The COVID-19 pandemic and climate change risks share many of the same characteristics, both in terms of their impact and why they have caught so many off-guard. Addressing climate risk is not a distraction from the economic recovery—for all entities, it is an indispensable part of it.
Far from being a ‘black swan’ event, there is an argument that businesses should have been better prepared to manage the impact of the pandemic on their operations, not only by having diversified their supply chains and customer bases as part of their basic structure, but also by having crisis management and business continuity plans—developed years earlier—ready to fire so they could rapidly transition and adjust to the supply and demand shocks we have seen on such an unprecedented scale. Indeed, SARS and the Ebola virus served as early warning signs.
But the risk now is that businesses will develop pandemic tunnel-vision—they might revise their internal governance and risk management strategies, and put in place plans so they can stay open if a wave of new infections arises, but what about other threats to their survival? Threats that might have an even more devastating—and permanent—impact than a pandemic.
The primary threat of that kind is climate change. The trouble with the current pandemic is that it has fed a narrative that the identification and management of climate risks is not the pressing ‘now issue’ that it was pre-pandemic. That the focus needs to be solely on managing the impact of COVID-19 and all other risks can wait.
Yet this narrative will only see entities repeat the same mistake that contributed to their current economic hardship as a result of the pandemic. Best practice governance and risk management is about perceiving, mitigating and adjusting for a broad range of operational threats, and putting in place the expertise and systems required to ensure a cohesive and seamless approach from the board down, in advance—not addressing each threat reactively, after the fact.
Like COVID-19, climate change is a risk that is dynamic and that continues to rapidly evolve, and has a similar ‘contagion effect’ in initially hitting some sectors particularly hard—such as the retail, hospitality and tourism sectors in the context of the pandemic and the energy, manufacturing and agriculture sectors in the climate context—before quickly spreading to others that depend on those sectors, including insurers and banks, and eventually impacting on the stability of the financial system and economy as a whole.
But despite the evolving nature of climate change, global regulators and intergovernmental organisations have begun to develop clear frameworks for entities to not only identify and disclose the specific climate risks impacting on them—from assets located in areas susceptible to flood, drought or rising sea levels to higher cost bases from regulatory changes such as putting a price on carbon—but to also take action to mitigate the impact of those risks.
The 2017 Guidelines issued by the UN Taskforce on Climate-Related Financial Disclosures (TCFD) remain the most widely accepted framework which enables entities to clearly undertake these steps, and the Guidelines are increasingly being embedded in formal regulatory standards in individual jurisdictions.
And in late June 2020, the Network for Greening the Financial System, comprising the Central Banks from 66 nations, released new mapping and stress testing scenarios which break down the specific climate risks that can impact any business in any sector, and which also link those risks to broader damage to the global economy.
Apart from new regulatory guidance, the push for dedicated action on climate change is also occurring at an industry level. Indeed, it is in businesses’ own interests to have in place clear climate risk disclosure and mitigation frameworks—backed by mandatory regulatory requirements—so they know what to report against and comply with. Businesses need to know the rules of the game. Otherwise, chronic uncertainty and indecision will impact risk-taking and officers’ willingness to undertake new projects and expose their operations to supply chains and investments that could be hardest hit by a changing climate.
In a signed statement in May 2020, 155 companies representing the Science-Based Targets Initiative—spanning 34 sectors and 33 countries, with a combined market capitalisation of over US $2.4 trillion—pressed the important opportunity that COVID-19 has provided for governments, regulators and businesses alike to align their investments in the global economic recovery period ahead with clean energy projects and low emissions technology.
Sustainability finance and bonds have a clear role to play in that process, raising capital for businesses from both government contributions and private debt and equity investors, and ensuring accountability by matching investments to specific outcomes in the mitigation of climate risks.
And on a more internal level, entities can use COVID-19 as a chance to review their costings, customer bases and supply contracts and to also conduct a wholesale risk assessment to understand how each line of their operations would be impacted by distinct adverse climate scenarios. ‘Stress testing’ of this kind is specifically recommended in the TCFD Guidelines and regulators globally are continuing to refine the specific metrics that entities should adopt to measure their climate exposure. Depending on the nature of the risks, entities with high exposure should take steps to diversify their supply chains and investment portfolios – whether they are manufacturers, service providers, financiers or insurers – so they can adjust as the physical impact of a changing climate continues along with further global regulatory change in relation to carbon pricing and emissions trading.
And why stop there? Climate risk should similarly not be another instance of narrow, tunnel-vision thinking—large scale cyber attacks, data and privacy breaches and major workplace health and safety incidents too may have a devastating impact on businesses and we have already started to see this occur globally.
All of these risks need to be proactively considered by all boards as standing agenda items at meetings. Directors are not expected to be experts in everything – but they are expected to obtain the advice they need from risk, technology, environment, financial and other specialists so they are in a position to plan for and ‘future proof’ a company’s operations with the stewardship and active engagement required as an essential component of good corporate governance. It is also critical to embed effective testing, reporting and risk escalation procedures within an organisation and to ensure risk management and compliance frameworks and functions are put in place to effectively identify, plan for and respond to rapidly evolving risks.
If entities do not take these steps, history will repeat itself—only with the cost potentially so much greater and more enduring than the fallout from being unprepared for a health pandemic. And in the case of climate change, without any prospect of a cure.
Scott Atkins is a Partner, Deputy Chair and Head of Risk Advisory at Norton Rose Fulbright.
Dr Kai Luck is an Executive Counsel and Director of Strategic Insights at Norton Rose Fulbright.