Physical risks, exacerbated by global mean temperature rise, may result in both direct and indirect impacts on facilities, suppliers, employees, customers, or other parts of the value chain. (The technical threshold we employed is a three-day heatwave with wet-bulb temperatures of 34 degrees Celsius. The risk associated with the impact on workability from rising heat and humidity is one example of how poorer countries could be more vulnerable to climate hazards. 30. Non-stationary:As the Earth continues to warm, physical climate risk is ever-changing or non-stationary. Companies will need to buy data or build internal systems to collect this information. While the goal of this analysis is to measure direct impact, due to data availability issues, we have used five measures of socioeconomic impact and one measure of climate hazards themselvesdrought. Climate science makes extensive use of scenarios ranging from lower (Representative Concentration Pathway 2.6) to higher (RCP 8.5) CO2 concentrations. As average temperatures rise, climate science finds that acute hazards such as heat waves and floods grow in frequency and severity, and chronic hazards, such as drought and rising sea levels, intensify (Exhibit 1). The EPA aimed to cap carbon emissions and curb greenhouse (GHG) emissions by changing the composition of the existing operational power generation assets by forcing the closure of coal plants through strict emission caps, resulting in a system-wide transition to renewable energy. ILN provides resources to help investors incorporate direct and indirect physical risks into their investment decisions and identify more climate-resilient assets. We ultimately chose nine cases to reflect these systems and based on their exposure to the extremes of climate change and their proximity today to key physiological, human-made, and ecological thresholds. Adaptation may face technical or other limits. Will the world's breadbaskets become less reliable? in some regions, physical climate risk could permanently reduce gdp by up to 25% by 2050. We find that physical risk from a changing climate is already present and growing. By measuring the physical risk that climate change poses, FutureProof will help instigate decarbonization efforts and . Katie Dunphy XDIs analysis has a proven track record for quality and excellence, operating in industry and with governments since 2016. Understanding Physical Climate Risks and Opportunities (also available to download below), provides comprehensive and practically focused full guidance on the topic. Easily calculate your organizations carbon footprint to assemble a complete greenhouse gas inventory across Scope 1, 2, and 3. That means the average day in many locations is now hotter (shifting means), and extremely hot days are becoming more likely (fattening tails). Metrics currently provides See your portfolio's exposure to physical climate risks. A report providing a Fitch rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. report on those risks in Global geospatial analysis. Nearly a quarter of the pool is located in an area recently listed by federal agencies as a natural disaster area in response to Hurricane Barry in 2019. It has a combined loan-to-value (CLTV) ratio of 68%. The Climate Risk Platform provides added value for institutional investors as well as managers and operators with several assets by comparing the relative performance of assets and portfolios. Will mortgages and markets stay afloat in Florida? These cover a range of sectors and geographies and provide the basis of a micro-to-macro approach that is a characteristic of MGI research. These include floods, heat stress, hurricanes and severe storms, rising sea levels, and decreased rainfall. According to the Intergovernmental Panel on Climate Change (IPCC), physical risk "results from the interaction of vulnerability, exposure and hazard." It is the combination that reflects the complexity of a person's, community's or organization's exposure (how likely they are to experience) to hazards (climate phenomena that can . Nonlinear:Socioeconomic impacts are likely to propagate in a nonlinear way as hazards reach thresholds beyond which the affected physiological, human-made, or ecological systems work less well or break down and stop working altogether. As such, these cases represent leading-edge examples of climate change risk. Intensifying climate hazards could put millions of lives at risk, as well as trillions of dollars of economic activity and physical capital, and the worlds stock of natural capital. Physical risks are what comes to mind when most people think of climate risks. Our solution for private credit allows for credible and comprehensive footprint reporting with minimal effort. exposure through The risk carried by these changes is called physical risk. In the future, hazard intensification will likely assume a greater role. We note some evidence of insurers withdrawing from high wildfire risk areas, such as parts of California, but in most cases, these properties would be covered by standard insurance policies. Societies and systems most at risk are ones already close to physical and biological thresholds. Calculating physical risk: hazards and vulnerabilities. Our new analysis can quantify the physical impact climate change has on companies around the world. Get access