The Forest and the Trees of the TCFD: Pairing Asset-Level and Strategic Resilience Assessments to Uncover Risks and Opportunities

In real estate, climate resilience is fast becoming an investment imperative. Losses in the sector due to climate-induced natural disasters are mounting and our customers are seeing financially material impacts to their portfolios. By 2070, $35 trillion in real estate assets will be at risk if the world does not change its current carbon emissions trajectory, according to the United Nations Framework Convention on Climate Change (UNFCCC).

Furthermore, the insurance industry has been evolving to, among other things, adapt catastrophic risk models to include climate projections, explore the pressing issue of insurability, and identify policies and services to enhance customers’ sustainability and resilience. The Climate Service (TCS), for example, recently announced an alliance partnership with Aon; through this relationship, we will work on strategies for coupling traditional catastrophic risk models with climate risk modeling to offer more robust analysis to the market.

As the insurance industry’s approach matures, insurance options for investors may change and, when it comes to certain assets, may disappear. As such, market values will diminish. Conversely, investments in resilient real assets and infrastructure will offer prospects for improved financial returns.

Now, more than ever, climate risk, adaptation, and resilience considerations are factoring into investment decisions. As such, pioneering investor-led initiatives like GRESB are enhancing their standards for the assessment and benchmarking of environmental, social, and governance (ESG) performance of real assets to integrate climate risk and resilience.

Leveraging the GRESB Resilience Module

In particular, the GRESB Resilience Module was developed to help real estate and infrastructure companies and funds evaluate and prepare for potentially disruptive events and changing conditions to become more resilient over time. Organized in four sections, the module is broadly aligned with recommendations from the Task Force on Climate-related Financial Disclosures (TCFD).

The GRESB Resilience Module framework, coupled with future scenario analysis tools, and asset-level climate risk and resilience assessments (see below,providing analysis validation as well as granularity on asset adaptive capacity), will help to meet increasing investor demand for information on climate-related risks and opportunities.

In this article we explain these processes in more depth, with the goal of illustrating how this approach can leverage the GRESB Resilience Module and inform actions to optimize assets and the critical systems and surrounding communities upon which they depend.

Where to Start: The Climate Risk and Resilience Assessment

A climate risk and resilience assessment is used primarily to understand the underlying conditions of assets such as office buildings, manufacturing plants, data centers, and warehouse facilities.  Assessments cover the risks and opportunities associated with observed climate trends and future climate projections and evaluate the current and future adaptive capacity and resilience measures needed to address and manage such risks and opportunities.

This process includes both future scenario analysis of climate-related risks and opportunities—which can be conducted qualitatively through a desk study or quantitatively through a modeling tool like the Climanomics® platform—and on-the-ground adaptive capacity and resilience analysis in collaboration with asset or facility managers through site visits.

Asset or facility managers understand the underlying conditions of the asset, its strengths and limitations, and the projects planned or being implemented to reduce the asset’s carbon footprint, improve its resource efficiencies, and adapt it for a changing climate. This process is essential to truly understand the risk (exposure, sensitivity, and adaptive capacity), costs, and the actions needed to enhance the asset’s resilience.

The 80/20 Rule: The Value of Asset-Level Assessment

Asset-level quantitative modeling is a first step in identifying the assets most at risk and in need of additional and/or on-the-ground scrutiny. Asset-level analysis is especially critical for companies in possession of—or invested in—hundreds or thousands of diverse assets globally; in such cases, building a resilience strategy is an otherwise daunting task. Only through granular analysis can an organization or investor identify the assets most in need of immediate investment.

True to the Pareto Principle (named for economist Vilfredo Pareto, the Principle suggests that roughly 80% of effects come from 20% of causes) we find the vast majority of the users of the TCS Climanomics^® platform uncover that most of their climate risk resides in a small number of assets. This may be due to the vulnerability of their location, asset type, or asset’s lack of adaptive capacity. This information affords important intelligence vis-à-vis priorities when it comes to investing in resilience efforts; it empowers companies to prioritize assets for which investments in adaptation or resilience efforts will have the greatest risk mitigation benefits.

This graphic illustrates an anonymized example of this effect. It represents the risk by asset location from climate change in millions of U.S. dollars. The underlying models consider the value of a property, hazard risks such as flooding, wildfire and extreme heat, and vulnerability of each asset to each of those hazards.

GRESB recently announced that asset-level reporting “will facilitate the next evolution in data accessibility and reliability in the GRESB Assessments and Benchmarks…Having asset-level data as the baseline for analysis will open up a deeper understanding of exposure to environmental risks and help to uncover the sources of improvements in a portfolio as well as the links to future portfolio performance.”

The importance of this work cannot be overstated given that managing and mitigating climate risk for real assets—retrofitting buildings, implementing design improvements, moving power lines underground, and upgrading water systems—are no small feats and require whole community buy-in, resources, and support. Among many other things, asset-level analysis can help companies identify priority areas for work that will maximize equitable resilience and provide significant returns on investment beyond company boundaries.

