Environmental Factors Flashcards
WEF environmental risk categories
- Extreme weather events and temperatures
- Accelerating biodiversity loss
- Pollution of air, soil and water
- Failures in climate change mitigation and adaption
- Risks linked to transition to low-carbon economy
Stockholm Resistance Centre findings
• Nine priorities relating to human-induced changes to the environment
• Regulate stability and resilience of earth system
• Four of the nine “boundaries” have been crossed:
o Climate change
o Loss of biosphere integrity
o Land-system change
o Altered biogeochemical cycles (N and P)
Climate Change (Overview)
- Change of climate, directly or indirectly due to human activity
- Alters the composition of the atmosphere
- Observed over comparable time periods
- Global issue with local manifestations (extreme weather) and global impacts (sea levels)
Climate Change (state of play)
• Stern Review – biggest market failure ever
• Scientific evidence points to increasing risk of serious, irreversible impacts from climate change
• 2018: IPCC: humans have caused 1 C, will reach 1.5 between 2030 and 2052
• UN Environment Programme Emissions Gap Report 2019: even if all Paris Agreement were established, still on course for 3.2 C temperature rise
o 1.5 C: 2020 to 2030: 7.6 % YoY drop in emissions
o 2 C: 2020 to 2030: 2.7 % YoY drop in emissions
Socioeconomic impacts of climate change
- Liveability and workability: 2017 East African drought – 800,000 displaced in Somalia – 2x more likely due to climate change
- Food systems: Ocean warming – 35 % decline in North Atlantic fish yields
- Physical assets: 2012 Hurricane Sandy – USD 62 bn in damage – 3x more likely
- Infrastructure services: 2017 flooding in China – USD 3.55 bn in direct economic loss
- Natural capital: 2012 30-year record low Arctic sea ice – 70-95 % attributable to climate change
Business risks
• Sectors at risk:
o Oil, gas and coal
o Heavy industrial sectors (petrochemicals, steel and cement)
o Buildings and transport sectors
• Climate risks:
o Transition risks – result of climate and energy policies, shift to low-carbon technologies and liability issues
o Physical climate-related risks – extreme weather events
• Businesses are exposed to range of risks:
o Stranded assets as climate policy action taken to reduce emissions
o Stress on water resources with implications for agriculture
o Physical impacts of climate change – rising sea levels near infrastructure and buildings
Climate change adaption and resilience
- Mitigation: reducing and stabilising levels of GHGs
- Adaptation: adapt to climate change already taking place and increase resilience
Climate change mitigation
• Involves:
o Reducing the sources of greenhouse gas emissions (burning fossil fuels, electricity, heat)
o Slowing down the process or enhancing sinks such as forests, oceans and soils
• Goals:
o Avoid human interference with climate system
o Stabilise greenhouse gas levels to allow ecosystems to adapt naturally
o Ensure food production not threatened
o Enable economic development in sustainable level
• Examples
o Energy – renewable energy sources
o Buildings – retrofitting to become more energy efficient
o Transport – electric vehicle adoption
o Industry – more efficient processes
Climate change adaption and resilience
• Involves:
o Adjusting to actual or future climate events
o Reduce harmful effects on the vulnerable
• Goals:
o Anticipating the adverse effects of climate change
o Taking appropriate action to prevent damage of climate change
o Take advantage of opportunities
• Examples:
o Drought resistant crops
o Clean cooling systems
o Building flood defences
o Protecting coastlines
Pressure on natural resources
• Increased pressure on natural resources caused by:
o Population growth
o Health improvements leading to people living longer
o Economic growth
o Increased consumption in developed and emerging economies
• Pressure on resources = resource scarcity
o Companies more efficient with natural resources
o Allows them to remain competitive and be sustainable
o Benefit on bottom line
Water
- 70 % world covered with water – 2.5 % is fresh
- Vital for human consumption, agricultural, industrial, household – set for demand rise
- WEF – water creates broader social challenges around economic uses, public water supply or environment
- 2 bn people experience high water stress
- 4 bn people experience severe water scarcity at least 1 m/y
- SDG 6 – ensure availability and sustainable management of water and sanitation for all
Biodiversity
• Invaluable services that for human health, well-being and economic growth
