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Net Zero: How to navigate physical risk

November 4, 2022

Carlos Sanchez, Managing Director for the Coalition for Climate Resilient Investment (CCRI) and Monique Mathys-Graaff, Head of Sustainability Solutions, talk about all things physical risk. We are all exposed to climate change but what are the risks to physical assets and how does CCRI look at this? They also discuss their Physical Climate Risk Assessment methodology (PCRAM).
Climate Risk and Resilience|ESG In Sight
Net Zero: How to navigate physical risk

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Net Zero: How to navigate physical risk


SPEAKER 1: Welcome to WTW's ESG In Sight Spotlight Series.


MONIQUE MATHYS-GRAAFF: This section is on net zero actions to stay on track. Specifically, we are focusing on the importance of physical risk to ensure climate and systematic resilience. We have with us Carlos Sanchez, Managing Director of the Coalition for Climate Resilient Investment. They are pioneering solutions with market players to better manage physical risks for our investments, as we are all exposed to climate change. Welcome, Carlos. Can you start by explaining to us again, as we talk about physical risk in this session, what it is? And we'd love to hear from you more about CCRI.

CARLOS SANCHEZ: Monique, thank you so much for this opportunity, and thank you to all listening to us today.

--to cover those two questions. So first, physical climate risks. Physical climate risks are climate manifestations. And these are a structure around basically acute, so extreme weather events, and chronic, slow-paced, progressive changes in climatic conditions. And as of the coalition, the coalition was born in 2019 at the General Assembly of the UN as a commitment from the global private finance industry, which at the time was represented by 35 institutions and 4 trillion in assets represented.

But today, we are thrilled to be 129 members and close to 30 trillion in assets represented, and all committed to work together for the development of those solutions that will address the current mis-pricing of physical climate risk-- and without a form of market failure, in the sense of not having the right information that inform decision making in the investment space.

We have broadly divided our work in two areas. So we work in an area that is government solutions. Because the same rationale, an entry point as of the problem formulation applies and is equally relevant to governments, and deliver a series of solutions for governments across the globe for them to make better decisions and have a measure of fiscal efficiency in the management of these risks; and then investor solutions that are, of course, the more relevant matter for this discussion today where we work in really understanding, addressing, and delivering to investor needs in their more strategic decision making practices when it comes to integrating these type of risks.

MONIQUE MATHYS-GRAAFF: Excellent. And you made the key point about decision making for leaders. I think that is what everyone has such a problem with currently, as we have so many challenges when we think about climate change, when we think about global pandemic health issues, when we think about current inflation challenges and other geopolitical challenges facing us currently.

Can you help us understand more specifically how CCRI is relevant to leadership in the listening audience that we have from investment managers and professionals, asset owners, as well as corporates globally? How is CCRI relevant to help tackle these big challenges today?

CARLOS SANCHEZ: Thanks. Because that's a very important question, Monique, and one in which we spend vast amount of time and energy, even before starting with the work of the coalition. Because that is crucial-- how you are going to be delivering, how you are going to be adding value to the day to day decision making of a given set of decision makers. And that, again, is equally relevant and applicable to governments as it is to investors.

But when we talk about investors, a key consideration that we understood very early on is that there is, apart from the risk, there is an opportunity, and that the better integration of physical climate risk in investment decision making is first and foremost good decision making. And apart from the good sounding phrase, we are spending a lot of time to translate that into practical and rigorous solutions.

So just to give you an example, there is this methodology called the physical climate risk assessment methodology, which establishes a well structure and orderly interpretation of physical climate risk data for the purpose of understanding the relevance and pricing in different lines in a cash flow model-- so from revenue projections, CapEx, OpEx, depreciation schedules, a risk from a more credit quality standpoint, and then going down to net present value.

We don't have all the answers, and that needs to be said very loud and clear. But there is a journey. There is a start of a narrative that is very well established. In some, what we are very keen to deliver is not to add to the consideration of value at risk, which is essentially understanding or measuring a risk that before we have not properly captured or measured, but this being a risk that will only become financially material when and if that risk materializes-- so if that event happens. What we are talking here is not about value at risk. It is about valuation risk.

And that means that what we are witnessing is how key market forces, mainly regulation, credit quality, standards, are really progressing in one direction only. And that is a better recognition and a better enforcement and a better rewarding. And that is crucial, the reward component of the adequate integration of these race. So what we are seeing is twofold. It is the opportunity, so actors that take care of the action and understand how the future practices may look like and adjust their own decision making, and the evaluation risk.

