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Physical climate risk is no longer someone else’s problem: Morningstar

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Companies are becoming more financially exposed to the devastating impacts of climate change, according to the latest analysis from financial services firm Morningstar Sustainalytics.

  • Physical climate risk could result in a loss of 45 cents for every dollar of cumulative operating cash to 2050.
  • The US looks set to be the most vulnerable to revenue and IP loss in 2027.
  • Utilities have the highest risk profile, but businesses with a global value chain must start accounting for such concerns.

Morningstar Sustainalytics, a global provider of ESG data, research, and ratings, has announced a series of further enhancements to its Physical Climate Risk Metrics (PCRM) product. The PCRM is intended to support investors and issuers in meeting new reporting obligations and assessing their portfolio’s resilience to the risks of climate change and economic transition. The recent enhancements will enable investors to leverage sophisticated data and insights when evaluating their exposure to physical climate risks.

The enhancements include the addition of two new reports offering deeper views into companies’ exposure, loss, and financial resiliency as it relates to physical climate risk. Within these reports, new indirect risk metrics have been added to better meet the Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations on the disclosure of both direct and indirect physical risk and the provision of insights across the entirety of the business value chain.

Guidance for investors exploring impact across the business value chain

As part of Sustainalytics’ evolving set of climate-focused solutions for investors, the comprehensive PCRM dataset provides visibility into the financial impacts of physical climate risks, considering a company’s revenue, physical asset value, and operating cash flow.

In a hot house world scenario (also known as the RCP8.5 scenario), where climate policy efforts are insufficient in preventing irreversible climate change and the severe consequences of related physical risks, companies with average physical climate risk exposure within the Physical Climate Risk Metrics universe (which covers over 12,000 companies) may lose an equivalent of $0.45 for every $1 of cumulative operating cash, between now and 2050.

The analysis shows that, contrary to the prevailing belief that communities in the global south are more likely to be affected by climate change, the United States is in fact the country most vulnerable to revenue and intellectual property loss (production capacity) in 2027. (RCP2.6 scenario)

Looking at specific industries, if the average global temperature can be limited to 2°C by the end of the century (RCP2.6), then companies in the energy, industrials, materials, and utilities sectors could face the most significant financial loss ratios due to direct and indirect physical climate risks.

Further analysis by industry shows that, in 2027, the Utilities sector will likely have the highest percentage of its assets labelled as high risk. Morningstar says that, in 25% of the assessed Utilities companies, at least 50% of companies’ global high-risk assets are in the United States, with another 25% in China, India, Singapore, Japan, and Brazil. Given that many areas in these regions are prone to flooding, likely to be exacerbated by forecasted the El Nino cycle, assets in these countries are likely to experience damage in the coming years.

Azadeh Sabour, senior vice president of Climate Solutions at Morningstar Sustainalytics said“With the increasing global adoption of climate-related regulation to accelerate decarbonization and within the limited time to mitigate the effects of global warming, investors need data and insights to understand their exposure to financial risks stemming from the increasingly frequent and devastating climate events.”

What is the PCRM?

PCRM is a bottom-up assessment of climate change-related adverse impacts from physical hazards, including major storms, wildfires, floods, and others. The dataset can support investor alignment with the TCFD recommendations and provides transparency into a company’s expected financial losses between now and 2050.

Developed in collaboration with XDI (Cross Dependency Initiative), an award-winning physical climate risk analysis leader, these metrics cover over 12,000 companies, spanning 12 million assets, 135 sectors, and 235 countries.

Collecting and parsing large amounts of asset-level and climate data requires significant technological resources, typically unavailable to many investors. Additionally, the asset-level data used to define each investment’s exposure has been historically limited in availability. With PCRM, investors can quantify the physical climate risks facing their portfolio companies without these tools of their own. They can gain access to multiple assessment views, including specific hazards, countries, estimated asset damage, estimated revenue losses, time series, and climate scenarios.

Morningstar Sustainalytics’ Physical Climate Risk Metrics are currently available as a standard package of five reports through its Data Services, and company-level reports will be available via its online client portal, Global Access, later this year.

SG Take

It is becoming increasingly clear that, whether or not stakeholders agree that ESG and climate aware strategies are necessary, the implications of climate change could lead to significant potential losses across a number of sectors.

As investors begin to factor such analysis into their own decision-making, companies cannot can afford to build their development strategies without considering such concerns.

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