• Biodiversity is the “variability among living organisms in different ecosystems; includes diversity within species, between species and ecosystems”
• Provides natural resources and natural capital:
o Natural capital is the world’s stock of natural assets including soil, air, water and living things, deriving ecosystem services
o Include food, clean water, genetic resources
• WWF’s 2018 Living Planet Report – 60 % decline in species’ populations between 1970 and 2014 – driven by habitat loss
• Sectors at risk:
o Fishing
o Agriculture
o Extractives (cement and aggregates)
o Forestry (timber and palm oil)
o Tourism
Land use and forestry
• Agriculture, forestry, and other land use (AFOLU)
• Impact on soil, water, nutrients and organisms – 23 % of anthropogenic emissions
• 2019: IPCC: stability of the food change set to decrease
• Forests cover 30 % of land area: part of carbon cycle: photosynthesis
• Deforestation: 15 % of global GHG emissions
• CDP: USD 941 bn revenue associated with commodities linked with deforestation:
o Palm Oil
o Soy
o Timber
• Risks faced:
o Supply disruption
o Cost volatility
o Reputational damage
• Opportunities:
o Agricultural and economic development
o Health and stability of forests
o Reduction of GHG from deforestation
Marine resources
• Largest carbon sink o More ½ world’s oxygen produced o Absorbs 50x more CO2 than atmosphere • OECD: EUR 1.2 tn in value added • Known as the blue economy o Fishing o Mining • 680 m people in low-lying coastal regions • Issues in numbers: o 33 % of marine fish stocks are harvested at unsustainable levels o 60 % are fished at maximum levels o 7 % are fished at lower than sustainable levels
Air Pollution
• Increased air pollution:
o Damages environment
o Negative impact on human health
o Reduces crop harvests through soil acidification
• WHO: 1/10 deaths are due to air pollution
• Lancet Commission on Pollution and Health: 9 m premature deaths in 2015
• Air pollution set to worsen
Water Pollution
• Pollution: contaminants such as chemicals and microorganisms are introduced to the natural environment
• 2014: Flint Water Crisis
o Changed water supply – to older pipes
o Lead leached, long term health implications
o Lawsuits to city, state and fed government, including utility companies (Veolia)
• Causes:
o Spills and leaks
o Untreated sewage or industrial waste discharge
Water and waste management
• Feedback loop:
o Increasing consumption and waste levels
o Put pressure on landfill waste
o Causing landfill taxes to rise and tougher regulation
• Different models for waste disposal:
o Domestic: Paid for by taxes or based on house values
o Industrial: commercial service – encourages cheapest disposal option such as landfill
• Fragmented:
o Landfill most popular
o Practices around recycling varies between cities and countries
Circular Economy
• Economic model that:
o Avoids waste
o Preserves value of resources (raw materials, energy and water)
• Based on three principles:
o Design out waste and pollution
o Keep products and materials in use
o Regenerate natural systems
• Ellen MacArthur Foundation: importance of circular economy
o Key areas: cement, aluminium, steel, plastics and food
o 9.3 bn t of CO2e savings
Physical Risks
• Arise from:
o Damage to property, infrastructure and land
o Impact supply chains
• Become more important in last 20 years:
o Rising sea levels from melting glaciers
o Acidification of oceans
o Extreme weather affects (Australia in 2019)
• PG&E:
o 2019: filed for chapter 11 bankruptcy from Northern California fires
o USD 30 bn in liability damages
Transition Risks
• Risks from policy, legal, technology and market due to transfer to low carbon economy
• UK EPC example:
o Landlords cannot rent house that is below EPC E
o Therefore, leaving stranded assets
• UNEP:
o Policy measures backing green finance have doubled since 2015
o Increasing policy presents a business risk
Direct and Indirect Impacts
• Direct impact:
o Activities are directly affecting biodiversity
o Surface water used for irrigation purposes
• Indirect impact:
o Caused by organisation’s supply chain
o Importing fruits and vegetables
o Road construction leading to new commercial development
• Sectors particularly at risk:
o Agriculture, aquaculture and fisheries
o Forestry
o Tourism and hospitability
Supply, operational and resource management issues
• Companies need to measure and disclose environmental impact from direct operations
• Examples:
o Toxic waste
o Deforestation
o Air emissions
• 2019: UK Government: Environmental Reporting Guidelines: KPIs to capture link between environmental and financial performance
• 2019: EU Commission: Circular Economy Action Plan
