Climate risk is being recognized by various stakeholders as a very real risk to the world we know and it is believed that we will soon face drastic and unforeseeable consequences induced by climate change. The World Economic Forum’s Global Risks Perceptions Survey 2018–19 revealed extreme weather events, failure on climate change mitigation and adaptation, and natural disasters as the three most likely risks of significant concern. However, despite the severity of the threat, there is still a stark disparity between what needs to be done and existing policies.
The effects of climate change will be felt on many levels, from deterioration of ecology and public health to economic slowdown. While there has been an existing discourse around rising sea-levels, extinction of numerous species etc. the fact that climate change will in fact have dire consequences on the economy and livelihoods is starting to get recognised more recently. This has been acknowledged by a number of big players in the financial sector, including the Bank of England, McKinsey, IFC etc. Climate risk is going to destabilize the economy in the following ways:
- As the earth continues heating up beyond 1.5 degrees celcius, natural disasters may strike with greater impact and frequency.
- Either pre-emptively due to the Paris Agreement and other policies or due to compulsion, climate-related regulation and legislation will increase in the near future.
Both these cases, it is felt could result in a chain reaction in the financial sector, also been referred to as a climate-induced Minsky moment; like the 2008 recession but on a larger scale. Investors in the coming years will be faced with three kinds of risks namely physical, transition and liability. Physical risk will be due to natural disasters and destruction of biological systems (including agricultural yields directly affecting the foundation of developing economies). Transition and liability risk will be due to the drastic changes the global market will have to make to adjust to a low carbon economy from the current carbon-intensive economy.
It is telling that the scenarios mentioned aren’t the distant future but reality, and we’re approaching doomsday at breakneck speed. A key factor behind that is the lack of prioritization, where despite progress in building environmentally-conscious practices there is still a reluctance to switch to them. For example, though the renewable energy sector has progressed, the carbon emissions generated by fossil fuel consumption are at a record high.
In order to tackle this problem, there is a need for a ‘grand coalition’ where the governments, the private sector, scientists, non-profit organisations and local stakeholders come together.
There is also a call for more integrated multidisciplinary research. For instance, research on the Russian heatwave concluded that taking into account more factors than one improves estimates of the likelihood of an adverse climate-induced disaster. The logic is simply that when there is an increase in the heat, it leads to greater precipitation which then affects the soil’s fertility and nutrient structure. And lastly, a key requirement to aiding a smooth transition to a low carbon economy and take measures to combat the threat of climate risk is high quality monitoring of environmental parameters and closing the data gap. This will help in the following ways:
- Allow industries to see how they can change their processes- proactive risk management
- Allow for more effective re-allocation of capital- eg. using pollutants as raw materials
- Allow investors to make sustainable investments with better information- ESG Due-diligence
- Quantifying climate change risk and assessing the same.
- Help insurance companies mitigate insurance losses as they increase from 1 in 100 to 1 in 10 or 1 in 5. Currently it is hard to predict the changing frequency, intensity of events, thus making it difficult for insurers to foresee the indirect risks such as disruption in value chain etc.