Companies are accustomed to managing risks such as legal liabilities, accidents, natural disasters, credit and finance risks and security threats. But what about risk arising from climate change, such as its potential effect on production and business operations, regulatory and litigation risks or reputational risks?
Processes and policies around climate risk — the risk profile of a company’s exposure to climate change — are still evolving, but companies are addressing climate change in ways that cross over between traditional risk management and corporate sustainability efforts.
The specter of climate change worries corporate decision makers, investors and insurers: How might the enterprise be disrupted and impacted financially by a changing climate? Corporate sustainability and social responsibility tend to be the functions that address greenhouse gas (GHG) emissions — their monitoring, reporting and reduction. But GHG emissions are not simply a matter of good corporate citizenship. As GHG emissions increasingly appear on the radars of government and the investment community, a company’s emissions profile presents additional risks in areas such as regulation and liability for environmental damage.
Let’s examine some of the ways climate change is finding its way into the corporate risk portfolio.
In its report Global Risks 2012, the World Economic Forum includes “rising greenhouse gas emissions” and “failure of climate change adaptation” in the same risk quadrant as food shortages, water supply crises and terrorism. Rising GHG emissions could become a serious threat, the group believes, if “governments, businesses and consumers fail to reduce greenhouse gas emissions and expand carbon sinks.”
In a 2011 white paper about the risks of climate change for business, David Batchelor, CEO at insurance and risk management firm Marsh (a subsidiary of Marsh & McLennan), writes, “While the scale and scope of the impacts of climatic change on society may be uncertain, direct impacts are more obvious.” Such impacts, Batchelor says, include “physical damage to property, failure of infrastructure and an increased likelihood of interruption in the supply of essential resources and services.”
There are also major implications from changes in the climate with regard to where we live, what we make and how we make them. Adapting our way of life and our businesses to take account of the changing climate is not being widely considered, yet a business-as-usual approach is increasingly untenable.
According to Ceres, a network of investors focused on sustainability leadership, climate change represents a major long-term risk for business. To maintain shareholder value, corporations need to start actively assessing and managing their climate-related risks. In its report The 21st Century Corporation: The Ceres Roadmap for Sustainability, Ceres says:
Our current fossil-fuel based economy has led to a growing concentration of greenhouse gases in the atmosphere that is driving more extreme weather events, more severe and frequent cycles of drought and flood, and rising sea levels. These phenomena are being met with new policies and regulations including those designed to limit and put a cost on carbon emissions. Businesses need to plan for a policy environment increasingly hostile toward carbon emissions and for the costs of adaptation to climate change.
Investors and Insurers Are Paying Attention
Large institutional investors are paying ever-closer attention to the climate-change risks of the companies they invest in, according to Anne Stausboll, CEO of CalPERS (California Public Employees’ Retirement System), which currently commands a portfolio of $231.9 billion. Introducing a Ceres report, Stausboll writes:
In light of our long-term liabilities, we need to understand the critical risks and opportunities faced by the companies in our portfolio.
Today, that includes the serious risks — financial, physical, and reputational — associated with issues such as climate change, natural resource scarcity, supply chain pressures and other global sustainability challenges. Any company that ignores these risks, and fails to develop a long-term strategy to address them, is diminishing its competitiveness in the 21st century. At the same time, there are enormous opportunities for businesses that fully embrace sustainability.
Ceres began its life 20 years ago in the wake of the disastrous Exxon Valdez oil spill. Since then, Ceres has become the sponsor of the Global Reporting Initiative, an international standard for sustainability reporting used by more than 1,100 companies. The organization claims to be the originator of the concept of climate risk. Ceres’ report, The 21st Century Corporation: The Ceres Roadmap for Sustainability, outlines 20 key expectations that today’s investors have of companies they invest in, expectations in the areas of governance, stakeholder engagement, disclosure and performance.
According to Mindy S. Lubber, president of Ceres, a crucial climate-change-related performance expectation for the roadmap is “a 50 percent improvement in energy efficiency and a 25 percent lower carbon footprint by 2020.” Companies that meet these kinds of expectations “will be best positioned to thrive in the coming low-carbon, resource-constrained global economy of the 21st century,” she stresses.
Management of sustainability issues within companies, Ceres believes, should take the form of board oversight, top-level executive engagement, management accountability, executive compensation, policies and management systems, stakeholder dialogue, investor engagement, formalized disclosure practices and performance monitoring and control. Efforts should extend into operations, supply chain, transportation and logistics, products and services and employment practices.
