilient to climate change.
  2. A current policy is put to the test to determine if it can handle the danger posed by climate change.
  • The adaptive-capacity technique looks at a system to see whether it can improve its ability to cope with climate change, including unpredictability. This strategy will also be influenced by a greater understanding of climate hazards.

Climate Risk Modelling

Companies have traditionally utilized various modelling tools to analyse their risk profiles over a wide range of variables. Incorporating climate into those activities now is a critical step toward creating a more resilient future—protecting your facilities, resources, investments, and people.

Climate modelling tools use future climate change prediction data to offer a picture of potential physical dangers that might have a significant impact on enterprises. Some of these tools, such as high-level risk ranking models, give risk ratings to regions without taking into account how climate change may alter those risk scores over time. Climate-adjusted danger risk score models, on the other hand, take climate change into account.

For example, they calculate risk scores depending on the threat presented by floods, wildfires, and droughts today and in the future under various warming scenarios. The insurance industry’s catastrophe modelling tools combine extra exposure information to offer a view on measures like physical losses and business disruption.

While climate risk disclosure requirements are the most prevalent motivator for action, top organizations have begun utilizing climate risk modelling results to support strategic decisions—whether that means flourishing in a low-carbon future or withstanding the physical repercussions of a changing environment. Read More

 

Author

  • The author has done a master's in Environmental science and is currently working as chief Environmental Advisor with New Delhi State Government.

0 Comments

Submit a Comment

Your email address will not be published.