Tools of Change

With climate change high on the risk register, directors need effective tools to assess the potential impacts and ensure the appropriate management processes are in place to protect their business. Dominic Rolfe reports.

The insurance industry has long used sophisticated modelling tools to assess and manage risk, including the potential impacts of a changing climate. However, for businesses outside that sector, particularly small business and not-for-profits, assessing exposure to infrastructure, property and other assets — as well as the social impacts — can be challenging. Not least now that regulatory agencies such as APRA have put climate risk high on the agenda.

In addition to traditional business challenges, there is also an argument that we are wired against reacting to the long-term threats of climate change.

“[Psychologist and Nobel prize winner in economics] Daniel Kahneman says that we, as humans, are very poor at dealing with issues that are in the future,” says George Marshall, founder of Climate Outreach.

“We are very focused on the short-term and tend to discount or to reduce the value of things happening in the future. We are cost averse… and we are reluctant to deal with uncertainty. We say, ‘Come back and tell me when they’re certain.’ And in Kahneman’s view, climate change is the worst possible combination. It’s not only in the future, it’s uncertain and it involves costs.”

Making a start

In 2017, when APRA board member Geoff Summerhayes warned of the need for companies to tackle climate risk, he essentially laid out a four-step process.

Tackling climate risk effectively, Summerhayes told an audience at the Centre for Policy Development, requires organisations to “put the appropriate risk management processes in place, calculate your exposure, assess your risk appetite, and make sound business decisions that limit your vulnerability and capitalise on opportunities.”

For many companies, the first stage of having risk assessments embedded in decision-making is perhaps the easy part. Not so simple is the ability to know what to do next. Because climate risk is an emerging field, there are still many uncertainties. For example, how do companies decide which tools are best for calculating climate risk, and then how can directors assess the results and put them into action? In basic terms, what are the nuts and bolts of assessing climate risk?

The first threshold is being aware that you need to consider climate risk. Professor Andy Pitman, director of the ARC Centre of Excellence for Climate Extremes, says there are three types of companies: those who are doing climate risk assessments; those who know they should do them but don’t know how; and those that don’t think they need to.

Given the legal responsibility to assess business risks, he believes that if you don’t assess climate risk, you don’t know if you are vulnerable or not.

“Any company that assesses its risks to supply-chain problems, to workforce issues, to infrastructure or anything like that,” he says, “should also assess their risk of climate change.”

For Pitman, the first and most significant step is to place the analysis of climate risk under the reporting line of the CFO.

Most commonly, when I’m approached by a company wanting to know its climate risk,” he says, “I’m approached by, for want of a better phrase, the ‘touchy-feely’ environmental green sort of unit in the company. But when the company wants to really know its climate risk, the unit is led by the CFO.”

Pitman believes that putting climate risk under the wing of the CFO has a number of key advantages. It signals to people within a company and externally that the issue is being seriously considered. Moreover, “[the assessment of climate risk] will then tend to come with a budget, a strategic focus, and awareness of the broad ways of assessing the company’s risk profile and how climate risk plays into that,” says Pitman. “The CFO also tends to be on a sufficiently senior level of management to make good decisions.”

Andrew Gissing GAICD, the director of Government Business and Resilience at Risk Frontiers, agrees that climate risk needs to be an integrated part of a business. “You can’t just see it as a standalone issue, as something different you can just commission a special report for,” he says. “You’ve really got to sit climate change risks against your forward-leaning strategy as an organisation and understand how that risk impacts your future business objectives.”

Next steps

Understanding your exposure to climate risk needs to begin with a forensic assessment of a company’s bottom line against well-known drivers of climate change, such as El Niño, cyclone and heatwave frequency, droughts and floods.

Pitman believes that companies can’t simply go to a climate scientist and say, ‘What’s my vulnerability to climate change?’ “You have to say, ‘I know I’m vulnerable if it doesn’t rain in March and April. What’s the probability in the next block of time; what’s the changing probability of no rainfall in March and April?’ You’ve got to know what you are vulnerable to.” For larger companies, tools such as catastrophe-loss models — long used by the insurance industry — offer both a long-term view and the ability to provide the degree of resolution on a risk that is necessary for high-level assessments.

