Sabine Chalopin, Head of ESG, Sustainable Infrastructure at Denham Capital, explains why infrastructure managers must think holistically about climate change.
After the cost-of-living crisis, the World Economic Forum puts extreme weather and natural disasters as the most severe risks facing the world in the next two years. It won’t come as news to the ESG investment community that climate risk is a hot topic. However, the focus over the past few years has largely been on transition risk and the measuring and reporting of Scope 1-3 emissions. Regulatory developments, notably the EU taxonomy, are undoubtedly shaping the investment industry’s ways of thinking about emissions and climate impact. Yet, as global warming increasingly impacts the world around us, the physical risks associated with climate change must be assessed and managed – like any other risk – by investment managers. For managers of infrastructure and other alternative assets, a thorough consideration of physical climate risk is a fundamental component of a robust ESG investment strategy.
Whilst sustainable infrastructure is essential to support the transition to a low-carbon economy, these assets are potentially at risk of the physical impacts of climate change. It only takes a cursory glance of the headlines to see that extreme weather events, such as flash flooding, as well as longer-term issues, such as rising sea levels, are increasing in frequency and severity around the globe. From a financial risk perspective, these physical climate impacts can be broken down into two buckets: acute risks and chronic risks. Considering both risk categories holistically is a pillar of responsible asset stewardship. A solar asset may not be at high risk of being hit by a tornado, for example, however it might end up underwater in ten years’ time due to sea-level rise.
Careful considerations
Potential impacts on assets from physical risks include direct damage as a result of extreme weather events, changes in water availability, sourcing and quality, disruption to operations and indirect impacts from supply chain disruption. For example, wind energy projects and electricity transmission infrastructure are vulnerable to storm damage. This can reduce power capacity or cause power disruptions. The impact on people must be carefully considered too. For example, workers on projects in warmer climates are more susceptible to occupational heat stress from extreme weather events.
Positively, reporting frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD), Equator Principles and the EU Taxonomy are encouraging investors to think about these risks. In the EU Taxonomy, for a renewable investment that is contributing towards the environmental objective of climate change mitigation, the investment also needs to meet the Do No Significant Harm (DNSH) principle. The criteria for DNSH include performing a robust climate risk and vulnerability assessment, proportionate to the scale of the activity and its expected lifespan.
Ensuring that infrastructure is ‘climate resilient’ can protect an asset’s longevity, performance and returns. However, developing climate-resilient infrastructure requires a holistic assessment of the potential physical climate risks and the mitigation of those risks through engineering features or management plans.
Holistic approach
The challenge for investment managers is that physical climate risks are not regionally uniform across the globe and will have different impacts across sectors. There is increasing demand from investors for asset managers to incorporate climate analytics into their forecasting and be able to assess potential risks over various scenarios and time periods. The role of accurate and consistent data in informing investment managers about climate risk cannot be underestimated.
However, the variations in regulatory requirements across jurisdictions pose a challenge for managers. Therefore, climate change risk assessments need to be project specific. At Denham Sustainable Infrastructure, we are using a Climate Solution provided by repath to help assess physical risk for temperature-related, wind-related and water-related risks and different climate change scenarios. For greenfield assets, this helps in the screening process, whilst for existing assets, it allows us to work with our portfolio companies to consider physical and non-physical solutions to reduce the most material risks.
Of course, there are multiple climate risk frameworks on offer to investment managers. Interestingly, we’re even seeing large insurance companies developing their own solutions to meet their increasing need to measure this risk category. For example, Allianz has developed a Climate Change Strategy, aimed at supporting their insurance customers to reduce climate-related risks through adaptation and low-carbon developments.
There’s no doubt that climate risk is having a greater and greater impact on managers’ investment decisions. According to research by S&P, over 90% of the world’s largest companies will have at least one asset financially exposed to physical climate risks by the 2050s. Furthermore, over a third of those companies will see at least one asset lose 20% or more of its value as the effects of global warming increase. Integrating climate risk into an ESG investment strategy is no longer a ‘nice to have’, but a critical consideration when thinking about protecting returns.
