Sustainability

Attesting to the United Nations Secretary General Antonio Guterres’s stern warning in late July that “the era of global boiling has arrived”, the World Meteorological Organization has recently announced that this September, the hottest one ever, would be firmly pushing 2023 to be the warmest year on record. In the same month, torrential storms and flash floods were also reported in Hong Kong and New York City, two of the densest urban centers. The record-breaking 600mm rainfall in the former over a mere 24-hour time window caused an estimated USD 100M flood cost alone. Beyond direct damages caused to buildings and infrastructures, such extreme weather events and the resultant disruptions could lead to increased insurance premiums, maintenance, operational costs, and potentially, a decrease in property liquidity and value.

It is noteworthy that the identification and disclosure of climate risk is not something new or foreign to participants of GRESB assessment. Since 2022, GRESB has released two specific products – (1) the GRESB Transition Risk Report shows real estate portfolio managers which of their assets are most exposed to climate-related transition risk and how this may affect their portfolio over time, at both a country and global level, based on the rate of decarbonization as benchmarked with the Carbon Risk Real Estate Monitor (CRREM); and (2) the GRESB TCFD Alignment Report helps participants tackle reporting challenges related to the Task Force on Climate-related Financial Disclosures (TCFD).  With the issuance of the inaugural sustainability standards by the International Sustainability Standards Board (ISSB) in June 2023, International Financial Reporting Standards (IFRS) S1 & S2, which integrate and are consistent with the TCFD’s 4 reporting pillars, the climate risk assessment and disclosure is fast moving from a “good to do” to “need to do”.  Amidst all these fast regulatory and market whirlwinds, there is an encouraging sign that the global built sector is responding fast to address the climate risk topic as evidenced in the latest “Progress Report on Climate-Related Disclosures 2023 Report”. Out of the 1365 global companies surveyed, the Materials and Buildings Industry (345 companies) disclosed on average 5.8 of the 11 recommended indicators of TCFD disclosure, the second highest following the Banking industry. 

While GRESB & TCFD-aligned risk disclosure and assessment are meant to drive transparency for investors, regulators, and the public at large; to effectively tackle climate risks and galvanize the broad built sector of accelerated climate actions, we would therefore like to propose 3 activities where further dialogues and broader collaborations are highly encouraged -  

1. Communicate the climate risks effectively for action

While GRESB’s transition risk report does provide a snapshot of the asset and portfolio’s risk exposure to being stranded, a more elaborated parametrization in terms of the valuation and financial impacts could better initiate and guide discussions on how best and how fast to remove or mitigate such risk.

The Transition Risk Assessment Guideline recently released by the Urban Land Institute (Europe) provides an excellent starting point to capture these financial impacts via the individual asset or portfolio’s discounted cash flow (DCF), see table below: 

Beyond the transition risks tabulated above which are largely technology and market-driven, another major category of transition risk posing direct financial impacts for real estate comes from legal and policy. Examples include the Local Law 97 in New York City and the European Union’s Energy Performance of Buildings Directive. Non-compliance or inability to meet with the required energy performance standards/ratings could result in fines or even direct impacts to the asset capitalization.

Similarly, the direct effects of physical climate risks, both acute and chronic, on real estate assets could also be incorporated into the asset's financial positioning accordingly, e.g. 

If enough data is made available, the combined impacts could be encapsulated as a “climate change premium”, location and time-dependent; and be formally adopted as part of an overall portfolio’s investment management.

Effective communication is pivotal to connecting and driving engagement towards actions. To tackle climate risk effectively requires us to translate them into language that could better guide the discussions and decision-making process in strategic business or financial planning. 

2. Contextualize climate scenarios in practical and locally-relevant variables 

One of the key themes relevant for all industries under the TCFD Status Report is the persistently lowest disclosure rates, across all industries surveyed, on the “resilience of strategies” recommended disclosure. 

