United StatesAs negotiations concluded at COP29 in Baku, the need for increased finance to deliver reductions in the emissions driving rising global temperatures and to improve climate resilience took centre stage. There is growing awareness that the climate has already changed, with 2023 the warmest year on record and, using a longer-term global average, temperatures are now 1.3°C above pre-industrial levels.[1]
In response, both mitigation and adaptation policies and implementation efforts must accelerate and drive investment in the transition to a more resilient and net-zero economy.
To date, governments around the world have failed to adequately address the need for greater climate resilience. The UK, which is now facing warmer, wetter winters and hotter summers, is no exception. In 2023, the UK’s Climate Change Committee found that “buildings, cities and infrastructure in the UK are built for climate conditions that will no longer exist in five years, locking in future problems of overheating, economic disruption and rising damages from weather extremes”.[2] Meanwhile, the Infrastructure and Projects Authority estimates that “total infrastructure investment [in the UK] over the next 10 years, including private investment, will be nearly £650bn”.[3]
For asset owners and asset managers this self-evidently poses extreme risks, but it also presents significant opportunities for further investment in the solution providers that can make industry and supply chains more resilient. Impax has taken a lead in investigating this issue as part of our participation in the Climate Financial Risk Forum (CFRF) Adaptation Working Group. The CFRF is a forum established jointly by the UK’s Financial Conduct Authority and Prudential Regulation Authority.
In its new report, Mobilising Adaptation Finance to Build Resilience, the CFRF provides a framework that governments, companies operating in the real economy and investors can use to mobilise finance and increase their resilience to physical risks.[4]
The CFRF Adaptation Working Group has identified a number of challenges identified involved in mainstreaming and scaling up financing for climate resilience, including:
- A lack of clarity over national and international adaptation policy priorities, an absence of sectoral roadmaps regarding priority adaptation actions, and insufficient expertise among decision makers on how to implement resilience strategies across government and firms;
- Inadequate guidance as to which potential climate futures (scenarios) companies should use in making decisions about strategies to enhance resilience and pursue business opportunities;
- Low quality and relevance/usefulness of data used for physical risk analysis – particularly the high degree of uncertainty involved in moving from global emissions scenarios to local hazard and asset level data;
- A lack of guidance on how to integrate scenario analysis into investment decisions. For example, for asset owners and asset managers, traditional discount rates underplay the impacts of future losses, risks and benefits, making it difficult to attribute an appropriate value to future physical climate risks in valuations of companies today. Traditional discount rates do not have to be used for valuation purposes. Scenarios should be selected depending on the timeframe of investment and type of asset; and
- A resulting lack of scaled investment opportunities into adaptation activities where there are not clear market signals for the need for increased resilience across sectors.
‘Aim-Build-Contingency’ (ABC) Scenario Framework
Financial institutions are used to dealing with uncertainty. However, given the variance of potential outcomes and their associated consequences, dealing with future climate change-based uncertainty requires a novel approach. Investment managers and owners understand market and macro impacts such as interest rate uncertainty, but the financial impacts of tomorrow’s climate are still largely unknown and hence risk assessment for investment decisions in this area are extremely challenging.
With technical guidance from the Met Office and the Universities of Oxford and Leeds, the CFRF’s report therefore recommends an ‘Aim-Build-Contingency’ (ABC) scenario framework to support decision-making through guidance on risk management, the identification of opportunities and options to enhance resilience.
- Aiming to stay below 2°C and and supporting international efforts to limit warming to 1.5°C.
- Building and budgeting for 2°C by 2050 to prepare to be resilient to the warming that current policy efforts imply.[5]
- Contingency planning for 2.5°C by 2050. This is a reasonable worst case scenario that would arise due to the failure of current policies.
The Task Force on Climate-Related Financial Disclosures (TCFD) guidance says that “organisations should include scenario analysis into strategic planning and or enterprise risk management processes” by “identifying a range of scenarios that provide a reasonable diversity of potential future climate states”.[6] The ABC Framework provides technical guidance that the finance sector needs on what ‘potential future climate states’ to be prepared for in making investment decisions and seeking further resilience investment opportunities, over different timescales. Examples include:
- For banks, the ABC Framework can help with assessment of local hazards and weather-related risks already manifesting in mortgage portfolios to better inform risk assessments (over near-to-medium-term).
- For asset managers, it can help inform engagement with portfolio companies in asking whether their transition and adaptation plans, are resilient to A and B and C scenarios. Integrated transition, resilience plans could be asked for from clients and portfolio companies (from near-to-medium-term decision-making).
- For insurers and infrastructure investment managers, it can inform to what warming levels contingency planning will be needed to build and maintain assets with long lifetimes, of greater than 10 years (from the near-to-longer-term).
Identifying investment opportunities in resilience
The CFRF’s report also calls for a roadmap to be created by national governments that identifies and scales-up financing for resilience-based investments across all sectors of the economy.
Traditionally, adaptation and climate-resilient investments have been focused on the additional capital required to make investments in flood defences, primarily motivated by the imperative to withstand the worst impacts of climate change in this area. The CFRF report opens up this debate and suggests that, alongside efforts to achieve net zero, the scope of the analysis required to ensure resilience needs to be much wider.
For example, for the built environment, this means designing resilience through the adoption of ‘low-carbon’ cooling in advance of inevitable temperature increases. Transport systems must be modified to withstand more extreme weather events. Energy and water infrastructure must be robust against the likelihood of increased floods and droughts and also hotter, more humid weather. There are also significant implications for agriculture, where increasing periods of drought, heat-stress and, in some places high humidity are likely to results in lower crop yields and unsafe outdoors working conditions.