• Global mining:
o 2019: Vale Brazil: Dam disaster
o 250 dead, 11.9 bn in market cap. Fell
o Sustainalytics – downgraded Vale
o Feb 2020: ICMM launched Mining Principles
Supply chain transparency and traceability
• Supply chains are complex as heavily interdependent
• Companies expected to understand, manage and disclose supply chains
• Traceability:
o Identify and trace the history, distribution, location and application of products, parts and materials
o Ensures reliability of sustainability claims
• CDP – GHG from supply chains often 4x higher than in direct operations
o O&G
o Cocoa
o Leather
o Forestry
• Key areas of risk:
o Energy use
o Raw material use
o Deforestation
• Traceability schemes
o Forestry Stewardship Council (FSC)
o Marine Stewardship Council (MSC)
o Roundtable for Sustainable Palm Oil (RSPO)
o Fairtrade Labelling Organisations International (FLO)
• Not-for-profit with measurement frameworks and tools:
o WWF – 50 performance indications
o EU Taxonomy for sustainable activities – assets, projects and activities are compliant with Paris Agreement
• Investors should access:
o Environmental requirements that suppliers are expected to meet in procurement policy
o Environmental risks through supply chain and discuss whether it has a mechanism to improve poor practices
Kyoto Protocol
• Adopted 1997, effective 2005 • Six main GHGs: o CO2 o Methane o Nitrous oxide o Hydrofluorocarbons o Perfluorocarbons o Sulphur hexafluoride • Commitments extended to 2020
Paris Agreement
• Conference of UNFCCC in Paris 2015 (COP21)
• Goal:
o Keep temperatures well below 2 C above pre-industrial levels
o Limit increase to 1.5 C
• Nationally Determined contributions (NDCs)
o Require signatories to determine, plan and report NDCs
o With updates every 5 years starting 2020
o 25-30 % reduction 2005-2030 are typical
• Members:
o 195 UNFCCC signed
o 184 have ratified it
• Article 6:
o COP25 in Madrid – no consensus reached on Article 6 (carbon markets)
o At COP26.binding agreement required
UNSDGs and Kigali
• UNSDGs: o Agreed by UN general assembly in 2015 o Cited by businesses • Kigali: o 2016 o Phase out manufacture of ozone depleting HFCs 80-85 % by 2045
EU Sustainable Finance Action Plan
• European Commission’s Capital Markets Union (CMU)
o Aims: deepening and integrating capital markets of EU member states
o By: investing in long term, infrastructure and sustainable development
• High-Level Expert Group (HLEG) on sustainable finance 2018 report:
o Classification system or taxonomy to guide sustainability
o Duties of investors in sustainable financial system
o Improving disclosure
o EU-wide label for green investment funds (Ecolabel)
o Sustainability part of mandates for European Supervisory Authorities (ESAs)
o Standards for green bonds
• EU taxonomy:
o Reduce the risk of green-washing of financial products
o Classification system to determine if activity is environmentally sustainable:
o Must contribute to one of six objectives:
Climate change mitigation
Climate change adaptation
Sustainable protection of water and marine resources
Transition to circular economy
Pollution prevention and control
Protection of healthy ecosystems
o Asset managers must explanations as to how and if they used the taxonomy criteria
o Useful for us as we sit in the greyer areas
• Climate benchmarks:
o Equity and corporate bonds benchmarks:
30 % and 50 % GHG intensity compared to investible universe
o Two benchmarks:
EU Paris-aligned Benchmark (EU PAB) – 7 % YoY reduction in CO2 emissions plus a 1.5 C limit to temperature rises and excludes fossil fuel companies
EU Climate Transition Benchmark (EU CTB) – similar targets but permits fossil fuels as transition
o EU Securities Regulator ESMA:
Focus on integrating ESG factors
Climate stress testing, green bonds and credit rating agencies incorporating ESG factors
Country level policy and prudential actions (France, UK and China)
• France:
o The French Energy Transition Law (2016)
o Institutional investors and asset management companies to explain how they take ESG criteria into account in risk management
• UK:
o FCA – consultation on climate change (2018)
o UK Government’s Environmental Audit Committee (EAC) – wrote to 25 largest UK pension schemes to warn of climate risks
o UK Department for Work and Pensions – trustees should publish statement that takes into account material ESG
• China:
o Green bonds market
o Engaging with EU on green taxonomy and environmental disclosure
Carbon markets
• The polluter pays principle
• Types of carbon pricing:
o Emission trading system (ETS): emitters can trade emission units to meet their emission targets
