Climate Change Blog – July 2018

Transition risk is a very topical issue in the industry, and certainty one that’s relatable to actuaries. 

What’s transition risk?

Transition risk leads to the increase of other risks – policy and legal, market, technology and reputation risk – as the world takes necessary steps to meet commitments under the Paris Climate Agreement signed in December 2015.

Government policy, such as the UK’s plans to shut down all coal-fired power stations by 2025, and changes to technology trends will have environmental, economic and social impacts, and pose a serious risk to the industries that actuaries advise.

The following sections summarises how the world is responding to transition risk.

What’s new…

… in government?

In April 2018, David Hall and Sam Lindsay published Climate Finance Landscape for Aotearoa New Zealand: A Preliminary Survey, a report Prepared for the Ministry for the Environment, Auckland by consultancy Mōhio.

The report explains the roles that the New Zealand government could play in climate finance to assist in New Zealand’s transition to a low emissions economy.

According to the report, the NZ Government can play any combination of at least four roles:

1. As a direct investor, the New Zealand Government already provides multiple grants in areas like energy efficiency and sustainable land management
2. An investment manager role would emphasise the importance of financing pipelines for climate-aligned projects and companies to nurture innovation to maturity, to provide growth capital for ideas that work.
3. A market maker role would recognise the New Zealand Government’s capacity to support climate-aligned projects and companies by being first purchaser, or a large-scale purchaser, of climate-aligned goods and services.
4. A trail blazer role would recognise the New Zealand Government’s capacity to lead the way globally, especially in those sectors where New Zealand has unique mitigation opportunities, such as land use and transport powered by renewable energy.

The report also identifies 10 recommendations that improve the environment for climate finance, including disclosure and reporting, climate change leadership and green investment fund.

… in banking?

16 international banks, convened by the UN Environment Finance Initiative (UNEP FI), published a methodology to increase banks’ understanding of transition risks and the Task Force on Climate-related Financial Disclosures (TCFD).

The methodology involves using transition scenarios to assess transition risk. The report emphasises that the exercise is not a precise forecast but a sensitivity analysis used for strategic planning and portfolio composition, and to increase awareness. The methodology aims to capture the expected loss conditional on a given transition scenario. The figure below is taken from page 32 of the report. It shows how the Merton framework (traditionally used for credit analysis) can be modified to assess transition risks.Full news on UNEP FI’s website

Full report available for download here

… in insurance?

European insurers continue to dominate the 2018 leader board, according to the report by the Asset Owners Disclosure Project (AODP) due to active debate around climate change disclosures and pressure from society. AXA, in first place, announced commitments to exclude oil sands and coal-fired power plants from its portfolios.

However, some of the report’s top-rated insurers continue to support high carbon businesses, which are inconsistent with the Paris Climate Agreement. In fact, 90% of the investment strategies in the sector fail to align with the Paris Agreement goals.

News covered by Actuarial Post

… in superannuation?

The Institute of Faculty of Actuaries (IoFA) produced a Practical Guide to Climate Change for Defined Contribution Pensions, highlighting the need for actuaries to consider transition risks relating to the investment of assets.

Considerations for member outcomes and actuaries include:

• reduced asset returns due to costs of climate change mitigation;
• losses from stranded assets – inability of a company to extract value from its assets (e.g. plants, rights, land) due to restrictions on its activities or a collapse in the assets’ economic value;
• default strategies that have been designed without consideration of climate risk;
• inadequate contribution structures where projections have not considered of climate-related impacts

This guide focuses on actions that actuaries could take to develop an approach to climate risk mitigation.

Would you like to know more?

Recent climate change articles published by members of the Climate Change Working Group:

• Climate Change Disclosure – Financial Institutions Feel the Heat by Sharanjit Paddam and Stephanie Wong
• Climate Related Financial Disclosures: The Way Forward? by Wayne Kenafacke.
• An Overview of the Actuaries Climate Index by David Hudson
• Climate Risk Management for Financial Institutions by Sharanjit Paddam, Stephanie Wong and Alison Drill 

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