And that is waiting and seeing how those changes in different key market forces methodologies will result into the adjustment from a valuation standpoint of a portfolio balance sheet, without necessarily having to suffer that give an impact, as with value of risk you would expect. So in that regard, we are confident that we are delivering not just to the short term loss and [INAUDIBLE] acute risk, but actually to the long term strategic most crucial dimension of investment decision making.

MONIQUE MATHYS-GRAAFF: Thank you so much for that critical point about the long term lens of what we need to consider for decision makers, especially how you contextualized going beyond a risk-only lens to ensuring we understand the opportunity set of value creation that is also present when we look at it holistically in the context of the macro government regulatory intersections of the assets, and what it means for our holdings as an asset base.

But if we think about the other immediate challenge that is faced by our listeners, is the climate reporting currently? And that's about drilling it down to a moment in time and giving clarity on what is the matrix, the measure of analysis of which physical risk is used. You've touched on the PCRAM methodology. And if you are to think about the journey-- I love how you keep speaking about the journey we're on. The journey we're on now is about reporting a point in time. How can the PCRAM methodology, when we think about reporting physical risks, assist our listeners?

CARLOS SANCHEZ: Thank you. And, needless to say, a very crucial question and another in which we have spent quite a bit of time, also in dialogue, with relevant institutions and bodies that have been advancing those. So, first and foremost, total support to those initiatives-- and as we all know, they are all crystallizing and taking shape and in a very steep learning curve in those underlying methodologies. But those are steps in the right direction.

However, embedded in your question there is that consideration of the need to rationalize and to understand what is the value and what is the purpose. What is the incentive to really follow that reporting? And what we always use is this notion of the continuum, in which we play a role and where we also locate reporting. So in that regard, we defined a continuum starting with voluntary disclosure. Then there is mandatory disclosure. Then there is more of a financial reporting component. And then there's a valuation, asset valuation dimension.

And, as you say, that is where you go into the deepest, more sensitive, most exciting dimension of investment decision making, that is to understand the long term and the different value attributes and discount at the present terms. So what we are seeing is that with the discussion with PCRAM being very much focused on that side of the spectrum, we are providing a sense of a validation complementary to those disclosure frameworks.

Not to say that they are perfectly compatible, because one, it touches on this dimension of current disclosure of certain considerations. And the other, again, is more the future projections and discounting. But we are starting to see that element of bringing together the enforcement and the reward, so kind of making the sense together. Because it's crucial that those two go together so the proposition and the incentives for investors are more complete.

MONIQUE MATHYS-GRAAFF: That's excellent. And as you speak about the valuation, I know that we've had lots of discussions about the PCRAM methodology. And it assists also with some of the mispricing, which presents a management of your long term valuation and your targets, your financial targets. It assists in providing greater sense of materiality. And it also assists in ensuring that you leverage opportunities sets. But all of these things, I think it sounds like we're going to see that in the journey more practical application. Where can the listeners expect to see more of this, Carlos?

CARLOS SANCHEZ: Oh, thank you for that question. So there is a lot happening, and we have achieved a level of preliminary success for which we are incredibly proud. But with that, we are only raising ambition and only being more convinced and motivated towards the future. So broadly speaking, our solutions are, as I described, divided into government solutions.

And I think that it's important to highlight that. Because what we are also trying to work towards is towards better connectivity between public and private when it comes to integration of physical climate-- so understanding how, from a government solution perspective for government decision making, there is a need to incentivize also private capital in its way of deciding so that that decision from investor-- which needs to be first and foremost about enhancing risk adjusted returns-- also deliver that social economic ecosystem value to a community and a country.

So that really belongs to the government decision making, although we know that investors are very keen to contribute to that. So in that, we are delivering solutions for national planning and fiscal policy, but then also investor. What I would really be keen for the audience to stay tuned is particularly in future iterations of the PCRAM methodology asset. It's only the first iteration. But there will be a 2.0 and a 3.0 coming up.

And with that, we are starting to see actual real investments that are willing to test this methodology for which we are very thrilled. So what we are seeing in the future is more of the proof of concept of all this methodology and technical discussion to materialize in real investment. So please stay tuned.

MONIQUE MATHYS-GRAAFF: And will we see you at COP27 this year?

CARLOS SANCHEZ: Yes, yes. Yes, yes.

MONIQUE MATHYS-GRAAFF: Excellent, thank you so, so much for your time and to all the listeners.


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