- Greg Lowe, Aon’s Global Head of Resilience and Sustainability, looks at the regulatory and physical risk challenges posed by climate change
How seriously is the UK’s real estate sector taking climate change risk? According to a recent RICS survey of real estate professionals, nearly half (46%) believe that climate risk factors have no importance or are irrelevant when it comes to making investment decisions.1 Despite this view, there are clear signs that the regulatory environment may start to push climate change up the agenda, as will the increasing need for businesses to proactively manage the physical risks which, even in the UK, are becoming increasingly evident.
Hot in the summer
An early summer heatwave across Europe has seen many countries experience their hottest ever June temperatures and France had its hottest day ever at 45.1C Single weather events cannot be solely attributed to climate change, but this heatwave fits a broader pattern of more frequent and extreme weather that climate science tells us to expect with a changing climate. Aon’s Weather, Climate & Catastrophe Insight Annual Report 2018 found that not only was 2018 the fourth warmest year on record, but the USD$225 billion of economic losses from natural disasters made it the third year in a row that catastrophe losses surpassed the USD$200 billion threshold. As a consequence of figures like these, there has been a distinct shift in the way that climate risk has evolved in the regulatory space with financial regulators realising there is a potentially large systemic financial risk from climate change. In 2015, The Financial Stability Board of the G20 – a meeting of the world’s leading central bankers – created the Task Force on Climate-related Financial Disclosures (TCFD); a taskforce with a mission to ‘develop recommendations for voluntary climate-related financial disclosures that are consistent, comparable, reliable, clear, and efficient, and provide decision-useful information to lenders, insurers, and investors’.
What good disclosure practice looks like
In 2017, the TCFD released a framework – or what would good practice looks like from a financial disclosure perspective. The UK’s Prudential Regulatory Authority picked up the taskforce’s recommendations and is now applying stress tests to general insurers. But it is only a matter of time until there is a wider implementation across other industries when it comes to the regulatory assessment of climate related risks, both in terms of the physical risks – what the TCFD calls ‘the disruption of operations or destruction of property’ – and the transition risk ‘such as policy constraints on emissions, imposition of carbon tax, water restrictions, land use restrictions or incentives, and market demand and supply shifts.2
Zero carbon target
The more immediate and short-term risks to real estate owners are very much of a transition nature. One risk that’s already had an impact is the inability of landlords to let F or G EPC rated buildings while on the longer term horizon, the UK’s adoption of a net zero carbon target by 2050 will have a likely consequence for real estate owners of having to make large scale investments in the energy efficiencies of their buildings. The zero carbon target is massive and probably being underestimated. And if these transition risks aren’t managed successfully, there will also be a knock-on effect for physical risk.
The TCFD describes the physical risks as presenting themselves in two forms. The first is in the more obvious acute risks like extreme weather and natural catastrophes. The second one – probably less obvious as a significant risk to most real estate owners – are the chronic climate risks like water stress, rising sea levels, and heat waves; risks that that aren’t normally of a short duration but can go on over a period of months or even years.
UK floods and wildfires
The UK doesn’t have the range of physical perils seen in other parts of the world, but it does have flood risk – as seen most recently in late June with flash flooding in parts of Scotland – windstorm risk and back in February, there were even wild fires in England after the country’s hottest winter day on record. The critical point about climate change is that assuming the UK is a stable operating environment, is probably no longer a good assumption to make. The south east of England for example is a critically water stressed region and there will need to be significant upgrades in water infrastructure and some of that financing will have to come from business rates and property owners. A handful of the bigger real estate organisations have these risks on their radar but it’s a small segment of the wider market. The challenge – unlike many other risks – is that climate change potentially touches so many different issues. It has implications across insurance expenditure, risk engineering, investment decisions and operational expenditure, and because it can hit so many different areas, the scale of the problem can almost paralyse organisations. The answer is to start by looking at two or three of the most critical ways that climate change could impact the business.
Access to data
From an operational perspective, is the organisation equipped to deal with the volatility that climate related risks can bring? The process begins with having access to the right data, analytics, and information about what these risks might be and fully understanding the potential exposure and financial costs.
Getting a better understanding of the total cost of risk when it comes to climate change is vital because it will signal when a business might need to make critical decisions at certain points in the future. There is a balance of retaining risk, transferring it (through insurance), or mitigating it through risk engineering. It is inevitable that the risk mitigation angle will become even more important for real estate owners in the future.
Tomorrow's top ten risk
This year’s 2019 Aon Global Risk Management Survey lists climate change in 31st place amongst the top risks facing businesses – a rise from 2017’s 45th place, although it was the top risk listed in 2019’s World Economic Forum’s Global Risks Report survey which reveals a disconnect in risk perception from global C-suite leaders and the rest of business. As the effects of climate change intensify however, so will the economic impact and so will the need for risk managers to do more to understand how the changing climate will impact their business and how they manage and mitigate the growing regulatory and physical exposures. For real estate owners, it is no longer a risk that can be downplayed.
1https://www.rics.org/globalassets/rics-website/media/news/wbef-2019-questions-write-up.pdf