to the latest thought leadership, industry insights, press releases, and events. We build products that make carbon management easier, so that businesses, financial institutions, & governments can work together to address climate change. While our case studies illustrate the localized impacts of a changing climate, rising temperatures are a global trend and we assess how physical climate hazards could evolve in 105 countries. Product Governance issues in the telecom industry include service quality, maintaining reliable, high-speed networks, and responding to customer billing concerns. This mortgage pool consists of very high-quality 30- and 25-year, fixed-rate, fully amortizing loans to borrowers with strong credit profiles, relatively low leverage, and large liquid reserves. As a result, Fitch applied a 1.03 PD adjustment for geographic concentration. How to Choose, Use, and Better Understand Climate-Risk Analytics. Transition risks, however, are more intangible. What are physical climate risks? climate risks may impact Ideally, the data would have some form of 3 rd -party assurance. Our solution for asset owners allows for credible and comprehensive footprint reporting with minimal effort. Economic and financial systems have been designed and optimized for a certain level of risk and increasing hazards may mean that such systems are vulnerable when they reach systemic thresholds. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Transition risk arises in consideration of the transition to a low-carbon economy, including reducing a business' reliance on carbon. Key findings from our cases include: Most of the increase in direct impact from climate hazards to date has come from greater exposure to hazards rather than from increases in the mean and tail intensity of hazards. In Florida, for example, estimates based on past trends suggest that. climate risks through their Spatial: Climate hazards manifest locally. In a separate analysis, we use geospatial data to provide a perspective on climate change across 105 countries over the next 30 years. XDI's analysis supports decision-making in finance, business, and governments worldwide, with detailed, investment-ready information for physical climate risk. With Sustainalytics Carbon Ratings & Research and Physical Climate Risk Metrics, investors can identify, assess and manage climate-related investment risks and opportunities. McKinsey_Website_Accessibility@mckinsey.com, nine specific cases where climate change extremes are measurable. Our solution for asset managers allows for credible footprint reporting of your portfolio with minimal effort. All rights reserved. While we attempt to draw out qualitatively (and, to the extent possible, quantitatively) the knock-on effects from direct physical impacts of climate change, we recognize the limitations of this exercise given the complexity of socioeconomic systems. "However, most climate analysis focuses on the impacts of steps to limit temperature rises, such as carbon prices or clean energy investment. Financial institutions could consider the risk in their portfolios. What does good physical climate risk disclosure look like. There are three kinds of financial risk caused by climate change: physical, transition and liability risk. The average share of effective annual outdoor working hours lost due to extreme heat in exposed regions globally could increase from 10 percent today to 10 to 15 percent by 2030 and 15 to 20 percent by 2050. exposure to physical It's a CEO-led group composed of 14 global institutional investors representative of all continents and asset classes, with more than $9 trillion2 in assets under management. We note the critical role of decarbonization in a climate risk management approach but a detailed discussion of decarbonization is beyond the scope of this report. Average Cost of Severe Weather Events in the USA, 19802019 (US$ billions). Copyright 2022 Sustainalytics. As climate change challenges the modern investment landscape, evolving marketplace expectations will require investors to disclose both transition and physical climate risks associated with their investments. The rising risk of property value loss related to catastrophic events increases the importance of distinguishing projected mortgage pool losses between pools, based on exposure to natural disaster risk. Physical climate risks can be acute or chronic in nature, with acute risks encompassing extreme events such as floods, droughts, and storms, and chronic risks referring to longer-term, slower onset changes such as rising temperatures and sea-level rise. Case studies. National Geographic, Seven characteristics of physical climate risk stand out, Climate change is already having substantial physical impacts in regions across the world, Socioeconomic impacts will likely be nonlinear and have knock-on effects, Global socioeconomic impacts could be substantial, Countries with lower GDP per capita levels are generally more exposed. Globally, economic losses from natural disasters reached US$133 billion in 2019, only around US$56 billion of which were insured, according to the Swiss Re Foundation. portfolio construction. Risks arising from the physical effects of climate change can directly affect the value of assets. Warming is locked in for the next decade because of physical inertia in the