Innovative Corporate Initiatives to Reduce Climate Risk

By Edward B. Barbier

Innovative Corporate Initiatives to Reduce Climate Risk

Businesses, investors, and insurers are requiring better quantitative assessments of their exposure to climate risks and their impact on climate change. They are incorporating these assessments in their day-to-day management and long-term investment decisions. Already, there are efforts to develop international guidelines, common policies and legal frameworks for such assessments, as well as the desire to foster climate financing. Reducing climate risks will require national and international policies that promote green market-based incentives, improve environmental regulations and foster innovation. However, as the main players in global markets, large businesses, investors, and insurers have the most important economic impact on the climate and face significant risks from climate change. For example, nearly two-thirds of historic carbon dioxide and methane emissions globally can be attributed to just 90 producers of fossil fuels and cement. The combined costs of pollution, ecosystem depletion and health impacts amount to over US$3 trillion annually for global companies. If businesses had to pay for these costs, profits would be reduced to zero. Around two-thirds of the world’s largest global corporations are exposed to water risk, especially in terms of water security and stress, with 405 companies reporting total losses of more than US$2.5 billion due to water scarcity.

Private sector is beginning to take a lead in fostering global climate responsibility

There is increasing evidence that the private sector is beginning to take a lead in fostering global climate responsibility and stewardship. Ahead of the opening of the Paris climate change conference in December 2015, Bill Gates of Microsoft, Mark Zuckerberg of Facebook, and other high-tech entrepreneurs, announced the formation of the Breakthrough Energy Coalition that will fund a worldwide public-private partnership among governments, research institutions, and investors to finance clean energy innovation and low-carbon development worldwide. The Coalition will target research and development (R&D) in “green” electricity generation and storage, transportation, industrial use, agriculture, and energy systems efficiency. Ten global corporations have committed to greenhouse gas reduction targets consistent with limiting global warming to less than 2 °C—the threshold that scientists widely agree would help avoid the most disastrous effects of climate change. For example, Sony Corporation, based in Japan, has achieved its target of a 30% reduction in GHG emissions from 2000 to 2015. Aggregate reductions by these ten corporations will amount to 799 million metric tons of carbon dioxide equivalent (MtCO2e), which is 2% of the world total. Other corporations are expected to make similar commitments, which would further boost the chances of meeting the 2 °C global warming limit.

A report on global corporate response to climate change noted that over 200 companies are directly engaging with policy makers in support of carbon pricing legislation, that companies “are already advanced in their use of carbon pricing”, and that “they are ahead of their governments in planning for climate change risks, costs, and opportunities”. It was recorded that in 2017 over 1400 companies worldwide impose a price on carbon in their internal operations and investment decisions. This is a substantial increase from 150 companies in 2014 and includes more than 100 Fortune Global 500 companies with total annual revenues of US$7 trillion. In East Asia, Japan has 129 companies using or planning to use an internal carbon price, and China has doubled the total number of companies internalizing the price of carbon from 54 to 105 between 2015–2017, including companies such as China Vanke, Shanghai Electric and China Mobile. South Korea has established the first national Emissions Trading System in Asia, and China plans to implement their own carbon Emissions Trading Scheme by the end of 2017, which will provide further momentum to the internalization of the price of carbon by corporations in South Asia.

There is growing evidence that improved climate risk management by firms affects their overall cost of capital and their attractiveness to potential investors. Improved climate risk management and performance signal to financial investors that firms can sustain higher debt capacity, require less expensive debt, and warrant lower equity risk premiums. In turn, investors are requiring better quantitative assessments of how firms are managing the climate risks, mitigating the damages that arise from climate change, and incorporating these assessments in their long-term investment decisions. For example, 75% of 36 surveyed global financial institutions state that they monitor climate and environmental risks of transactions, and 42% account explicitly for such risks in their credit assessments. Over 1750 investors, from over 50 countries and representing approximately US$70 trillion, have agreed voluntarily to incorporate six key principles for responsible environment, social and governance goals into their investment analysis and decision-making process. Greater transparency concerning firms’ climate risk management and performance will, therefore, increase the willingness of investors to provide long-term financing of such firms, as well as increase the rate of return on such investments.

Already, there are efforts to develop international guidelines, common policy, and legal frameworks to support innovative corporate initiatives to reduce climate risk. At Shanghai in February 2016, finance ministers and central bank governors of the G20 major economies committed to developing such frameworks. Members agreed to “green” the US$90 trillion of investments required over the next 15 years to achieve global sustainable development and climate objectives. The G20 has also launched the Green Finance Study Group, co-chaired by China and the UK, to explore ways of mobilizing private capital for green investments. Further government action is required to assist in the establishment of common practical frameworks, methodologies, and tools to provide a systematic approach to monitor and integrate climate factors into credit and investment risk assessments.

Firms would benefit from better climate risk management

The mounting global problems of climate change, ecosystem degradation, natural resource degradation, and pollution are indications that the creation of economic wealth is currently under-pricing these environmental risks. There is growing evidence that both firms and investors would benefit from considering better climate risk management in their investment and business decisions. The potential economic and environmental gains to investors, firms, and society suggest that there is an important role for policies that support such efforts by businesses. Central banks, financial authorities, and governments can advance this objective by developing financial regulations that support investment decision-making that considers factors such as improving climate and environmental performance, establishing better climate risk management and reporting requirements to foster green STI, and developing international guidelines and common policy and legal frameworks to support better climate risk management, assessments, and reporting.

Although firms and investors globally are increasingly taking climate and sustainability reporting seriously, they are looking for better guidance and regulations from policymakers on such measures. Financial authorities and central banks must take the lead in ensuring that the public and private sources of capital provisioning in the economy take into account currently under-priced climate risks. Also, governments internationally must cooperate to develop common policy, and legal and regulatory frameworks to support such initiatives. The current lack of coherent policy direction and coordination remains a key barrier to more widespread adoption of improved environmental performance and risk management by businesses globally.

 

This is an excerpt of the journal article: Innovative Corporate Initiatives to Reduce Climate Risk: Lessons from East Asia, by Edward B. Barbier and Joanne C. Burgess. Published: 21. December 2017 in Sustainability 2018, 10(1), 13. DOI: 10.3390/su10010013 under a Creative Commons Attribution License (CC BY NC 4.0).

  

Edward B. Barbier
Professor

Edward B. Barbier is a Professor in the Department of Economics, Colorado State University and a Senior Scholar in the School of Global Environmental Sustainability. His main expertise is natural resource and development economics. He has served as a consultant and policy analyst for national, international agencies, including many UN organizations, the OECD and the World Bank.