How Climate Change is Redefining Business Risks

Climate change poses a spectrum of risks and consequences that are anticipated to adversely affect our economy. These repercussions encompass property loss, infrastructure expenses, service-related risks, and threats to financial stability.  

Presently,  business expectations, stakeholders, investors, and regulators exhibit a heightened interest in understanding how companies are addressing the impacts of climate change, encompassing both transitional and physical aspects. They seek insights into the risks and opportunities identified, the underlying assumptions in their analyses, and the strategies adopted to mitigate risks and capitalise on opportunities. 

This blog explores the evolving scenario of climate-induced risks for businesses, shedding light on how organisations are navigating this complex terrain. 

Transparency – a Pivotal Element 

According to a global and Australian analysis, Australia's top 100 companies excel in various criteria for robust climate risk reporting compared to the world's largest 250 firms (the G250). However, there's a notable lag in Australia's reporting concerning the transition to net zero emissions compared to the G250 counterparts. 

Notably, Australia's property and agricultural sectors, including the Murray–Darling Basin, face substantial challenges. To address these challenges, banks, investors, asset managers, and governments are adopting sustainable finance practices, integrating environmental, social, and governance considerations into business and investment decisions. 

 In NSW, the 2040 economic blueprint outlines a trajectory for a sustainable environment with reliable and affordable energy, aligning with key government documents like the Net ZeroZero Plan Stage 1: 2020-2030 and the Electricity Infrastructure Roadmap. 

Australia and NSW’s Economy 

Australia boasts a robust economy driven by key exports such as mineral resources, agriculture, tourism, and education. Despite comprising only 0.3% of the global population, Australia contributes 1.6% to the global economy, with a GDP of around $2 trillion. NSW, as the largest state economy, accounts for approximately 30% of Australia's economic output, valued at over $600 billion in 2019–2020. The state's economic health is intricately connected to the environment, relying on natural resources and ecosystem services. 

NSW's economy exhibits diversity in exports, ranging from agricultural produce like beef to natural resources such as coal, copper, and aluminium. Service exports, including tourism and education, make up about 40% of NSW exports. Over the past three decades, the state has transitioned from a reliance on non-renewable resources and agriculture to a more diversified, service-oriented economy, encompassing financial services, professional and technical services, property services, information media and telecommunications, health, and education. 

This economic diversification not only bolsters NSW's growth but also enhances its resilience to the adverse impacts of climate change.  

Impact of Climate Change on the Economy 

Climate change is poised to significantly affect the economy by potentially diminishing productivity and increasing infrastructure and service costs. Projections indicate that by 2061, climate change-induced heatwaves could result in the loss of between 700,000 and 2.7 million workdays annually. The modelling further emphasises that Australia's property and agricultural sectors will bear the brunt of these changes in the future. 

1) Decreased Agriculture and Food Production  

Adverse events such as droughts, heatwaves, cyclones, and floods exert a detrimental impact on agriculture and food production. Climate change-related extreme events are anticipated to cause a 50% reduction in agricultural output in the irrigated areas of the Murray–Darling Basin by 2050. This basin currently contributes 50% of Australia's irrigated agricultural output by value, covering a significant portion of NSW. 

Already, severe droughts have led to a 1% reduction in Australia's gross domestic product (GDP). Projections for 2061 indicate that climate change's influence on pastoral and growing conditions could result in annual average production losses ranging between $750 million and $1.5 billion. The decrease in commodity production may elevate the cost of these commodities, potentially triggering ripple effects across the economy, and leading to increased inflation and financial instability. 

2) Property Loss and Damage 

Climate change is anticipated to escalate the frequency and severity of extreme weather events and elevate sea levels, heightening the risk of natural disasters like bushfires, severe storms, floods, coastal erosion, and the inundation of low-lying coastal areas. These events have a direct impact on both private and public properties, resulting in damages and diminished property values. Such repercussions influence the financial well-being of individuals and the overall state economy. 

By 2030, the combined effects of climate change and extreme weather are predicted to diminish the value of the Australian property market by approximately $571 billion. In the case of sustained high greenhouse gas emissions, this devaluation trend is expected to persist beyond 2030. 

The rise in sea levels poses a threat to properties through coastal erosion and the more frequent or permanent inundation of low-lying coastal areas. Projections for 2061 estimate that between 39,000 and 46,000 properties will be susceptible to coastal erosion or flooding. This is foreseen to elevate the annual costs of property damage and land loss to a range of $850 million to $1.3 billion. Looking ahead to 2100, an increasing number of commercial, industrial, road, rail, and residential assets across Australia will face risks from rising sea levels. 

