The risk transition: shifting investment to a low carbon economy

WP2 Finance Workshop

The transition to a low-carbon economy entails diverse uncertainties and risks. The long-term, pervasive and in many cases highly uncertain nature of climate change and its surrounded perceived risks, make this transition uniquely challenging to rational and well-informed policy and investment decisions. If the low-carbon transition is to be successful, actors in the economy must be well prepared to face and overcome such challenges, reduce their potential impact, and to exploit the opportunities for wealth and welfare creation that may arise. A finance sector well prepared for such risks and challenges is crucial in helping to achieve a successful and prosperous low-carbon transition.

This workshop has been designed to learn from leading actors in the field, including Bank of England and the Chair of the Financial Stability Board (FSB) Task Force – which is industry-led disclosure task force on climate-related financial risks - recent developments on climate-related risks and opportunities to which companies are exposed. The worlsh seek to investigate whether and how the finance community is prepared and able to i) reduce the risk exposure associated with high-carbon assets and ii) facilitate a smooth transition to a low carbon economy. 

Find more information about the workshop at here. 

What were the main results?

Switching to a low-carbon economy entails diverse transition risks and uncertainties. Transition risks, which include policy, legal, technology, and market changes to meet the climate targets, pose relevant financial risk (e.g. stranded assets) to organizations. Therefore, inadequate information about such risks can lead to a mispricing of assets and misallocation of capital. A further challenge for organizations is to understand the potential effects of climate change on their businesses, strategies, financial performance and decisions made today. Indeed, most significant effects of climate change are likely to emerge over the medium to longer term, but their precise timing and magnitude are uncertain.

Efforts to mitigate and adapt to climate change may also produce opportunities for organizations and investors. For example, through resource efficiency and cost savings, the adoption of low-emission energy sources, the development of new products and services, access to new markets, and building resilience along the supply chain.

Better disclosure of the financial impacts of climate-related risks and opportunities would help organisations and investors to appropriately incorporate the potential effects of climate change into their decision processes. In particular, to make more informed financial decisions, financial actors would need to understand how such risks and opportunities are likely to impact their income and cash flow statement, balance sheet as well as their strategies and business models under different conditions.

In this context, TSB’s recommendations have been structured around four thematic areas representing the core elements of how companies operate: governance, strategy, risk management, as well as metrics and targets. These areas reflect the type of information investors expressed a need for, in order to make better, more informed decisions.

Although these recent developments, speakers underlined that the finance community still lacks standards, analytical capacities and scenario analyses to account transition risks into their investment decisions.

What's next?

Recognising the progresses made in climate-related financial reporting, the extent to which disclosure will evolve, it depends on whether stakeholders contribute to the quality and consistency of information that is disclosed.

Some proposed solutions emerged from the workshop were 1) to extend the forecast period and model the impact of long-term risks on organisations’ future cash flows; 2) to accelerate the risk posed by climate change by modelling impact of accelerated transition on the cash flows in the next 3-5 years; 3) to increase the risk premium in scenario analyses reflecting new risks.