Carbon Risk Assessment in the Financial Sector

By: Mirele B. Goldsmith

How can financial institutions and individuals factor climate change into their decisions about investments?  This question was considered at a meeting hosted by Moody’s Investors Service on Paving the Road to Paris COP21: Discussing Carbon Risk Assessment Strategies on July 27, 2015.  (The list of speakers may be found here.)

Those of us focused on sustainability are well aware that over time climate change will impact every aspect of the economy.  The finance sector is facing this fact now that governments are beginning to introduce regulation requiring disclosure of the risks that climate change poses to investors. At the meeting there was a lot of talk about France, where legislation has just been proposed to require disclosure of climate risk.  China is also considering legislation.  The European Union already requires pension funds to consider climate risk.  The SEC requires that companies disclose material risks from climate change, although the speakers described this requirement as “toothless.” 

What risks could climate change pose to financial returns?   The most obvious risk is that companies will be impacted physically (operator risks) and investors will bear the costs. The risk that seems to be most on the minds of experts is changes in policy.  As one speaker put it, “it is becoming more expensive to pollute.”  Changes in technology which may make businesses obsolete or lead to falling prices are another risk.  And there are reputational risks.

Much of the meeting focused on just how the financial risks of climate change can be quantified.  The two big sources of uncertainty are first, that we don’t know how much and what kinds of actions will be taken to mitigate climate change.  And second, we don’t know how much the climate will change.  Risk projections are usually informed by past experience, but there is no historical data that can be used to build and test models of climate risk.

The speakers presented several tools that are designed to help investors at various levels incorporate climate into their risk assessments.  Speakers from the World Resources Institute and UNEP Finance Initiative gave an overview of their Carbon Asset Risk Discussion Framework.  The framework, which provides questions to ask but no answers, provides a structured approach to assess exposure to climate risk, valuate, and manage it.  Mercer has released a report on Investing in a Time of Climate Change that is meant to help investors assess their portfolios using four climate-risk factors to assess exposure under four possible climate scenarios.  Mercer’s approach is more user-friendly because it provides answers based on assumptions about how investments in certain sectors and regions will be impacted under specific scenarios.  However, given how much is unknown, this approach obviously requires making a lot of assumptions.  2 Degrees Investing Initiative has worked with UNEP Inquiry and CDC Climat Research to produce a review of various approaches to carbon risk assessment: Financial Risk and the Transition to a Low Carbon Economy.  The Bloomberg Carbon Risk Valuation Tool (available to Bloomberg subscribers) was also mentioned in passing.

This meeting was focused on technical questions about how to assess climate risk in order to protect financial institutions and individual investors. However the speakers also alluded to the critical need to mobilize the influence of financial markets to accelerate action to mitigate climate change.   On this point, speaker after speaker emphasized the issue of the difference in time horizons for investment decisions and the major risks to investments from climate change.  Most investment decisions are made for 2-10 years, while these experts expect to see major impacts on investments from climate change only in 25-30 years.  In order to leverage the power of markets to address climate change investors something will have to change.

Mirele B. Goldsmith is an environmental psychologist, program evaluator, and activist.  She is an expert in how to change human behavior – the key to solving environmental problems and building a sustainable future.  Mirele’s clients include community-based organizations, associations, and businesses, that are engaging employees, tenants, board members, and constituents, in saving energy, reducing waste, educating about sustainability, and advocating for change.  Mirele is a certified SSC Green Auditor and the principal of Green Strides Consulting.

Best of the Blog - July 2015

Each month, we highlight some of our more popular content on the SSC blog!

In case you missed them, here's a round-up of our most popular blog posts from this past month. These are the articles that received the most attention from our online audience. Check them out! 

  1. Puma, Adidas, Under Armour - Who Has the Best Sustainability Sustainability
  2. Sustainability Software: Total Cost of Ownership Revisited
  3. 4 Mistakes That Are Holding Back Your Company's Sustainability 
  4. Grow Your Sustainability Consultancy Business by Speaking Your Client's Language 
  5. How to Get Your Company Moving Towards Sustainability

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Deciding on a Measurement Process: Calculating Your Company's Carbon Footprint


Enjoy this blog post from the SSC archives:

You can't manage what you don't measure -- but deciding what to measure, how to measure it, when to measure it, and where to capture and store the data can be one of the most challenging pieces of a carbon management strategy. If you're stuck at this stage (or getting ready to tackle it), here are some questions to guide your decision:

Which carbon calculation standard do you want to use? 

There are several carbon calculation standards out there, but 99% of companies will end up choosing the GHG Protocol. Why? 

The Greenhouse Gas Protocol (GHG Protocol) is the most widely used international accounting tool for government and business leaders to understand, quantify, and manage greenhouse gas emissions. The GHG Protocol, a decade-long partnership between the World Resources Institute and the World Business Council for Sustainable Development, is working with businesses, governments, and environmental groups around the world to build a new generation of credible and effective programs for tackling climate change. It provides the accounting framework for nearly every GHG standard and program in the world - from the International Standards Organization to The Climate Registry - as well as hundreds of GHG inventories prepared by individual companies.

Our advice: whatever standard you choose (e.g. an industry specific standard), make sure that it's built on (and in compliance with) the GHG Protocol. It makes life so much simpler.

Which emissions categories are most relevant to your organization? 

In sustainability jargon, this is a question about materiality -- which activities within your operations and value chain generate material emissions? The GHG protocol outlines more than a dozen different categories (like "purchased electricity" and "employee commuting") to choose from. In most cases, you want to calculate emissions from Scope 1 (direct emissions) and Scope 2 (indirect emissions), along with a handful of Scope 3 (indirect emissions) categories that make the most sense given your size and industry.

Which carbon footprint tool makes the most sense?  

There are a wide variety of options to measure your company's carbon emissions. There are excel spreadsheet models, and dozens of software programs -- both SaaS and enterprise-level options. Some companies even choose to develop their own internal calculators that integrate directly with their internal systems (like ERP, timesheets, business travel reimbursement, etc.). To dive deeper into this process, check out our free white paper on Choosing Sustainability Management Software. It's a vendor-neutral look at how companies can choose the most effective software option, including the pros and cons of some of the most popular software features.

How will we manage the process? 

How many facilities are we going to include? Where is the raw data now, and how will we get it into our carbon calculator? Where are we missing data, and how can we best fill in the blanks? What is our timeline? All of these questions should be answered -- at least tentatively -- at this stage of the process.

Are simple mistakes holding back your sustainability? Find out how to correct those mistakes here!