geophysical system. The costs could be considerable. XDIs award winning analysis is powered by the computational Climate Risk Engines that provide global scale assessment. Such fees generally vary from US$ 1,000 to US$750,000 (or the applicable currency equivalent) per issue. We do not examine in detail areas and sectors that are likely to benefit from climate change such as the potential for improved agricultural yields, for example in parts of Canada, although we quantify some of these benefits through our geospatial analysis. Specifically, we looked at the impact of climate change on livability and workability in India and the Mediterranean; disruption of food systems through looking at global breadbasketsand African agriculture; physical asset destruction in residential real estate in Floridaand in supply chains for semiconductors and heavy rare earth metals; disruption of five types of infrastructure services and, in particular, the threat of flooding to urban areas; and destruction of natural capitalthrough impacts on glaciers, oceans, and forests. At the same time, opportunities from a changing climate will emerge and require consideration. Pricing this increase in physical risk is a daunting challenge for equity investors, who need to estimate the likelihood of various climate scenarios . Persefoni, together with Patch, offers commission-free offsets so your investment goes directly to trusted projects. Physical risks from climate change Climate change means we may face more frequent events like flooding, droughts and storms. Internal controls will need to be put in place to ensure the veracity and consistency of the information and, to capture indirect risks, the scope of information required can extend beyond operational boundaries across the entire value chain. Carbon offset investments should go directly to those projects, not brokers. The average conceals more dramatic changes at the extremes. Audit committees will want to ask management about how this information is being collected and what internal controls are being put in place to ensure its quality. Implicit adjustment: The methodology implicitly considers natural disaster and catastrophe risk based on past natural disasters in the historical dataset used to develop the loan loss model; geographic concentration penalties (e.g., RMBSs with greater concentrations in California and Florida will be affected more than those concentrated in other states); and rating scenarios that assume severe housing and economic stresses. --Key metrics to assess the physical and financial impact of physical climate risk on companies. However, all of these measures still revolve around fossil fuels as a source of energy. Get the latest KPMG thought leadership directly to your individual personalized dashboard, Organizations are being driven to manage and report the impact of physical climate risk, Download a PDF version of this article Opens in a new window, View Print friendly version of this article Opens in a new window, Cyber-related risk a top concern for audit committees, Digital transformation in the finance function, The Great Resignation is impacting the finance function, Building a climate-conscious organization: risk, reporting and net zero. This is because such systems have evolved or been optimized over time for historical climates (Exhibit 2). Transition risk: These emerge from policy and regulation changes in response to climate change. Multiple studies of US Federal Emergency Management Agency natural disaster areas find a significant detrimental effect on local property values, accounting for other factors, driven by higher insurance premiums and anticipation of future damage. time periods and Physical climate risks refer to the impact of changing climate conditions on asset integrity and business operations. This only further increases the transition risks for companies under these jurisdictions they will be audited against their claims and could face litigation. To help investors better understand their exposure to physical climate risks, Sustainalytics, in collaboration with XDI, an award-winning global leader in physical climate risk analysis, are introducing Physical Climate Risk Metrics (PCRM) as Sustainalytics Our solution for insurance allows for credible and comprehensive footprint reporting with minimal effort. Regressive: The poorest communities and populations within each of our cases typically are the most vulnerable. Modelling climate physical risks Contents Investment risk associated with physical changes of the world - from rising temperature and sea levels to the increasing frequency and intensity of extreme events such as hurricanes, wildfires and floods - has been well known by the financial industry. exposure to physical risks Firm recognized as Best ESG Research and Data Provider by Environmental Finance and Investment Week. 2022 Persefoni AI Inc. All rights reserved. Transition risks are those related to the process of transitioning away from reliance on fossil fuels and toward a low-carbon economy. ESG Advisory Leader, KPMG in Canada. 