Ryan Crompton, director of Modelling and Research Solutions at Risk Frontiers, says, “Rather than having basic analyses that say, for example, if wind speeds are going to increase by five per cent, therefore damages increase 20 per cent, catastrophe-loss models allow us to look at a range of future scenarios where cyclones might increase or decrease in intensity or frequency in specific locations, and then find what the losses look like.” However, smaller businesses that don’t have the means to engage large external or internal assessments shouldn’t baulk at this quantitative hurdle.

“What’s sensible for any business, but particularly SMEs given their capacity, is to do a broad desktop risk assessment and determine the level of risk,” says James Wright, director and CEO of the Future Business Council.

“If you determine that your exposure is relatively low, then you wouldn’t invest too much more into assessment. But if you feel like the exposure is high, then you need to continue through the risk-assessment process to really capture what it is and develop more robust mitigation strategies.”

The Future Business Council is soon to launch a central landing page on its website to help businesses connect with tools, case studies and contact points. Other industry-specific bodies are also providing resources, such as the Climate Kelpie website that provides resources for farmers and farm advisors, as do many government sites such as the CSIRO. One CSIRO tool, Australian Climate Futures, allows users to obtain data for projected future changes in up to 16 climate variables.

Pitman believes that if companies have limited resources, then finding objective, expert information is key.

“I think seeking advice from someone reasonably well known in the field and having a 15-minute conversation could probably guide smaller companies on what they need to do,” he says. “But they need to talk to people who really know this stuff and those people tend to be hardcore, card-carrying researchers.”

If a business, large or small, decides to engage outside help, they need to be scrupulous in checking the credentials of the firm. “I would ask for their CV and I would want to see that they were a contributing researcher in the field, and recently,” says Pitman. “They need to be right up to date with the science, know the idiosyncrasies of what is and isn’t knowable. You also need to make sure that this is the person who is doing the work, not who takes the money. That they’re not a generic, environmental kind of person who can write beautiful reports.”

Risks and rewards

Climate risk isn’t entirely about negative outcomes. By taking stock of a company’s position, there is the opportunity to employ mitigation or adaptation strategies to hedge against certain climate outcomes.

“There will be undeniably commercial opportunity for those companies that can identify issues and implement things quickly and efficiently,” says Pitman.”

Pointing to the example of Tahbilk winery, Wright says, “After assessing and observing the potential impacts around climate risk to their assets, they started making some investments, particularly around irrigation, to support their water security. They also started communicating their sustainability and adaptation credentials publicly so that they were no longer just selling wine, they were selling their story and an eco-experience.”

It’s something that Wright believes will simply become the norm.

“In a few years’ time, [assessing climate risk] will be something that is much more front and centre for businesses. We are just going through that journey but there’s a long way to go before there’s the right amount of awareness for business at all levels.”

Tony Fontes, owner of Whitsunday Dive Adventures

“We’ve always been aware of the risk of environmental problems for the reef. But climate change took precedence over everything else around six years ago when it became pretty apparent, to even a non-scientist, that climate change wasn’t “if” but “now”. The impacts on the reef were going to be significant with ocean temperatures rising, bringing coral bleaching, and so on. When the largest coral bleaching on the planet occurred in 2016, everybody was running scared.

Mitigation is the only option because we had a category four cyclone go through Airlie Beach last March, leaving practically nothing in its wake in terms of coral.

Operators had to rethink, and a lot quit offering snorkelling and diving because it was too hard to find decent sites. They changed the focus of their business to running jet skis and climbing mountain tops. With the increasing severity of cyclones, that’s something businesses needed to take into account.

For climate change information, I go to the Great Barrier Reef Marine Park Authority. We also have regular, local marine advisory committees, which include people working within the community, who talk with the coral scientists, give feedback to them and they give feedback to us.

Not every tourist operator agrees with this but my business tries to educate the customer, so they become a proponent for the reef. They then understand the risk the reef is facing and when they go home, they can kind of shout and scream to help protect the reef because it’s a problem way beyond the shores of the Whitsundays or even Australia. We’ve also looked at ourselves and reduced our carbon footprint. It’s no good trying to hang in there, if you’re not willing to stand up and do it yourself.”