XDI’s Top Ten TCFD Physical Risk Tips for Companies

Former Governor of the Bank of England and current United Nations Special Envoy on Climate Action and Finance Mark Carney has declared its time for mandatory Task Force on Climate-related Financial Disclosures (TCFD) reporting. This, and the Canadian government’s linking of mandatory TCFD reporting TCFD reporting tomandatory for corporate coronavirus relief means it’s the time for businesses to make TCFD reporting part of their risk management regimes.

I’ve pulled together our top ten points on TCFD; tips for companies just learning about the frameworkTCFD, andas well as for those already using it to ensure they are getting the most out of the process. This is a deeper dive into what to do if you are serious about making good decisions about the physical risks on your business.

XDI’s Top Ten Tips to make TCFD reporting work for you:

Take TCFD reporting seriously and treat it as a journey, not a one-off event. Many companies use TCFD reporting for compliance reasons including, as noted, to qualify for government support or meet specific ESG standards. It is worth going beyond this box-ticking approach and to use the TCFD process to truly understand your climate risk. Many companies are already feeling the impacts of weather-related events, and it is good business to understand those and plan accordingly. We have already seen that the scale of physical risks experienced by many companies is of a similar order of magnitude as other risks (such as credit risk or insurable losses). Physical risk planning is best done as an ongoing business process that feeds into existing risk management processes, allowing you to invest in solid business resilience.
Understand exposure vs vulnerability. Simple approaches to physical risk assessment usually stop at understanding exposure risk rather than providing a plan for asset resilience. Exposure analysis is where hazard maps, such as flood maps, are placed over your asset locations, which shows whether you have assets in hazard zones. Is it not enough, however, for you to know if your key assets are sitting in a flood zone. It is far better to understand if your assets are vulnerable or resilient to the flooding based on how well they are constructed. For example: How deep is the extreme flood risk? Are key electrical components located above or below this critical elevation? Is forest fire really a risk to brick and concrete assets, or only those with important timber componentry? This is the intelligence you need to make effective business decisions because you can focus on those assets that are genuinely at risk, rather than just those that are constructed in risky locations.
Assess climate risk based on actual asset data rather than loss tables or industry averages. When working out risk, the damage to your assets can be calculated by using industry averages or historical damage tables. This works by saying that a typical warehouse in a specific location is damaged by a wind event of a certain speed. Or that in the past, 10% of buildings burned down in a serious fire, so there is a 10% chance that your building will burn down in a similar fire. However, The problem is that no-one has ever built a truly average asset. Every building, pump station and substation has its own unique construction and nuance that will determine whether it is vulnerable or not. The best physical risk assessments focus on both the siting and the actual construction and siting of each asset, and test it for resilience by those criteria. at that specific location.
Understand your cross dependencies. The biggest risk to your assets may not be their design and construction. They may be well built and resilient over their asset life for their location,b. But what about the supply chain infrastructure on which you depend; is that resilient? How do you know if the road network will continue to allow access to your site, or the power network is strong enough to keep working through extreme weather events?. Cross dependencies can have far more impact on your operations than what happens at your sites, so understanding the whole risk profile requires analysis of all of the aspects of your business.
Assess hazards to the whole portfolio. A common mistake by many undertaking TCFD reporting is to include only the assets that are directly within their control such as factories, warehouses, office buildings, etc. But what about suppliers, your investment portfolio, held equities, bonds and other associated companies and business partnerships? Do you understand how much risk they carry and whether they will transfer any of that risk to you. A comprehensive understanding of physical risk requires a deep understanding of the transferred risk in your portfolio of investments.
Assess risk using multiple time horizons and scenarios. The current crop of climate models still provide a range of possible futures that we will experience. This level of uncertainty is unlikely to change within our lifetimes, so it’s important to create realistic boundaries around the possible risks you may face and therefore the range of actions you need to deal with. The various scenarios, also known as Representative Concentration Pathways (RCP’s), provide a range of possible climate outcomes based on how much carbon our economy ultimately forces into the atmosphere. So this is a good place to start. You can compare business as usual (RCP 8.5) with strong mitigation (RCP2.6) to provide the range of possible risks you need to consider. Another important issue is time horizons. The best analysis provides results that are relevant to your decision-making horizon. Is the next decade most important to you, or do you need to think about 20, 30 or even 100 years hence. Your TCFD physical risk analysis should include timeframes relevant to your business. Getting results out to 2100 can give your business a sense of how severe the future may be.
Use climate change analytics instead of adjusted catastrophe models. Catastrophe models rely on historical data, which is limited to insured loss of an outmoded asset base within the former geographic boundaries of climate change hazards. Now that we are in a dynamically changing climate, the past is no longer a good predictor of the future. Physical risk analysis should be based on robust metrics that account for future climate change, and evolve over time. For example, extreme heat projections need to account for both the increase in average daily temperatures as well as the likely extent of extreme weather in any given year.
Assess risk using real hazards vs trends. Much analysis of climate change impact is based on the trend data. The trend is often median or average of the climate change projections. However, using trend analysis ignores that much of the worst weather happens at the extremes not in the middle. It is the extreme winds or flood events that cause most of the loss in your portfolio of assets. Therefore, your TCFD physical risk reporting should be based on extreme weather analysis that includes the full range of climate model outputs, not just the averages. It should also cover all of the likely hazards the assets will experience over their operational life. For example, does the analysis cover building subsidence due to extended drought? This is a risk to many assets around the world and is often not included in climate risk reports.