The Importance of Assessing Transition Risk

Transition risks can occur when governments and economies adopt policies to, for example, discourage the increased release of carbon and other harmful greenhouse gas (GHG) emissions and encourage greener, more sustainable ways of operating. They can drive big shifts in asset value or higher costs of doing business for some industries, while increasing opportunities for other industries.

Example transition risks can be grouped into policy (e.g., carbon pricing), reputational (e.g., shifts in consumer preferences), legal (e.g., exposure to litigation), and technological (e.g., costs to transition to lower emissions technology) risks. Due to their dependence on complex socioeconomic factors and scarcity of data, transition risks present modeling challenges, especially for multinational entities operating in many geographies.

Transition risks tend to increase over time the longer economies wait to transition to greener policies, as sectors have less time to adapt. Thus, for the long-term real asset investor, transition risks can be material.

Using scenario analysis in the Climanomics^® platform, under the RCP8.5 scenario (a high emissions scenario) the financial impacts from physical risks often become more dominant over the course of the century. However, under the RCP4.5, or a scenario more in line with the Paris Agreement, we routinely see certain transition risks eventually surpassing physical risks for many assets in terms of financial impacts.

The resultant ‘dance’ that occurs between physical and transition risks over time underscores the importance of modeling, visualizing, and analyzing—through tools such as the Climanomics^® platform and onsite visits at the top “at-risk” locations—transition risk, physical risk, and opportunities simultaneously to obtain a full and accurate picture of financial impacts. Similarly, analysis for multiple decades is critical to obtain as risks can significantly impact investors’ terminal value, and thus, the rate of return.

This graphic illustrates an anonymized example from the Climanomics^® platform showing average annual financial impact due to climate-related physical and transition risks facing a multinational corporation in the 2040s decade.

Transition risks are modeled in a variety of ways by the platform. Carbon price risk modeling, for example, employs a carbon price model based upon either the Shared Socioeconomic Pathways scenario SSP3-60 or SSP3-45 (depending on climate scenario). For each location, a likely carbon price is assigned and combined with GHG emissions data for each asset. Other risks are modeled with a variety of strategies, using academic, public, and proprietary data, parameterized against temperature risk, coastal flooding, and more.

Opportunities

Although climate-related risks are top of mind for many asset managers and real estate developers, climate-related opportunities are increasingly important to become more sustainable and resilient. Opportunities, as outlined by the TCFD recommendations framework, include resource efficiency (water, energy, materials, waste), energy source (renewable price stability and price reduction), products and services (low-emission new and existing products), markets (positioning in new and existing markets), and resilience (physical resilience, transition resilience, and ability to seize new opportunities).

Some of these benefits will increase as the impacts of climate change grow, thus the sooner benefits are captured, the better. For example, if drought risk is modeled to increase substantially in the coming decades at a location, investing in water efficiency and local adaptive capacity measures today can yield cost savings that may compound over time.

In this way, many opportunity measures are directly correlated to risks; without measures in place to increase opportunities, the risk is multiplied. Hence the importance of including opportunity analysis in climate risk calculations.

As companies move beyond their analysis of climate-related risks and opportunities, it is important that they consider other future trends that could impact their financial health and resilience. By designing for the short- and long-term through a Future Ready lens, WSP is progressively helping cities, communities, and companies get ready for the future—ready for rapid urbanization, ready for heavier rainfall and hotter temperatures, and ready for a more connected and efficient world.

Conclusion

Results reported so far through the GRESB Resilience Module are mixed. On the one hand, certain highly performing companies and funds combine experienced and empowered leadership with robust risk assessment and integrated business strategy when it comes to climate risks and opportunities; however, these likely represent a small fraction of the industry. For the most part, climate risk and resilience programs vary significantly and publicly available information about them is limited and inconsistent. Moreover, some companies and funds have not yet developed any such programs.

As climate change impacts intensify around the world, those sectors that are most dependent on physical assets, including real estate and infrastructure, are on the frontline. A comprehensive evaluation of climate risks and resilience can help real asset investors accurately weigh risks and returns and empower investors to move companies and portfolios from business as usual to “Future Ready.”

This article was written by James McMahon, co-founder and CEO, Tory Grieves, VP of Analytics for The Climate Service, and Emily Wasley, Senior Project Director and Future Ready Advisor, WSP.

About the authors: After studying physics at Harvard and atmospheric chemistry at MIT, James McMahon led IT initiatives at Coca-Cola for a decade before transitioning to a senior role at NOAA’s National Centers for Environmental Information where he worked closely with authors of the IPCC report that won the 2007 Nobel Peace Prize. Tory Grieves holds an MBA and a Masters of Environmental Management degree from Yale University. She began her career as an environmental scientist before transitioning to NatureVest where she structured green infrastructure credit markets. She now leads analytics initiatives at The Climate Service. Emily Wasley serves as senior project director and Future Ready Advisor with WSP’s Sustainability, Energy, and Climate Change team leading their corporate climate and water risk and resilience practice. She has over 15 years of experience in climate change, sustainability, adaptation, and all-hazards resilience and serves as President-elect on the Board of the American Society of Adaptation Professionals (ASAP).