The recent COVID pandemic definitely has tested company's and society's capacities to develop and practice organizational resilience – agility, flexibility, adaptability, and self-sufficiency; and the capacities to “survive, adapt and thrive no matter what kinds of chronic stresses or acute shocks experience”.

The reported gaps on disclosure of how resilient the organization's climate strategies are against various climate scenarios and trajectories could likely be due to a lack of sector or industry-specific plug-ins that directly delineate the relationships or dependency of their strategies with the common climate model components such as macroeconomic, energy, emission intensity, and climate variables.

While climate models could be remote to comprehend, weather-related events are easier to be contextualized. So, a good starting point could be to take a stock-check of the “resilience strategies responses” (e.g. height and number of flood gates) and stress-test them against a range of extreme weather-related events and the hazards known. As a guide, IFC’s Building Resilience Index provides a good and comprehensive list of physical risk mitigation measures applicable to buildings and infrastructures. As weather effects are local-based, further guidance development by the local meteorological units, or building code reviews could be helpful to better contextualize the macro climate model variables into relevant parameters that asset owners and operations could work with.

3. Understand and seek for climate risk management schemes via a system-network lens

Risks do not operate in a vacuum, nor propagate in linear tracks. They are dynamic, inter-dependent, and networked – a mirror of our world; and climate risks are no exception. While a direct physical risk impact may result in disruption to one individual factory’s production schedule, the potential coupling and cascading of the events of this asset’s network matters, e.g. the 2011 tsunami in Japan and the massive floods that basically grounded transportation and the associated supply-chains disruptions in Thailand resulted in estimated economic loss of over USD 40B for the global automotive sector.  

While the built sector’s supply chain degree of globalization maybe less, it has its own sets of challenges where failures of tackling climate risks may trigger cascaded risks such as liability or reputation risks as occupied buildings or infrastructures are the physical backbones with close ties to people’s lives, businesses’ operations and supply of critical utilities and public-goods services. Thus, enhancing risk-sharing schemes amongst the various parties, or risk-transfer mechanisms via insurance are areas where the broader built sector stakeholders could benefit by more open dialogues and data sharing. It is less costly to mobilize and incentive the needed market capital to flow in where there is a time window to have the resilience delivered and risk-appropriate removed via underwriting, than to wait until the cost of mobilizing such capital becomes too high or when the risk is deemed too large that even the insurance industry may opt to exit. At that stage, the default option is to “accept” the risk – to either write-off the asset, or accept to live with whatever other losses and consequences that climate inaction may bring.

To conclude, resilience-based adaptation and decarbonization-based mitigation measures are imperatives for managing climate risks in terms of risk avoidance and mitigation. Risk-sharing and transfer mechanisms exist, but more industry-wide dialogues and collaborations are needed to help encourage, enhance, and evolve new business models and product offerings from the insurance sector or risk underwriting parties. With the accelerated pressures on climate risk disclosures by asset managers or owners, Schneider Electric is committed to supporting the built sector’s accelerated climate actions and working with the broader industry stakeholders to tackle climate risk together – from strategy to action.

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Author:
Dr. Bess Ng, Associate Principal, Sustainability Business, Schneider Electric

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References: 
•    GRESB Transition Risk Report & TCFD Alignment Report (2022)
•    Financial Stability Board “Progress Report on Climate-Related Disclosures 2023 Report” (Oct 2023)
•    Financial Stability Board “2023 TCFD Status Report” (Oct 2023)
•    Urban Land Institute - Europe “Transition Risk Assessment Guidelines” (June 2023)
•    Resilient Cities Network (https://resilientcitiesnetwork.org/)
•    International Finance Corporation (IFC) – Building Resilience Index (https://www.resilienceindex.org/) 
•    World Economic Forum “The Global Risks Report 2023” 18th Edition (Jan 2023)
•    Schneider Electric Sustainability Research Institute “How Schneider Electric’s Climate Risks Interact” (July 2023)
•    Global Adaptation & Resilience Investment Working Group “The State of Climate Adaptation and Resilience Investment” (Nov 2022)