This article first appeared on the World Economic Forum’s Agenda blog.
Concerns about climate change have been rising over the past 10 years, and this year the top five long-term risks in the World Economic Forum’s Global Risks Report were all in the environmental sphere. With all key indicators pointing to a bad situation getting worse, both the public and private sectors need to accelerate their climate risk mitigation and adaptation efforts.
The long-term impacts of climate change, such as temperature and sea level rises, and recent spikes in extreme weather events, such as wildfires and tropical storms, are compromising critical infrastructure, crop production, and the livability of many heavily populated areas.
Climate-related risks are also amplifying growing tensions stemming from trade, geopolitical, and domestic conflicts.
For business leaders in particular, the combination of environmental risks and interconnected risk areas is creating pressure for action to address near and long-term threats as well as investment and growth opportunities.
CLIMATE RISK IMPACTS AND INTERCONNECTIONS
Climate change is striking more rapidly than many expected. It has already had significant consequences, and its impact will grow in the coming decade.
Polar ice is melting more quickly than anticipated, with significant implications for sea-level rise and exacerbated geopolitical risk as neighboring states in the Arctic compete for new shipping lanes and natural resources. A growing proportion of the world’s population is now more exposed to catastrophic flood risk due to the combination of climate shifts and rapid urbanization in coastal and low-lying areas.
Australia is experiencing a continent-scale wildfire emergency, with more than 5 million hectares burned. California’s catastrophic 2018 wildfire season caused over $22 billion in direct property damages, bankrupted a local utility, and left that state to suffer routine blackouts to protect infrastructure and reduce liabilities. Shifts in seasonal temperature and rainfall are damaging crop yields, increasing the stress on countries dependent on agricultural output, and intensifying disputes over water resources.
Climate change is also exacerbating biodiversity loss, which was already accelerating due to deforestation, industrial expansion, pollution, and population growth. Recent reports have brought greater attention to the irreversible consequences on biodiversity within and between species, which threatens food security and — in a vicious circle — amplifies climate change impacts. For example, damage to coral reefs increases flood risk and deforestation in the Amazon increases the potential for drought and fire.
PRESSURE FOR CHANGE
There is mounting pressure for change to mitigate and adapt to the direct impacts of climate risk and its connected downstream risks. There was a marked uplift in climate activism this past year, including nonviolent civil disobedience actions and the prominence of green agendas as an electoral issue. However, multilateral progress was limited, with COP25 in Madrid ending in disappointment.
Pressure is also getting channeled to the private sector, with employees criticizing management actions on climate change and the targeting of pension funds to divest from fossil fuel assets. Investors and rating agencies have also exerted pressures on companies, whether through engagement on low-carbon transition or net-zero emissions plans and investments or through inclusion of climate risks in ratings methodologies.
There have also been growing demands for transparency, with financial regulators such as the Bank of England stress testing banks and insurers against climate scenarios, policymakers proposing mandatory climate-risk disclosure legislation, and litigation against companies failing to disclose climate risk.
BECOMING MORE STRATEGICALLY RESILIENT
The risks for companies will grow due to both the direct impact of climate change on business operations and supply chains as well as the greater demand for action from increasingly concerned stakeholders. The clamor for action on governments may also reach a point where they respond in a disorderly way with heavy-handed and disruptive interventions that impose significant costs on companies.
Companies can proactively manage climate change risks and pressures in a number of ways.
Companies should actively monitor legislative and regulatory developments so they don’t get caught out by policy changes or unexpected regulation. Some developments are motivated by strong and sudden public pushes, such as the anti-plastic movements, while others, such as auto-emission standards regulations, fall prey to conflicting expectations and can catch an industry off guard.
Companies should prepare for increasing pressure on climate issues from all of their stakeholders — investors, customers, employees, and communities. Could there be demands from investors to withdraw from certain sectors, such as fossil fuels? Could employees initiate a walkout over climate change responses? Will customers boycott unsustainable products?
Or could there be litigation tied to lack of action on climate change mitigation or adaptation?
Risk quantification and scenario planning is a positive step. Companies should critically analyze their climate change risks, from physical exposures to policy changes to transition challenges to financial impact. Today’s improved data and computing power means that potential sources of disruption — for operations, markets, customers, and investments — can be modeled and better incorporated into overall risk management and business plans. More rigorous analysis also can help companies identify risk indicators to monitor, and fulfill the likely expansion in requirements for climate-risk disclosure by institutional investors, lenders, and legislatures.
TURNING RISK INTO OPPORTUNITY
The pressures stemming from climate risk also create significant opportunities for businesses to align their strategies with the direction of change.
New and expanded product and market opportunities will be created. Some will be oriented to specific areas, such as renewable energy, regenerative growing practices in agriculture, or sustainability-linked financing. Many more companies have the opportunity for climate risk-related product, service, and supply-chain innovations that will attract customers, investors, and employees with a heightened sensitivity to the issue. In fact, according to CDP, companies have reported opportunities arising from the low-carbon transition to be worth $2.1 trillion compared to around $1 trillion of downside risk.
The private sector should also aim to capture some of the benefits of climate resilience investments. The World Bank estimates that investing in new resilience infrastructure generates around $4 in benefit for every $1 invested. The private sector should closely collaborate with the public sector in the co-development of financing incentives and de-risking mechanisms to enable relevant technology or infrastructure investments.
The role of the private sector in enabling the rebuilding and improved resilience of communities following catastrophic disasters should also expand. Risk transfer from the public to the private sector via insurance or other risk financing mechanisms can help strengthen community resilience to future climate change impacts. Asia’s SEADRIF is a first-ever risk transfer mechanism that helps reduce the burden of catastrophic disaster costs on public finances through innovative risk financing, insurance, and climate resilience solutions.
While business leaders should aim to create greater resilience for their companies to climate risk, the same understanding of climate dynamics can help them pursue these and other opportunities for growth.
AUTHORS
John P. Drzik is the New York-based Chairman of Marsh & McLennan Insights. Oliver Wyman is a division of Marsh & McLennan Companies.
