Accounting for Climate Change: Translating Climate Data into Financial Risk

SEI Researcher Tanya Fiedler’s pioneering research on climate risk is helping businesses to play their part on climate change.

Image via UnSplash, by Matthew Henry.

As wildfires ravage one of the coldest places on earth and floods submerge trains stations and lives in China, it is clear that the climate crisis presents a multitude of intersecting crises. Dr Tanya Fiedler believes that to address climate change, an interdisciplinary approach which responds to the incentive structures of businesses is vital.

Pointing to the bureaucratic nature of government and intergovernmental agencies, Dr Fiedler argues that the flexibility and immediacy of the business sector are key reasons why businesses can lead in addressing the climate challenge:

“Businesses … can be so much more agile. They can move much more rapidly than a body such as the United Nations, which relies on the consensus of multiple jurisdictions each with their own and often conflicting agendas.”

Dr Fiedler’s background in accounting and longstanding interest in interdisciplinary work has allowed her to explore this space of potential for climate action, operating as a translator in the junction between climate scientists and business. By listening to both parties, Dr Fiedler works to identify both common needs and points of disconnect.

Dr Fiedler’s work is especially timely as, acknowledging the growing risks to business-as-usual, business agendas have been shifting in recent years to focus more on the climate crisis. Dr Fiedler notes that “The Taskforce on Climate-related Financial Disclosures (TCFD) has been really significant in the sense that it’s flipped the conversation from climate change being an environmental issue to it being a financial issue.” This opens the door for approaches which systematically integrate climate risks in terms that appeal to the concerns of business.

Calculating risk

After the 2008 global financial crisis, the G20 nations established the Financial Stability Board to identify potential future risks that could destabilise the global economy. Climate change was one of the key risks identified and, from this, the TCFD was formed. In 2017, the TCFD released a set of recommendations that defined the different types of climate risks companies should consider, in addition to guidance on how these should be incorporated within internal decision-making processes and external disclosures.

The different types of climate risk identified come broadly under headings of ‘transition’ and ‘physical’ risks. Transition risks are risks related to the transition to a lower-carbon economy (e.g. the shift in consumer preference from fossil fuels to renewables will impact oil, gas and coal companies). Physical risks are the risks related to impacts arising from the physical effects of climate change on a company’s assets, operations or supply chains (e.g. rising temperatures and lower precipitation have changed the environment cocoa beans grow in some regions, causing reduction in yield).

Translating climate risk assessments for business

Focused on the translation of climate information into data that is useful for financial decision-making, Dr Fiedler and colleagues’ recent Nature Climate Change article analysed how information provided by climate science can be legitimately used for the purpose of assessing physical climate risk:

“What we’ve observed, is that there’s a problem in this translation process because, while it is great that business is now actively interested in using climate information, business doesn’t always understand what it can be legitimately used for. This is because governments have historically funded research that examines the impacts of increasing greenhouse gas concentrations in the atmosphere on the climate at the global or continental scale. By contrast, businesses are much more likely to want to know about the effects of climate extremes (things like cyclones, flooding or extreme heat) at local scales – so at the level of individual assets and operations.”

Dr Fiedler believes that this disconnect can be bridged through engaged research and interdisciplinary work, noting that “Engaged research is about working with industry and producing research that is of relevance to the real world.”

In their article, Dr Fiedler and her colleagues argue that climate science does not yet allow businesses to prepare for climate-related risks by taking bits of information from pre-existing climate models and simply transplanting these into their own agenda. Instead, it must be done in conversation with climate scientists, in particular climate modellers, and on a bespoke basis:

So, there is ongoing and intense research on the effects of climate change at regional and local scales, and there is much information that is useful for business now. However, this information isn’t available in a format that is easily accessible to business. Accordingly, there is considerable risk that businesses will unknowingly use such information incorrectly. In the article we suggest a methodology of sorts, which is that a business undertakes a simple forensic analysis of its accounts, to understand the types of weather events it has been historically vulnerable to. Once a business has this understanding, they should then go to the climate science community and ask what information can be provided about this/these vulnerabilities for locations and over timeframes of interest to that business.”

To date, businesses have responded favourably to the article, inviting Dr Fiedler and her colleagues to contribute further to the emerging conversation:

“Andy Pitman and I recently did an internal peer review for a white paper that was written by the credit rating agency Standard & Poor’s (S&P). And we have been invited to deliver a number of webinars to different global organisations like the investment bank UBS, and the Network for Greening the Financial System (NGFS) who are a network of global central bankers and prudential regulators, including the Reserve Bank of Australia.”

Dr Fiedler notes that this is an important new direction in the conversation, as these organisations are now interested in determining their own risks, as well as in placing accountability on banks and insurers, who are increasingly required by prudential regulators to stress test their balance sheets against different physical and transition-related climate scenarios.

Dr Fiedler’s role as a translator has also been recognised even closer to home, by the University of Sydney. The recently launched Sustainability Investment Strategy forms part of the University’s broader commitment to climate action by increasing investment in sustainable solutions and excluding fossil fuel companies with inadequate transition plans from investments. Thanks to years of open dialogue with industry players, Dr Fiedler was an instrumental contributor to the Strategy. Her broad network of international industry connections has provided her with an informed sense of how rapidly the market is moving and how rapidly investors are shifting capital in a different direction.

Getting the framing right is crucial: risk and opportunity, not moral admonition

Dr Fiedler is passionate about moving away from a focus on ‘sustainability’, defined as the effects of a business on its environment, to one that is focused on the effects of the environment on a business.  Doing so enables a framing, language and ideas that business is much more receptive to.

“It’s not that the effects of a business (or by extension an endowment fund) on its environment are unimportant – they are incredibly important. But the ways in which you can best help businesses/funds to shift in their behaviours and impacts is for them to understand the risks to them and, by extension, the opportunities. So, I was trying to change the tenor of the conversation away from sustainability. Because if the University understands that this is about how the broader environment – global capital markets, consumer expectations and also climate change – might impact the University and its potential to fund future research and education, then it might also begin to see climate change in a different light.”

Dr Fiedler is looking forward to what comes next, noting that the strategy has already shifted the University outlook but there is still a lot of work to be done in defining what pathways of commitment will look like.

“It’s a process of osmosis. The more people you talk to the more discussions you have, and slowly you begin to understand what the consequences and implications are of taking different pathways. From this, you begin to come to a view as to what the best pathway will be, in terms of ensuring outcomes that are both financially and environmentally sustainable. And that view is always about opportunity. So, what is there, in all of this, that presents an opportunity to the University and its wider community?”

Tanya Fiedler is a lecturer in Accounting at the University of Sydney Business School and an SEI Fellow. Tanya’s research interests include the fields of carbon accounting, strategy, valuation and market-making. In 2016 at the University of New South Wales (UNSW) she completed her PhD research, which examined the making of Australia’s first nation-wide carbon market. Tanya’s research also examined the calculative practices and technologies by which greenhouse gas emissions were quantified by engineers for that market, so that they could be valued by accounting. Prior to her academic career, Tanya worked as a consultant for Energetics, a specialist carbon and energy consultancy.