o Carbon tax: directly sets a price on carbon by setting explicit tax rate, price per tonne of CO2e
• History:
o Trialled in the UK in 2000s
o Adopted as EU ETS in 2005 – regulates half the European economy with a carbon price
• Locations:
o Sporadic
o USA, NZ, South Korea, CAN
o China: expected national scheme in 2020, largest in the world
• Companies use:
o Internal price on carbon creates assumed cost per ton of carbon emissions
o Uncovers inefficiencies and incentivise low carbon innovation
o Used to access new projets
o 1,300 companies – 100/500 Fortune Global use internal price
Task Force on Climate-related Financial Disclosures (TCFD)
• G20 finance ministers and Central Bank governors asked Financial Stability Board (FSB) how finance sector could account for the climate related issues
• Mark Carney: “inadequate information leads to mispricing of assets and capital”
• Sets out:
o Recommendations for companies and financial institutions
o For investors, lenders and insurers
o To better identify risks and opportunities
• Core elements
o Governance: Organisation governance around risks and opportunities
o Strategy: Climate-related risks and opportunities on business
o Risk management: process used to identify and assess risks
o Metric and targets: assessment of risks
Corporate and project finance (Assessment of environmental issues)
• Qualitative and quantitative environmental factors
• Scoring system used to benchmark company against peers, influenced by:
o Industry
o Country
• Energy consumption measured by:
o Level of absolute emissions of greenhouse gases from fossil fuel combustion
o CO2e
o Savings compared to benchmark year based on estimates or actual measurement of comparable assets
• Water utilisation measured by:
o Water usage taken from the ground
o Pollution assessed against indicators and incident reports
• Waste utilisation measured by:
o Costs generated from the disposal of waste in operations
o Includes landfill, incinerated waste, recycled
o Aspects such as CCS, pollution control and W-to-E
• International Finance Corporation’s (IFC) Equator Principles
o Risk management framework
o Performance standards such as resource efficiency, biodiversity
• Example:
o Risk: Excessive water use – Impact: depletion of water resources
o Risk: Excessive land use – Impact: soil degradation
Public finance initiatives (Assessment of environmental issues)
• Public funding usually blended with multilateral funding institutions and disbursed by:
o Green infrastructure funds (ASEAN Catalytic Green Finance Facility)
o Specialised banks (Asian Infrastructure Investment Bank)
o Funding platforms (Tropical Landscapes Finance Facility)
• Climate Policy Initiative (CPI)
o Annual average public climate finance totalled USD 254 bn in 2018
• Most spending on:
o Transport
o Adaption
o Energy efficiency
o Land use
• Examples of public finance:
o Export credit
o Development banks
o R&D
• Initiatives that usually require public and private funding:
o Energy
o Waste
o Transport
o Flood defence
• Governments need to be aware of policy so they don’t invest in stranded assets
Asset management (Assessment of environmental issues)
• Different portfolio types have different climate-related risks, must understand:
o Hedge risk
o Invest in assets with lower climate change risk
• Sustainability Accounting Standards Board (SASB)
o Established in 2011
o Disseminate sustainability accounting standards
o Interactive proprietary tool to identify and compare disclosure topics across different industries and sectors : ‘materiality map’
o Covers
GHG emissions
Air quality
Energy management
Waste and water
Ecological impacts
• Risks:
o Munich RE: physical impacts of climate change to insurers
o Enterprise value adjustment for physical risk to climate change: O&G, utilities
Overview for material environmental analysis
• Two approaches to assess financial risks
o Understanding environmental factors that pose risks to financial assets and liabilities such as event probability and how risks evolve over time
o Translating environmental risk factors into quantitative measures of financial risk that can inform firms’ risk management and investment decisions
• Tool choice depends:
o Asset class and risk type i.e. fixed income might look at credit risk
o Direct or indirect exposure – flooding vs. transition risks
o Scope: individual asset, portfolio level, macroeconomic level
o Value chain: supply chain, operation, assets, logistics and market
o Level: Company or project, sector, country
Company or project level material environmental analysis
• Balance sheet:
o Value of tangible or tangible assets
o Access to and cost of capital