Additionally, extreme weather events such as bushfires result in direct property losses and damages. The devastating 2019–2020 bushfires, for instance, led to the destruction of nearly 2,500 homes in NSW alone. The overall cost of the bushfire season is estimated to surpass $100 billion, encompassing direct property losses and damages, as well as indirect expenses related to relief and recovery operations, along with the social and environmental damages incurred. 

3) Infrastructure and Service Costs 

Climate change is expected to exert heightened pressure on essential services, including electricity, water, and health services. 

The electricity demand is likely to surge as homes and businesses resort to increased air-conditioning usage to combat rising temperatures. This surge in demand, coupled with the extreme temperatures themselves, elevates the vulnerability of energy services to potential failures. An illustrative example is the power outages experienced across NSW, Queensland, and South Australia during the heatwaves in 2017. 

Rising temperatures and unpredictable rainfall patterns will impact water supplies in both regional and urban areas, leading to a reduction in water availability and necessitating more stringent water restrictions. 

Health services are anticipated to face increased strain due to the amplified frequency of heat waves and other health-related consequences of climate change. In response, these services will need to expand and adapt to meet the escalating demand. 

4) Financial Stability Risks 

Australia's financial institutions and system face susceptibility to climate change risks. Presently stable, these systems prompt considerations of future risks induced by climate change. 

The likelihood of increased insurance premiums arises as a consequence of climate change, driven by the escalating risk of natural disasters. This encompasses crop insurance, property insurance, as well as health and life insurance. Certain properties, situated in areas prone to climate impacts like bushfires, floods, or sea-level rise, may become uninsurable. This situation would compel property owners to either bear the risk or opt for construction in safer locations. 

Financial exposure for banks and other lenders emerges if the value of collateral they secure decreases due to climate change. 

Furthermore, natural disasters wield broader impacts on the economy, causing business disruptions, influencing tourism (both immediately post-disaster and in the long run), and affecting the physical and mental well-being of the community. 

5) Health and Well-Being 

Climate change has a profound impact on our health and overall well-being, influencing livelihoods and productivity. Instances like heatwaves and natural disasters lead to the loss of lives and injuries, impairing individuals' capacity to work and contribute meaningfully to society. Prolonged events like droughts also take a toll on mental health, creating ripple effects throughout the economy. 

Moreover, the repercussions on health and well-being can escalate the demand for healthcare services, subsequently driving up healthcare costs. 

Business Risks and Responses to Climate Change 

Various segments of society are advocating for more robust measures on climate change and, in numerous instances, assuming a proactive role in climate action. 

When it comes to the business risks, here are the key risks and their response to climate change: 

1) Financial Risk 

The Financial Stability Board, an international organisation overseeing the global financial system, established the Task Force on Climate-related Financial Disclosures (TCFD) to enhance the reporting of financial information related to climate impacts. The TCFD acknowledges the financial risks posed by climate change to the global economy.  

Moody’s Investors Service, a major credit rating agency, released a statement in January 2020 highlighting that climate-related risks present a prolonged credit challenge for New South Wales. Specific concerns include disruptions to economic output and increased budget pressures due to drought and bushfires, along with a growing risk of water-related stress in Greater Sydney over the long term. 

 2) Litigation Risk 

Climate change poses a legal risk to businesses, as evidenced by notable cases. In 2020, Mark McVeigh from Brisbane settled with Rest Super Fund for not adequately disclosing how it managed climate change risks. The fund acknowledged climate change as a significant, direct, and current financial risk across various categories.  

Another case involved the Abrahams family suing the Commonwealth Bank of Australia (CBA) for alleged violations of the Corporations Act in its 2016 annual report, which lacked disclosure of climate change-related business risks, including potential investment in the Adani Carmichael coal mine. CBA, in response, made substantial changes to its annual report in 2017, incorporating climate risk acknowledgment, leading to the withdrawal of Abraham’s case. CBA has since conducted a scenario and risk analysis of its portfolio. 

 3) Directors Risk 

The consideration of climate change as a director's duty applies to all businesses. In 2016, a significant legal opinion established that climate change risks are foreseeable risks for Australian companies. Courts may hold directors accountable for breaching their duty of care and diligence if they neglect to address "climate change risks" now, recognising the potential future implications. 

