Elizabeth Cava, audit and assurance partner, Deloitte Bermuda
The many impacts of climate change will have a profound impact on individual companies over time. Boards and managements are having to consider the risks and how they should respond to them.
While climate risk has traditionally been treated as a long-term issue and something more talked about than acted upon, the pressure to act is growing.
In a world when ESG is gaining momentum, investors and consumers increasingly demand sustainability. Regulators in some parts of the world are also starting to mandate disclosures of climate risk, particularly when it is connected to financial risk.
Navigate Bermuda spoke with Elizabeth Cava, audit and assurance partner at Deloitte Bermuda, for her thoughts on how Bermuda’s financial-services industry in particular is managing climate risk.
Navigate: What are the greatest challenges faced by company boards and senior managers as they decide what they should do to address climate change?
Cava: Two challenges which stand out to me are how boards will drive integrated thinking (in which sustainability is embedded in all aspects of a company’s operations) and how companies will manage the data required to report on their chosen metrics and targets.
Climate risk may currently be on a company’s risk register, though as organisations progress, climate risk will need to be fully integrated into a company’s risk-management framework and all areas of operations. The shift to integrated thinking will be important for organisations to build credibility when reporting on their metrics and targets. Being credible to stakeholders will be important, and a change in thinking should cascade from the board of directors down the organisation. Appropriate training and briefings will be necessary. Stakeholder expectations are and will continue to change so management cannot be complacent in the execution of overseeing this change in thinking.
Management and boards will need to carefully think through the metrics and targets used to assess and manage climate-related risks, including an appropriate timeframe for achievement. Different standards and frameworks will suggest or prescribe certain metrics to disclosure. For example, the Task Force on Climate-Related Disclosures (TCFD) has certain cross-industry climate-related metrics such as greenhouse gas (GHG) emissions, carbon pricing and the proportion of assets and/or activities materially exposed to physical or transition risks. However, with GHG emissions, there are currently limitations to reporting on Scope 3 emissions (the indirect emissions which occur in a company’s value chain), as one of the most widely used methodologies does not quite allow for comparability between entities. Climate-related targets might require the need for scenario analysis, requiring a technical understanding of assumptions and models in which the expertise to properly perform a review may be limited in the organisation.
Underlying all of this is data. There is a scarcity of data that is fit for purpose and at the right level of granularity for companies to work with. Many organisations do not currently capture or have the controls in place to report on targets and metrics. For companies with investment portfolios to manage, thinking through the various data points and providers can pose a challenge in that companies have different reporting methodologies compounded by the different ranking and screening methodologies for data providers.
Navigate: What kinds of climate risks should companies in Bermuda be considering?
Cava: Bermuda’s financial-services companies will need to consider both the transition risk related to moving to a lower carbon economy and the physical impacts of climate change. Certain financial-services companies may also need to consider liability risk, should parties who have suffered loss and damage from climate change seek to recover those losses.
Physical risks, or the damage from weather-related events such as storms, certainly affect the losses that insurers and reinsurers will record. Even life insurance companies will also face greater impact as heat waves, droughts, fires, can change morbidity and mortality assumptions. Banks and capital markets are exposed to physical risks through their lending activities and the associated collateral. Monitoring of credit loss exposure should include data points to capture climate risk exposure on the loan portfolios. Asset managers and asset owners are exposed to physical risks through their portfolio companies and models producing valuations of companies should include assumptions on exposures to climate risks. For companies needing to hold “safe” assets, the changes in climate may affect credit quality of certain sovereign or municipal issuers.
Transition risk can take the form of changes in technology, regulation and policy changes and consumer sentiment and can be difficult to measure due to interconnectivity with other variables. Banks will need to assess transition risk in their loan origination and credit monitoring processes. Asset managers and asset owners will incorporate monitoring of these trends in reviewing portfolio company performance and due diligence in projects to invest in. For insurance companies, transition risk will impact underwriting activity for certain lines of business as well as the assets insurers will invest in.
Navigate: Are companies treating the potential impact of climate change on their businesses as something that requires action now or something that can wait a few years?
Cava: Companies are at various stages of maturity currently, though the discussions around climate risk, from regulators to company boards, have increased exponentially in the past year. Certain larger reinsurers publish separate sustainability reports, with metrics, targets and disclosures mapped to one or more frameworks or standards, with independent assurance reports. Others are just starting to think about the materiality of ESG factors to their business, the governance structure and incorporation into the risk-management frameworks. Another change is that whereas in the past, exclusionary practices, such as not underwriting or investing in carbon-intensive companies, might have been sufficient, stakeholder sentiment is evolving, making financial-services firms key in addressing climate change, given their vital role in capital markets.
Navigate: What effect, if any, has the pandemic had on companies’ attitudes to climate risk?
Cava: While not necessarily affecting a company’s attitude toward climate risk, the pandemic has shown that companies might have identified a risk but not thoroughly thought through the potential changes to their operating model and business. For example, there were companies which, prior to 2020, had pandemic risk on their risk register but not in business continuity plans. Many business continuity plans were in place with short-term inaccessibility to physical spaces and not months-long remote working. Companies could draw on this experience when building enterprise support to have climate risks be fully integrated in their operations.
Navigate: Will companies in Bermuda be impacted by regulatory requirements for climate risk disclosures in the European Union coming in the next couple of years? Would you expect regulators elsewhere to require such disclosures over time?
Cava: Bermuda has a number of companies with operations in Europe which will be impacted by changes in the EU regulations. Additionally, insurance companies regulated by the UK’s Prudential Regulation Authority will be expected to have embedded the TCFD disclosures by the end of 2021. The United States is quickly catching up with Europe, from the Biden administration committing to rejoining the Paris Climate Agreement to the SEC directive to enhance its focus on climate-related disclosures in public company filings. Bermuda’s SEC-listed companies will be impacted by any enacted rule changes.
Other regulators are certain to follow as stakeholder focus on climate risk increases. The New York Department of Financial Services has published a climate change regulatory framework, though no additional regulation at the moment. Switzerland’s Financial Market Supervisory Authority recently announced it will require certain insurers and banks to disclose qualitative and quantitative information pertaining to climate risks on their businesses. New Zealand has also enacted similar regulatory changes.
The Bermuda Monetary Authority (the “Authority”) has communicated that it is increasing its focus on climate change matters with the introduction of a regulatory and supervisory team specialising in the licensing and supervision of innovative business model proposals to address climate change risk and the associated protection gap. The regulator has also communicated its goal to integrate sustainability into its regulatory frameworks. Earlier this year, the Authority published the results of a survey conducted last year on the impact of climate change to Bermuda’s insurance industry and also indicated that it is actively monitoring and responding to developments with respect to climate related disclosures. In 2021 the Authority has indicated that it will be performing an exposure and vulnerability analysis pertaining to climate change risk of Bermuda’s commercial insurance market.