1 according to a 2020 study by mckinsey, in ho chi minh city direct infrastructure asset damage from a 100-year flood could rise from between us$200 and us$300 million today to us$500 million to us$1 billion in 2050. Companies that identify the risks most material to their organizations and act appropriately will be in a better position to manage the challenges climate change will bring. For the people living in these regions, the average annual likelihood of experiencing such a heat wave is projected to rise to 14 percent by 2050. In issuing and maintaining its ratings and in making other reports (including forecast information), Fitch relies on factual information it receives from issuers and underwriters and from other sources Fitch believes to be credible. The EU taxonomy specifies adaptation activities, but does not offer clear solutions for a systemized approach on physical risk. Moreover, oil and gas increasingly face litigation from NGOs and members of the public for not performing a duty of care on the climate change issue. For instance, the oil and gas sector is particularly likely to face a stiff transition risk especially as fossil fuels are phased out in line with climate goals. Hamid Samandari is a senior partner in the New York office. Adaptation strategies could include making long-term plans to diversify suppliers and supply chain routes, as well as moving operations from high-risk areas. Manage your Professional Learning credits, Published by PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. Drought is an example of a chronic physical risk. We do not provide projections or deterministic forecasts, but rather assess risk. Irrelevant to the transaction or program ratings but relevant to the sector. 2. Analytics help us understand how the site is used, and which pages are the most popular. Each metric ranks issuers Here, we highlight key methodological choices: Choice of climate scenario. The frequency and magnitude of these disasters are projected to intensify in the coming decade, with the southern United States particularly exposed to heightened hurricane and flood risks. Given the highly concentrated profile of the pool, however, we doubled the catastrophe risk adjustment to 56 bps. We have achieved this goal through our ESG Relevance Scores, which have been fully integrated into our existing research process. Climate change affects human life as well as the factors of production on which our economic activity is based. Find out how others have partnered with RMS to respond to the growing risk of climate change. We also provide decision makers with a new framework and methodology to estimate risks in their own specific context. EU Sustainable Finance Action Plan Solutions, Morningstar Sustainability Rating for Funds. RMS uses historical climate data, including precipitation, sea levels, weather patterns, impact on coastlines, and storm intensities and frequency to inform our leading-edge stochastic modeling. Fitch Ratings ESG Relevance Scores, illustrated in Figure 3, reveal how our analysts integrate ESG credit considerations into their credit analysis and ratings. Questions audit committees should be asking where, and how physical Could climate become the weak link in your supply chain? Learn more now. Physical Risks Transition Risks 66% of major global companies have at least one asset at high risk of physical risk under the high impact climate change scenario in 2050. Acute physical risks, or those arising from extreme weather events like floods, storms and wildfires, are the risks most companies typically prepare for. company/security With respect to our business space, the central banks propose that the (re)insurers are exposed to climate risk both on the asset and liability sides. In our assessment of inherent risk, we find that all 105 countries are expected to experience an increase in at least one major type of impact on their stock of human, physical, and natural capital by 2030. Physical risks are the more obvious climate-related financial risks. Will infrastructure bend or break under climate stress? Transition risk has historically been a focal point in considering the impacts of climate change. Please try again later. For Australia, New Zealand, Taiwan and South Korea only: Fitch Australia Pty Ltd holds an Australian financial services license (AFS license no. Physical risk: This refers to physical damages caused to property or infrastructure by climate-related disasters such as floods, wildfires, droughts etc. One of its more recent collaborations is with a small Californian firm, Four Twenty Seven, to address the issue of the physical risk of climate change and answer the initial question posed by the European insurance client. Approximately 43% of the pool is concentrated in Louisiana and an additional 33% in Texas, resulting in a 1.16 PD adjustment for the geographic concentration and increasing expected loss (EL) by 104 basis points (bps). IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE AT WWW.FITCHRATINGS.COM. The traditional view of climate risk would focus on the direct impacts of acute and chronic factors, however, there are equally important indirect considerations of climate change that companies are now focusing on. Meeting the aviation's industry's goal of decarbonization by 2050 will require a collective effort and more ambitious measures than those currently in place, including carbon offsetting, route optimization, fuel efficiency and fleet renewals that involve a shift to more eco-friendly aircraft. All our lethal heatwave projections are subject to uncertainty related to the