We explore some of the background to issues that businesses face when addressing climate change.
1. What has the world agreed to do about climate change?
In December 2015, 196 countries of the world set out their ambition and strategy to prevent the most dangerous and irreversible impacts of climate change as signatories to the Paris Agreement. The Paris Agreement contains a commitment to keep global average temperature rise to 'well below' 2°C above pre-industrial levels, to strive towards limiting the increase to 1.5°C, and to reach net zero emissions in the second half of the century. The Paris Agreement provides the goalposts for society's responses to climate change.
In 2018, the IPCC set out the deep and widespread impacts of 1.5°C warming, such as the loss of 70-90% of the world's coral reefs. The landmark Special Report on Global Warming of 1.5°C. found that even limiting global warming to 1.5°C would require 'rapid, far-reaching and unprecedented' changes in all aspects of society and the economy.
If all countries implement policies to meet their current 'nationally determined contributions' under the Paris Agreement, the OECD predicts that global average temperature would rise by 2.6°C to 3.1°C by 2100. Australia's 2030 emissions reduction target is to reduce emissions by 26-28% from 2005 levels. All countries are required to increase the ambition of their bottom-up promises with a five-yearly 'global stocktake' and 'ratchet mechanism'.
2. What do market stakeholders say about climate change?
With this scientific consensus on climate change and global agreement to transition to net zero emissions, climate change has rapidly evolved from an ethical and environmental issue. It is now widely recognised by leading market stakeholders such as prudential regulators, institutional investors and credit rating agencies that climate change presents material financial risks (and opportunities) for business.
3. How does climate change create these risks for business and investors?
Physical risks are both acute catastrophic and gradual onset. These include more frequent and intense extreme weather events, coastal inundation, ocean acidification, as well as ecological impacts such as species extinction. These physical impacts have consequences for infrastructure and assets, productivity, supply chain integrity, and the cost and availability of finance and insurance.
Transition risks arise from the transition towards a net-zero emissions economy, and associated shifts in the regulatory, technological and stakeholder landscape within which business operates. These have financial implications for demand and supply projections, revenue and costs, and balance sheet values.
Litigation exposures from the attribution of climate change to a company's activities or the failure to manage the impacts of climate change on the business.
These result in direct and indirect costs, with implications for financing and insurance.
While the most significant of these risks compound over the long-term, they also arise in the medium and short term. For many businesses, climate change already presents material risks over mainstream investment horizons.
4. Are all sectors affected?
These risks are far-reaching across the economy, but some sectors are particularly exposed, including energy and resources, chemicals and manufacturing, agriculture, food and beverage, tourism, infrastructure, real estate and development, logistics and transport, and financial services.
5. What are the opportunities?
Market and regulatory forces provide opportunities for sustainable business models and new markets in the climate transition, such as renewable energy, electric vehicles, sustainable fashion, and plant-based proteins. Beyond these sectoral opportunities, green finance provides businesses across the economy with opportunities to access capital in the equity and debt markets, with particularly strong demand for green bonds and sustainability-linked loans.
6. How are businesses expected to respond?
The precise impacts of climate change and society's responses are dynamic and uncertain. It is recognised the impacts will be significant, but it is not known exactly when and how. This has implications for investor portfolios and financial stability. Australian regulators (from ASIC, APRA, the ASX, RBA to AASB and AuASB) and the global institutional investors (such as the Climate Action 100+ with more than US$30 trillion in assets under management) expect businesses to incorporate climate risks and opportunities into their governance, risk management and corporate strategy and to report in line with the Recommendations of the G20 Financial Stability Board's Task Force of Climate-related Financial Disclosures. The AASB and AuASB expect Australian companies to consider material climate-related assumptions in accounting estimates, and make appropriate disclosures in the financial statements.