Minimising flood risk in the built environment
One of the key case studies in the CFRF’s report highlights the UK property market’s rising exposure to flood risk.
When a homeowner takes out a mortgage or re-mortgages, the lender, usually a bank, expects that insurance coverage is presented in the initial application. However, the insurance market typically takes a short-term perspective and insurance runs yearly. If that property is flooded the following year, and insurance is withdrawn or insurance premium goes up substantially, there is a risk that the homeowner will no longer be able to afford property insurance. Banks may also see the impacts if this results in increasing defaults on property loans.
The scale of potential losses is increasing with rising flood exposure. In turn, the risk of stranded assets is also increasing. The report highlights measures that could reduce this risk and improve resilience, such as the introduction of ‘Flood Performance Certificates’ (FPCs) for homes, similar to Energy Performance Certificate rating energy efficiency on homes.
However, even with these measures in place and encouraging more investment in future-proofing buildings in the UK, there will still be cases of tail risk where banks and insurers will not be able to cover losses.
The CFRF Adaptation Working Group is strongly recommending to the UK government to sustain and extend Flood Re. Flood Re is a flood re-insurance scheme that provides reinsurance both to promote the affordability and availability of insurance for UK households at high flood risk and to manage the transition to risk-reflective pricing of flood insurance for household premises. It currently covers these tail risks and is due to end in 2039.
There is also a compelling argument that Flood Re’s remit should be extended to other sectors and Flood Re has workstreams underway that include one on FPCs to provide homeowners with a view of their home’s risk, including a scoring methodology.
Investing in solution providers
As the climate changes, the need to improve society’s resilience to floods, storms, droughts, wildfires, extreme heat, sea level rises, and the proliferation of diseases and pests will result in significant new investment opportunities. Solution providers span companies operating in areas such as power grids, water infrastructure, agriculture, information and communications, the modelling and pricing of climate risks, as well as human health resilience.
As part of the Adaptation Working Group’s outputs, the University of Oxford has published an open-source adaptation taxonomy, hazard and asset level databases.[7]
Impax has long thought about resilience, mitigation and resilience in response to client interest in the growth opportunities of companies providing solutions around these areas. Having designed one of the world’s first ‘green taxonomies’ in 1998, we created a ‘Climate Taxonomy’ – an internal tool used as part of our investment process to identify a universe of companies whose products and services offer climate solutions, including adaptation solutions – in 2018.[8] Impax has also been involved in renewable energy infrastructure investments for nearly 20 years. We assess the physical climate risks of our projects as part of the development process and incorporate necessary adaptations into project site designs, such as cooling systems for electrical equipment or flood protection.
Real economy and policymakers
Financiers cannot act alone, though. The impacts of climate change are actually in physical effects such as high wind speeds, elevated water levels and wildfires, which may just impact small areas and communities but can also extend to regional and national levels.
It is now increasingly urgent that companies across the economy assess the risks they’re facing in this area and disclose to their investors the nature of these risks together with their plans to establish cost-effective resilience. Investors are increasingly expecting companies to disclose the location of major assets and report on how their business strategy is resilient to the uncertainties arising from climate change.
Analysing a single ‘expected outcome’ impact of potential hazards is not enough. Understanding tail risks and the operational, supply chain and financial impact of increased likelihoods of extreme weather events is key. Government regulators also need to set clear targets on what good resilience looks like.
For the UK, the Aim-Build-Contingency scenario framework provides an important contribution and has the potential to increase the economy’s resilience alongside the government’s net-zero commitments. We recommend that the CFRF’s advice be used by the UK Government to guide investment by the National Wealth Fund and in the procurement of major infrastructure projects to mobilise private sector finance into resilience.
The UK is a global leader on mitigation and net-zero commitments. However, to avoid the worst impacts of climate change over coming decades, we believe that investments to improve resilience should receive the same level of attention from policymakers and the private sector as mitigation. The finance sector stands ready to invest in the opportunities that ‘adaptation-inclusive transition plans’ can bring and build a thriving net-zero economy, while making it more resilient to the impacts of climate change.
[1] This is based on a 20-year mean period, combining the last decade of the observations with trends from a climate model for the next decade. Betts, R. A., et al, 2023: Approaching 1.5 °C: How will we know we’ve reached this crucial warming mark? Nature. Please also see the Met Office Climate Dashboard.
[2] Climate Change Committee, 2023: 2023 Progress Report to Parliament
[3] Infrastructure and Projects Authority, February 2024: Analysis of the National Infrastructure and Construction Pipeline 2023
[4] Climate Financial Risk Forum, October 2024: Mobilising Adaptation Finance to Build Resilience. Paper co-authored by Cath Bremner (Impax Asset Management), Ingrid Holmes (Green Finance Institute), Jason Lowe (Met Office and the University of Leeds) and Nicola Ranger (University of Oxford).
[5] Climate Action Tracker, 2023. 2100 Warming Projections: Emissions and expected warming based on pledges and current policies.
[6] TCFD, 2024: The Use of Scenario Analysis in Disclosure of Climate-related Risks and Opportunities.
[7] Resilient Planet Finance Lab, 2024: A Climate Scenario Taxonomy for the Financial Sector. University of Oxford Environmental Change Institute.
[8] We produced one of the world’s first green taxonomies as part of our classification of Environmental Markets in 1999. This was adopted by FTSE Russell in 2007 as the foundation for what they now call their Green Revenues Classification, which has an independent, expert, advisory committee. Since then, we have supported FTSE Russell in a biannual review of this taxonomy.
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