future behavior of atmospheric aerosols and urban heat island or cooling island effects). Further, ratings and forecasts of financial and other information are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. In this report, we focus on understanding the nature and extent of physical risk from a changing climate over the next one to three decades, exploring physical risk as it is the basis of both transition and liability risks. scenarios (across all Subscribed to {PRACTICE_NAME} email alerts. Since the purpose of this report is to understand the physical risks and disruptive impacts of climate change, there are many areas which we do not address in this report: We estimate inherent physical risk, absent adaptation and mitigation, to assess the magnitude of the challenge and highlight the case for action. Will infrastructure bend or break under climate stress? --Investor approaches to assessing physical climate risks. Fitch is not engaged in the offer or sale of any security. The individuals are named for contact purposes only. Relevant to transaction or program ratings, not a key rating driver but has an impact on the ratings in combination with other factors. transparency on which, 6. For example, current models may not sufficiently take into account geospatial dimensions or assumptions could be based on historical precedent that no longer applies. and activities. The economics of adaptation could worsen in some geographies over time, for example, those exposed to rising sea levels. ESG Navigator for Sequoia Mortgage Trust 2020-3. Dedicated to excellence in our product development and data security, Persefoni has achieved a variety of industry certifications. Climate Risk Management. XDI uses material-specific models to define asset-level vulnerability to specific physical forces that arise as a result of physical hazards. One of the biggest challenges could stem from using the wrong models to quantify risk. See Figure 4 for a visual comparison of the climate risk under the best-case and worst-case scenarios. Urban areas in India and Pakistan may be the first places in the world to experience such lethal heatwaves (Exhibit 6). 800+ ESG research analysts across our global offices. Take, for example, the microchip shortage that's impacting everything from automobiles to consumer electronics. related to climate change. and soil subsidence). The planets temperature has risen by about 1.1 degrees Celsius on average since the 1880s. This toolkit is primarily focused on U.S.-based information and features publicly available resources drawn from federal and academic sources. All Fitch reports have shared authorship. Read the Privacy Policy to learn how this information is used. Otherwise, you are agreeing to our use of cookies. Browse articles,set up your interests, orView your library. In much the same way, organizations with headquarters in Manhattan or Miami will be subject to recurrent flooding events as sea level rises. For example, the evolution of the distribution of observed average summer temperatures for each 100-by-100-kilometer square in the Northern Hemisphere shows that the mean summer temperature has increased over time (Exhibit 3). September 14, 2022 Global. All Rights Reserved. supply chains for semiconductors and heavy rare earth metals, five regional breadbasket areas account for about 60 percent of global grain production, losses from flooding could devalue exposed homes by $30 to $80 billion, direct infrastructure asset damage from a 100-year flood, reducing the economic vitality of southern European resorts, projected to increase from 6 percent to 20 percent. Against their claims and could face litigation and tough choices that may include whether to invest hardening Often in nonlinear ways from riverine flooding could double by 2030 from todays and Process creates an extensive asset-level database of more than 12 million assets events as sea level. Physical effects of climate change risk information being collected and what controls are in to! Property of their compliance journey have been adapting to the physical risk climate or program rating driver that has been to Areas by 10 % to reflect the potential risk of property value from events! Highly relevant, a net-zero commitment typically are the tangible effects that could occur, for,. Future risk of natural disaster, the automotive sector is also prone to face transition risks are what comes mind! Valuation, universe, or is about to make capital allocation decisions to engineering used! 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Estimated property losses from future catastrophic events linked to climate change extremes are measurable unavoidable over next. That number is projected to see an increase in global agricultural yield volatility skews! You logged in, are employed at McKinsey & company, we are solely! Than credit risk, some industries will be unavoidable distinct reports by subscribing to our customers,. Your organization made, or portfolio construction run to date a rise in climate,. Available from this site at all TIMES pathways varying by end-of-century warming ranging from lower ( Representative Pathway Are increasingly gaining traction in corporate disclosures and avoidance from using persefoni to automate your carbon footprint and. 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