Sabine Chalopin, Head of ESG, Sustainable Infrastructure at Denham Capital, explains why infrastructure managers must think holistically about climate change.
After the cost-of-living crisis, the World Economic Forum puts extreme weather and natural disasters as the most severe risks facing the world in the next two years. It won’t come as news to the ESG investment community that climate risk is a hot topic. However, the focus over the past few years has largely been on transition risk and the measuring and reporting of Scope 1-3 emissions. Regulatory developments, notably the EU taxonomy, are undoubtedly shaping the investment industry’s ways of thinking about emissions and climate impact. Yet, as global warming increasingly impacts the world around us, the physical risks associated with climate change must be assessed and managed – like any other risk – by investment managers. For managers of infrastructure and other alternative assets, a thorough consideration of physical climate risk is a fundamental component of a robust ESG investment strategy.
Whilst sustainable infrastructure is essential to support the transition to a low-carbon economy, these assets are potentially at risk of the physical impacts of climate change. It only takes a cursory glance of the headlines to see that extreme weather events, such as flash flooding, as well as longer-term issues, such as rising sea levels, are increasing in frequency and severity around the globe. From a financial risk perspective, these physical climate impacts can be broken down into two buckets: acute risks and chronic risks. Considering both risk categories holistically is a pillar of responsible asset stewardship. A solar asset may not be at high risk of being hit by a tornado, for example, however it might end up underwater in ten years’ time due to sea-level rise.
Careful considerations
Potential impacts on assets from physical risks include direct damage as a result of extreme weather events, changes in water availability, sourcing and quality, disruption to operations and indirect impacts from supply chain disruption. For example, wind energy projects and electricity transmission infrastructure are vulnerable to storm damage. This can reduce power capacity or cause power disruptions. The impact on people must be carefully considered too. For example, workers on projects in warmer climates are more susceptible to occupational heat stress from extreme weather events.
Positively, reporting frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD), Equator Principles and the EU Taxonomy are encouraging investors to think about these risks. In the EU Taxonomy, for a renewable investment that is contributing towards the environmental objective of climate change mitigation, the investment also needs to meet the Do No Significant Harm (DNSH) principle. The criteria for DNSH include performing a robust climate risk and vulnerability assessment, proportionate to the scale of the activity and its expected lifespan.
Ensuring that infrastructure is ‘climate resilient’ can protect an asset’s longevity, performance and returns. However, developing climate-resilient infrastructure requires a holistic assessment of the potential physical climate risks and the mitigation of those risks through engineering features or management plans.
Holistic approach
The challenge for investment managers is that physical climate risks are not regionally uniform across the globe and will have different impacts across sectors. There is increasing demand from investors for asset managers to incorporate climate analytics into their forecasting and be able to assess potential risks over various scenarios and time periods. The role of accurate and consistent data in informing investment managers about climate risk cannot be underestimated.
However, the variations in regulatory requirements across jurisdictions pose a challenge for managers. Therefore, climate change risk assessments need to be project specific. At Denham Sustainable Infrastructure, we are using a Climate Solution provided by repath to help assess physical risk for temperature-related, wind-related and water-related risks and different climate change scenarios. For greenfield assets, this helps in the screening process, whilst for existing assets, it allows us to work with our portfolio companies to consider physical and non-physical solutions to reduce the most material risks.
Of course, there are multiple climate risk frameworks on offer to investment managers. Interestingly, we’re even seeing large insurance companies developing their own solutions to meet their increasing need to measure this risk category. For example, Allianz has developed a Climate Change Strategy, aimed at supporting their insurance customers to reduce climate-related risks through adaptation and low-carbon developments.
There’s no doubt that climate risk is having a greater and greater impact on managers’ investment decisions. According to research by S&P, over 90% of the world’s largest companies will have at least one asset financially exposed to physical climate risks by the 2050s. Furthermore, over a third of those companies will see at least one asset lose 20% or more of its value as the effects of global warming increase. Integrating climate risk into an ESG investment strategy is no longer a ‘nice to have’, but a critical consideration when thinking about protecting returns.
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