• Profit and loss;
o Price, quantity and availability of goods and services (i.e. water scarcity)
o Ongoing costs of running operations (physical risks such as flooding)
• Decision example:
o Adjust price-to-earning (P/E) ratio
Reflect company competitiveness
Comparison with peers higher or lower environmental standards
Sector Level material environmental analysis
• Environmental risks: o GHG o Energy o Extractives o Transportation • Physical risks: o Buildings and infrastructure o Urban infrastructure • Influence: o Environmental risk premium – change the discount rate used o Sector-wide considerations have to be overlaid on the company analysis
Country Level material environmental analysis
• Single country exposure: o Environmental regulations o Emissions targets o Enforcement • Several-country exposure: o Disclosure varies o As do above factors
Analysing environmental risks
• No common standard, use third-party research and frameworks to analyse risks and costs
• Key approaches:
o Carbon foot printing
Measure emissions and intensity of operations
Compare it to global benchmarks
Identify priority areas to reduce emissions
TCFD – report weighted average
Challenges:
• Not yet available for unlisted assets
• Scope 3 rarely included
• Uses different estimation methodologies
o Natural capital approach
Measure, value and prioritise impacts and dependencies on ecosystem
Natural Capital Protocol (NCP) – decision making framework, enables organisations to identify, measure and value direct and indirect impacts on natural capital
o Climate scenario analysis
Forward-looking – how may perform in future states
Institutional Investors Group on Climate Change (IGCC) practical investor guide:
• Financial impact: scenario analysis – pricing of climate risks
• Alignment: with the 2C (investment beliefs)
EU Non-Financial Reporting Directive:
• Data sources and assumptions
• Apply recognisable methodologies
• Focus on materiality
• Generating a set of outputs that can be measured as KPIs
Green and ESG-related products
• Green bonds
o 2007 first bond by the European Investment Bank
o 2014 ICMA sets out Green Bond Principles (GBP)
o External verification of use of proceeds by second party opinion
o Climate Bonds Initiative: green bond issuance at USD 170 bn in 2018
o Dominant sectors:
Energy – USD 80 bn
Buildings – USD 77 bn
Transport – USD 52 bn
• Green loans
o Labelled debt that are linked to climate impact key performances
o 2018 Green Loan Principles (GLP) – UK and Asia Pacific Loan Market Association
Clear use of loan proceeds
Project sustainability objectives evaluated and communicated to lenders
Loan proceeds are managed through project account
Strict reporting mandated
o 2019 Sustainability-linked Loan Principles (SLLP) – UK, Asia and US
No specific green purpose
Borrower incentives to drive ESG performance
o 2019: 92 bn
• Examples:
o Louisiana Local Government Environmental Facilities issued bond for coastal flood defences
o Solvay issued sustainability linked load – ambitious greenhouse gas reduction target – 1 mt by 2025
• Investor considerations:
o Eligibility of assets to meet criteria (green, ESG, SDG)
o Use of proceeds effectively allocated to eligible projects
o Transparency and reporting
o Whether issuer or borrower has ESG strategy
• Centre for International Climate Research (CICERO)
o Dark green: projects that correspond to long term low carbon and resilient such as wind energy
o Medium green: projects that represent steps towards low carbon such as hybrid buses
o Light green: climate friendly but don’t represent the long term vision such as efficiency investments
o Brown: opposition to long term vision such as new infrastructure for coal
Blue economy
• Definition:
o Sustainable use of ocean resources for economic growth, improved livelihoods and jobs while protecting health of ecosystem
• Examples:
o Aquaculture
o Marine transport
o Desalination
• Stress on ocean:
o Pollution
o Climate change
o Over-exploitation
• Opportunities
o Growth prospects for ocean economy
o Capacity for future employment creation
o Role in addressing global challenges
• Areas for action:
o Approaches that produce win-win outcomes for businesses and ecosystem
o Creation of ocean-economy innovation networks
o Initiatives to improve measurement of ocean economy by satellites
• World Bank and EC – Blue Economy Development Framework (BEDF)
o Prepare policy, fiscal and administrative reforms
o Identify value creation in blue sectors
o Identify strategic financial investments
• OECD
o Ocean based economies can outperform global economy
o Ocean economy could double contribution to USD 3 tn