 4) Insurance Responses  

The Insurance Council of Australia acknowledges the physical, transition, and liability risks associated with climate change. By 2030, one in every 19 property owners in Australia may confront the possibility of insurance premiums becoming effectively unaffordable amounting to 1% or more of the property value per year. Munich Re, specialising in reinsurance and primary insurance, has cautioned that insurance costs might reach prohibitive levels. This situation could evolve into a long-term social issue, deepening inequality by creating disparities in access to affordable insurance. 

 5) Bank Sector Response 

Banks are addressing climate change as a financial risk that requires active management. Bank Australia, for instance, provides discounted home loans for properties meeting specified energy efficiency standards.  

In 2020, ANZS unveiled its climate change policy, committing to cease direct financing for new coal-fired power plants or thermal coal mines, including expansions, by 2030. Additionally, ANZS will only extend loans for large-scale office buildings if they meet high energy efficiency criteria. 

Global Organisations and Their Response to Climate Change 

Globally, there is a growing recognition of the imperative to shift our economies to address the inevitable consequences of climate change and diminish the threats posed by future climatic shifts. Numerous nations are exploring avenues to leverage the potential benefits inherent in this transition. Given Australia's, and specifically New South Wales' (NSW), economic ties with other nations, particularly key trading partners, the interconnectedness highlights the relevance of this global shift. 

The adoption of 'sustainable finance' is emerging as a crucial strategy to facilitate economic adaptation to climate change. Sustainable finance encompasses financial activities designed to promote more favourable environmental outcomes. This approach involves the consideration of environmental, social, and governance factors when making financial decisions, signalling a proactive commitment to aligning financial practices with broader sustainability goals. 

Australia’s Response to Climate Change 

Numerous national organisations, industry bodies, and initiatives are actively laying the groundwork for a sustainable economy resilient to the risks posed by climate change. The resilience of such an economy hinges on collaborative efforts between governance structures and agencies. 

The Australian Sustainable Finance Initiative (ASFI) plays a pivotal role in shaping an Australian economy that prioritises well-being, social equity, and environmental preservation. By emphasising financial system resilience and stability, ASFI has introduced a roadmap aimed at safeguarding Australia's economy from the impacts of climate change. 

The Australian Government Productivity Commission serves as a critical advisory body on microeconomic policy, regulation, and various social and environmental issues. In its 2013 inquiry report, "Barriers to Effective Climate Change Adaptation," the commission underscored the importance of governments incorporating climate change considerations into risk management practices. It emphasizsed the necessity for flexible policymaking approaches to effectively address the risks associated with climate change. 

The Australian Prudential Regulation Authority's (APRA) Prudential Practice Guide – Draft CPG 229 Climate Change Financial Risks is specifically crafted to guide APRA-regulated entities, including banks, insurers, and superannuation trustees, in effectively managing the financial risks associated with climate change. This initiative reflects a proactive stance in preparing and fortifying financial entities against the evolving challenges posed by climate-related risks. 

NSW’s Response to Climate Change 

The NSW Government has formulated policies and resources aimed at assisting both state and local governments in systematically assessing and addressing climate change risks within their planning and decision-making processes. Key policies and strategies integral to managing the impacts of climate change on the NSW economy encompass: 

1) NSW Government’s Net ZeroZero Plan Stage 1: 2020–2030: Serving as the cornerstone of NSW's climate change initiatives, this plan lays the foundation for achieving net-zerozero emissions by 2050. 

2) NSW Climate Change Policy Framework: Outlining the long-term objectives, this framework aims to attain net-zerozero emissions by 2050 while enhancing NSW's resilience to a changing climate. 

3) Climate Risk Ready NSW Guide: This guide stands as a primary source of information and guidance, specifically designed for NSW state government agencies to proactively prepare for the impacts of climate change. 

4) NSW Treasury’s NSW 2040 Economic Blueprint: Identifying challenges and risks to the economy, including those associated with climate change, this blueprint highlights opportunities for the NSW Government to foster economic growth and improvement. 

5) NSW Government’s Electricity Infrastructure Roadmap: Detailing a comprehensive plan, this roadmap delineates the transition of NSW's electricity sector to renewable energy over the next two decades. 

6) NSW Treasury’s Guidance on Climate-related Matters in Financial Statements: Offering guidance on incorporating climate-related considerations, this document aids NSW public sector entities in addressing the effects of climate change in financial statements. 

7) NSW Treasury’s Risk Management Toolkit: Geared towards supporting public sector agencies, this toolkit facilitates the development of robust and integrated risk management frameworks, including those addressing risks posed by climate change. 

Thus, preparation is the key to tackling the impact of climate change on business risks and productively responding to them. 

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