According to Ceres, insurance companies in particular are vulnerable to such climate-change-fueled environmental risks. As precedent, the roadmap report cites the effect of asbestos litigation on Lloyd’s that began in the 1980s. The insurer ended up taking a hit for $54 billion in insurance claims, which nearly brought down the company. Ceres says:
Insurance companies are particularly exposed to environmental and social risks through the practices of their clients… As society struggles with the physical effects of climate change and resource scarcity, insurers can be expected to see a rising tide of liability claims stemming from extreme events, human displacement, infrastructure failure, pollution of scarce water supplies and other damages attributed to the action or inaction of corporate clients.
Ceres says insurers are now “optimizing their risk models to better incorporate changing hazards associated with climate change and to test adaptation strategies in light of intensifying hazards.”
Managing Climate-Change Risk
According to consulting firm McKinsey & Company’s most recent survey on sustainability practices, 22 percent of respondents are taking action to mitigate their companies’ operational risk related to climate change. McKinsey & Co. surveyed 3,203 executives across regions, industries, company sizes and functions. The 22 percent figure is significant, although much lower than responses for more top-of-mind concerns, such as reducing energy use in operations (63 percent) and reducing waste from operations (61 percent).
However, drilling down into the results reveals greater concern over risks of climate change than at first glance. The 3,203 respondents included 293 sustainability executives, and out of those specialists, 44 percent said their companies are taking action to mitigate climate change risk.
McKinsey & Co.’s analysts identify potential for companies to derive value from a focus on long-term sustainability issues such as climate risk. They write:
Integrating sustainability into strategic initiatives is especially important because these issues play out over the long term. It’s easier for companies where they are core concerns to understand trends and make strategic bets in advance of consumer preferences, stakeholder pressure or regulation. GE, for example, placed early bets on climate change: in 2004, before Al Gore and Hurricane Katrina made this a top-of-mind issue, the company resolved to double its research investments and sales in clean technology. It also promised to green its own operations. As a result, GE’s Ecomagination division has been a tremendous growth engine, with product sales reaching $18 billion in 2009.
The Marsh report, cited above, recommends that corporations assess their exposure to climate change at the board level, “so that directors can be aware of where climate change-related risks will appear on the list of the company’s biggest risks.” Companies need to develop an enterprise risk management process for climate change and similar areas, under which they can “consider the particular loss events and circumstances which pose the greatest risk to business objectives, will allow the business to assess the risks from climate change in terms of the likelihood of potential impact events and to consider the appropriate responses through continuous monitoring of risks and development of appropriate risk management processes.” (See Sustainability — The Changing Climate of Risk.)
Many companies have begun reporting GHG emissions annually. The Carbon Disclosure Project (CDP) collects and publishes data on GHGs and climate-change risk from companies worldwide. The companies publish the information and provide it to the organization’s signatories, including 655 institutional investors with $78 trillion in assets. Over 3,000 companies responded in 2011, including 81 percent of the Global 500 and 68 percent of the S&P 500.
CDP asserts that its disclosure program “has helped move climate change and energy efficiency onto the business radar and into mainstream business thinking.” The effort helps the companies themselves, which “are better able to understand how to protect themselves from the impacts of climate change and become more energy efficient.” Investors benefit by becoming “more aware of the risk to their portfolios” and being able to “achieve more sustainable and strong shareholder returns.”
CDP finds that, as of 2011, about 90 percent of firms have integrated climate-change risks or opportunities into their overall business strategies and reports that their carbon-emission efforts have oversight at the board or senior management level. About 80 percent of companies have implemented emission-reduction targets and have made progress toward meeting those targets.
In its industrials sector report, CDP notes the following specific measures taken by some of those companies:
- United Technologies — installation of high-efficiency air-conditioning systems, migration away from chlorofluorocarbons (CFCs) for air and refrigeration, adoption of hydrogen fuel cells
- Lockheed Martin — virtualization of 4,000 data servers, saving an estimated 8,876 pounds of CO2 emissions yearly per server, plus saving $2.6 million and 26 million kilowatt hours of electricity yearly
- Waste Management — generation of enough waste-to-energy electricity to power 1.1 million homes, deployment of 850 natural-gas vehicles and development of technologies to convert waste to fuel
- British Airways — communicating with customers about its climate-change mitigation efforts and work with biofuels, and reporting to customers the emissions arising from their flights at the point of sale.
There’s no doubt about it: Climate-change risks are a growing concern for corporations, their decision makers, their investors, their insurers, their regulators and the public. Companies and industry groups are struggling to get their arms around the issue and obviously still have a long way to go. In coming years, though, we can expect to see more solidification in processes for managing climate risk.