Make sure your risk metrics are expressed in direct financial terms. The results of your TCFD reporting should be in direct financial terms. This way it can feed directly into your financial risk management process. One way to express this is to compare the probability of a damaging event, with the cost should that damaging event occur. In any given year there is a probability of a flood, and should it occur you can expect a certain amount of damage. By combining these two factors you can create a technical insurance premium that can be used to monitise the impact.

Get help. If you are just starting out using TCFD reporting or are already using it but feel that you’re not using it to full effect, get help. Climate risk analysis is a new discipline for many companies and it will take time to skill up and bring it into your decision processes. XDI can help. We carry out detailed climate risk analysis for companies and governments that directly addresses each of the issues raised in this article. We also provide an online tool that anyone can use to get started called EasyXDI. XDI helps our clients to not only understand TCFD reporting but to carry out climate risk analysis for a true picture of what that risk means and how to prepare for it. For more information or to talk to us about helping you begin the TCFD process, please get in touch.

About XDI

XDI Cross Dependency Initiative provides physical climate risk analysis and reporting for financial service providers, business and government. We have worked with a wide range of financial sector and government clients including the British Columbian government, Legal and General Investment Management and Government of New South Wales. We work with a number of management consultancies in the UK and North America to provide the physical risk component of TCFD reporting. XDI’s analysis uses multi-award winning data analysis technology and is the best on the market using extensive asset and climate data to run statistical analysis on high speed servers. XDI creates detailed asset-by-asset failure risk, supply chain and transport risk and cost benefit analysis. We’re looking forward to helping businesses gain a better understanding of climate risk and prepare for what’s ahead in the post-pandemic economy.

– Rohan Hamden, CEO, XDI, EasyXDI

rohan@xdi.systems

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NOTES:

On May 11, the Prime Minister of Canada announced support for large employers during the pandemic under the Large Employer Emergency Financing Facility (LEEFF). At the time of writing, details of the program were not immediately available, but the announcement explicitly stated that “recipient companies would be required to commit to publish annual climate-related disclosure reports consistent with the Financial Stability Board [FSB]’s Task Force on Climate-related Financial Disclosures [TCFD], including how their future operations will support environmental sustainability and national climate goals.”

In other words, to be approved for LEEFF funds, companies will have to disclose information on the material financial impacts of climate-related risks and opportunities in line with TCFD’s 2017 recommendations. The TCFD was established by the FSB in 2015 to enable investors, lenders, and insurers to better understand their exposure to climate risk. Voluntary disclosures consistent with TCFD provide information on how companies and clients are managing climate-related risks and opportunities.

Canada’s own Mark Carney, former Governor of the Bank of Canada and Governor of the Bank of England, and current United Nations (UN) Special Envoy on Climate Action and Finance, chaired the FSB during the period that the TCFD developed its recommendations. Michael Bloomberg, co-founder of Bloomberg L.P. and former UN Special Envoy on Climate Action and Finance, led the TCFD’s work. To date, over 1,000 organizations, representing over $12 trillion in market capitalization, have signalled their support of the recommendations.