[Skip to content]

Sign up for our daily newsletter
The Actuary The magazine of the Institute & Faculty of Actuaries

Managing carbon risk

The Carbon Disclosure Project (CDP)
is the largest ever investor collaboration.
This year’s CDP attracted the
support of 225 investment institutions
globally, representing in excess of
$31.5 trillion of assets under management
approximately a quarter of the world’s total.
The CDP is also notable for including most of
the largest and most established firms, such as
Merrill Lynch and Goldman Sachs.
The CDP is a simple process whereby investors
request information on companies’ greenhouse
gas emissions and how companies
manage the risks and opportunities that may
arise from climate change. The CDP currently
writes to 2,400 companies globally.
The CDP is the largest and most prominent of
a number of investor collaborations on climate
change and sustainability issues; others include
the Global Reporting Initiative and the Global
Framework for Climate Risk Disclosure. This
year’s World Economic Forum also tried to get in
on the act, with the launch of the Climate Disclosure
Standards Board (CDSB), whose aim is
to establish a generally accepted framework for
climate-risk-related reporting by corporations.
So why are hard-nosed investors like Goldman
Sachs so interested in a ‘green’ issue like
climate change? First this information is not
available elsewhere, it does not form part of
companies’ accounts; and while some of the
information forms part of Corporate Social
Responsibility (CSR) reports, it is often not
amenable to comparison and is incomplete.
The main reason is that unlike other issues
that often form part of CSR, climate change
owing to the direct physical risks that it represents,
its effects on the economy, and the
changes to the business environment caused by
society’s attempts to mitigate its effects may
alter the future earnings potentials of companies
and hence their values.
Climate change is one of a number of interrelated
global trends, such as peak oil, the ageing
population, and the rapid growth of China
and India, that form the economic environment
in which firms operate. While climate
change is often seen as a long-term issue with a
slow onset, regulation changes or non-linear
impacts could send signals to markets and lead
to rapid price changes.
Market sectors will be affected asymmetrically
and firms will fare differently within each sector.
Companies that are forward looking and
recognise the importance of climate change
and its implications for their business are likely
to prosper, whereas companies that are slow
moving or stuck in high-emission industries are
likely to suffer.
Positive and negative
Companies face a number of current and potential
risks and opportunities from climate
change. It must be remembered that risk can be
positive as well as negative, so those that are
well positioned will benefit relative to companies
that are not.
? Physical risk: companies’ assets may be damaged
and suffer business interruption owing to
increased severity of extreme events and changing
weather patterns. We have already seen a
number of manifestations of this: for example,
oil companies were affected by the 2005 hurricane
season in that most of their facilities in
the Gulf of Mexico were destroyed. Similarly,
reinsurance companies had a particularly bad
year, with losses from hurricane Katrina alone
totalling $80bn. Less dramatic but equally economically
damaging future risks will be caused
by changing weather patterns: for example, by
large water users such as agriculture, mines, and
hydroelectric power plants being unable to
source enough water to operate.
? Regulatory risk: governments are moving to
curb greenhouse gas emissions, therefore companies
that have large emissions may face
increased costs. This may potentially affect a
number of industries but not necessarily the
large emitters or energy companies, which can
often pass costs ‘downstream’. Research suggests
that the industries most affected will be logistics,
building materials, and bulk commodities.
? Competitive risk: this results from a possible
decline in consumer demand for energyintensive
products and a rise in cost for
energy-intensive processes. This is already starting
to show in some industries: for example,
many US automobile companies are faring
badly compared to Japanese companies partly
because of their choice to manufacture less fuelefficient
? Reputational risk: from perceived ‘inaction’
on climate change. Many companies are investing
heavily in carbon reduction strategies as it
becomes perceived as a major consumer issue.
Companies are also finding that these strategies
help to motivate and retain staff. A related area
is litigation risk; we are seeing an increased
number of litigation cases against companies in
relation to climate change. A recent example is
the Californian government suing automobile
firms for damage caused by emissions. The risk
facing companies here is not the direct litigation
pay-outs but disclosure; it took 40 years after the
first case before tobacco companies had to pay
out for lung cancer. This is where litigation cases
get past an initial stage, and the defendant has
to provide information demanded by the litigant,
which can include embarrassing internal
memos and emails, and potentially cause lasting
damage to a company’s reputation.
? New business opportunities: there will be
more demand for low-carbon, high-energyefficiency
goods and services. The impact of climate
change may also create demand for new
products and expertise: for example, for flood
defenses and increased demand for insurance.
Different products will be produced and consumed
in new locations: for example, wine
grown in the UK or diseases found in new locations
requiring new drugs.
Many companies are going further than
required by regulation. The main motives seem
to be reputational and brand related; most of
the companies that do this are public facing.
Examples are supermarkets reducing the carbon
emissions required to produce and transport
food, banks such as HSBC going ‘carbon neutral’
by offsetting their travel and energy use,
and BT buying ‘the world’s biggest renewable’
energy contract.
Institutional investors are increasingly aware
of these risks and opportunities, and therefore
require accurate, comparable and forwardlooking
information. Carbon reporting is also
becoming increasingly popular with politicians.
In his recent US Senate testimony on combating
climate change, one of Al Gore’s recommendations
was for carbon reporting. Similarly,
the UK Conservative Party is considering introducing
mandatory carbon disclosure should it
form the next government.
Therefore, it looks as if carbon reporting is
here to stay and is expanding in the near term.
However, does carbon reporting achieve anything?
The CDP is now in its fifth iteration and
in this time the response rate and quality of
responses has improved dramatically: the
response rate has increased from 47% of FT 500
companies in CDP1 to 72% in CDP4. However,
there are problems: the data is not always comparable,
has rarely been audited, and in some
cases is of poor quality. Investors require
forward-looking data, whereas CDP responses
concentrate on existing emissions.
More fundamentally, while the CDP has
increased awareness of climate change issues
within the corporate sector and led to massive
increases in monitoring and reporting, it is still
a peripheral issue; the carbon emissions from
companies since the launch of CDP in 2000
have risen inexorably.
Future challenges
There are as yet unresolved issues with carbon
reporting, not surprising given the complexity
of the issues and the newness of the field. The
main problem is the comparability of data
between companies. The World Business Council
for Sustainable Development has developed
a greenhouse gas protocol for reporting; however,
this is far from universally adopted. It
becomes particularly complicated when making
comparisons between companies in different
sectors, but even within sectors there are
difficulties when companies operate in different
markets. For example, a car company producing
luxury vehicles will probably produce
less energy-efficient products than one operating
at the lower end of the market.
Another issue is boundaries: for example, how
subsidiaries, components and emissions from
products are treated. Poor-quality data is a problem
as highlighted above, some responses are
verified or audited but there are no auditing
When it comes to other aspects, like impacts
or product strategy, the quality of responses is
highly variable but does provide some valuable
insights in the best (and worst) cases. Such
information can be used to generate ratings of
corporate responses to climate change, which
can serve as an aid to communication and portfolio
More fundamentally, while the CDP has
increased awareness of climate change issues
within the corporate sector and has led to massive
increases in monitoring and reporting, it
has not penetrated far enough. This reflects the
fact that a reporting initiative that is not backed
up by forceful engagement is likely to be seen
as an optional survey by many companies.
In conclusion, carbon reporting looks as if it
is here to stay and will indeed expand. This will
be a key area in the future for companies and
investors and it is an important area for actuaries
to monitor. Climate risks could be correlated
across portfolios, and risks to assets
could correlate with risks to liabilities: for example,
severe weather events could cause both
increased liabilities for insurance companies
and negatively impact assets.