Environmental Factors

Question 1

WEF environmental risk categories

Answer 1

• 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

Question 2

Stockholm Resistance Centre findings

Answer 2

• 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)

Question 3

Climate Change (Overview)

Answer 3

• 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)

Question 4

Climate Change (state of play)

Answer 4

• 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

Question 5

Socioeconomic impacts of climate change

Answer 5

• 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

Question 6

Business risks

Answer 6

• 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

Question 7

Climate change adaption and resilience

Answer 7

• 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

Question 8

Pressure on natural resources

Answer 8

• 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

Question 9

Water

Answer 9

• 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

Question 10

Biodiversity

Answer 10

• 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

Question 11

Land use and forestry

Answer 11

• 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

Question 12

Marine resources

Answer 12

•	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

Question 13

Air Pollution

Answer 13

• 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

Question 14

Water Pollution

Answer 14

• 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

Question 15

Water and waste management

Answer 15

• 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

Question 16

Circular Economy

Answer 16

• 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

Question 17

Physical Risks

Answer 17

• 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

Question 18

Transition Risks

Answer 18

• 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

Question 19

Direct and Indirect Impacts

Answer 19

• 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

Question 20

Supply, operational and resource management issues

Answer 20

• 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

Question 21

Supply chain transparency and traceability

Answer 21

• 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

Question 22

Kyoto Protocol

Answer 22

•	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

Question 23

Paris Agreement

Answer 23

• 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

Question 24

UNSDGs and Kigali

Answer 24

•	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

Question 25

EU Sustainable Finance Action Plan

Answer 25

• 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

Question 26

Country level policy and prudential actions (France, UK and China)

Answer 26

• 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

Question 27

Carbon markets

Answer 27

• 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

Question 28

Task Force on Climate-related Financial Disclosures (TCFD)

Answer 28

• 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

Question 29

Corporate and project finance (Assessment of environmental issues)

Answer 29

• 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

Question 30

Public finance initiatives (Assessment of environmental issues)

Answer 30

• 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

Question 31

Asset management (Assessment of environmental issues)

Answer 31

• 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

Question 32

Overview for material environmental analysis

Answer 32

• 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

Question 33

Company or project level material environmental analysis

Answer 33

• 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

Question 34

Sector Level material environmental analysis

Answer 34

•	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

Question 35

Country Level material environmental analysis

Answer 35

•	Single country exposure:
o	Environmental regulations
o	Emissions targets
o	Enforcement 
•	Several-country exposure:
o	Disclosure varies
o	As do above factors

Question 36

Analysing environmental risks

Answer 36

• 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

Question 37

Green and ESG-related products

Answer 37

• 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

Question 38

Blue economy

Answer 38

• 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