The financial imperative for climate resilience: How to achieve best ROI

Organisations from across the world met during Climate Week NYC, September 19-23, to address the challenges and opportunities of cutting carbon and developing climate resilience.

On Wednesday, September 21, Mott MacDonald hosted a webinar that brought together leaders from financial institutions, asset owners, ratings agencies, and academia to explore a critical question: how to unlock the trillions of dollars needed to adapt to the physical impacts of climate change.

Chair

Professor Denise Bower OBE, executive director for external engagement and sustainability, Mott MacDonald

Panel

Josh DeFlorio, chief, resilience and sustainability, Port Authority of New York and New Jersey (PANYNJ)

Carlos Sánchez, executive director, Coalition for Climate Resilient Investment (CCRI)

Alicia Seiger, managing director, Steyer-Taylor Center for Energy Policy & Finance, Stanford University

Nora Wittstruck, senior director and ESG sector leader for US public finance, S&P Global Ratings

Overview

Governments, institutions and investors are feeling the impact of climate change on physical infrastructure more than ever before. They are becoming aware of the need to adapt, to become resilient. But quantifying the physical risks climate change presents, as well as the resilience measures that can mitigate those risks in financial decisions, is far from common practice.

As a result, the level of investment in climate resilience is currently low, exposing infrastructure owners, investors and users to increasingly severe and frequent physical impacts.

Linking resilience with value

Extreme events are becoming more frequent. Extreme heat is buckling train tracks and melting roads. Drought is lowering water levels and jeopardising water and power supplies, and severe storms and wildfires have cut off electricity, destroyed homes and disrupted transport networks.

‘The climate emergency is very much here and our infrastructure is not ready.’

Professor Denise Bower OBE, Mott MacDonald

Despite this, physical climate risks are not routinely priced into investment decisions, putting the future value of assets at risk.

In recognition of this, the Coalition for Climate Resilient Investment was formed at the UN General Assembly in September 2019. CCRI has focussed on developing and piloting methodologies to integrate physical risks into investment decisions at the asset level, national level and throughout the infrastructure finance market.

Physical Climate Risk Assessment Methodology (PCRAM)

Carlos Sánchez, executive director of CCRI, spoke about the work of the organisation, including the creation of a new Physical Climate Risk Assessment Methodology (PCRAM, developed with Mott MacDonald).

PCRAM is a first-of-its-kind methodology that builds understanding of how to assess climate risks and quantify the benefits of addressing them. PCRAM provides a means to shift from the present approach of reactive disaster recovery towards proactive adaptation. This will preserve the value of infrastructure, its ability to provide essential social, economic and environmental services, and its delivery of financial return to investors.

PCRAM is an important step forward in translating between climate science and financial accounting. It will help investors and asset owners prioritise their investments.

Disclosure of exposure to climate risks is becoming mandatory for large organisations in many parts of the world. Organisations with a high level of risk could experience disinvestment, harder lending terms and higher insurance premiums. It is therefore increasingly important to model risks accurately, identify cost-effective adaptation options, and invest to reduce risk exposure.

Proactive management

Nora Wittstruck of S&P Global Ratings described the importance of management’s preparedness in organisations responsible for major infrastructure. This is something that ratings agencies consider in their qualitative assessment of organisations. She explained that in the US, 75% of infrastructure is funded (owned) and operated by state or local governments that cannot divest away from climate risks. They must learn to adapt and mitigate in the face of increasingly severe events and rapidly rising repair costs.

Their lack of response to such events could negatively affect their ratings, hindering their ability to raise finance. They are downgraded if their failure to plan for climate related events leaves them unable to achieve their core mission. By building resilience, they can improve their ratings and their access to capital.

‘As insurance companies recapture their financial losses, premiums for which people are having to pay for property and casualty insurance are really becoming quite significantly expensive. It may lead to long-term economic decline, which is very important for the way that local governments generate revenue to fund their operations as well as their debt service costs.’

Nora Wittstruck, S&P Global Ratings

Growing urgency

Recognising the need for proactive planning, California’s governor Gavin Newsom called for an expert advisory group to make recommendations for how the state can better manage climate risk through disclosure. Stanford University’s Alicia Seiger co-chaired the group of 20 global experts.

Seiger, noted that in 2020 the state spent $1bn on firefighting, against a budgeted spend of $350M. Climate change is elevating California’s susceptibility to major wildfires. Climate impacts in other regions of the USA, and the world, may be wind and rainstorms, tidal surges, extreme heat or even extreme cold. Increasingly, the costs of remediation after a climate event exceed contingency budgets.

California’s climate risk disclosure advisory group considered two pathways:

• Direct expenditures in the state’s roughly $300bn budget
• Financial portfolios such as those managed by the state’s three biggest pension funds, together totalling roughly $1trn

For the direct expenditure pathway, the group recommended guiding principles to establish disclosure thresholds, technical assistance, minimum standards for engagement on corporate disclosure, and using PCRAM for project level physical and transition risk.

For the financial portfolio pathway, the group emphasised fiscal management underpinned by robust and transparent asset data.

Alicia noted that tensions are emerging as financial markets transition from voluntary to mandatory climate risk disclosure. Improved regulation is required to drive consistency in risk assessment and disclosure – what is being measured and how it is reported.

Best practice: Port Authority of New York and New Jersey

The Port Authority is a financially independent and self-sustaining public agency. Its service area includes assets within a ~25-mile (40km) radius of the Statue of Liberty in New York Harbor, including five airports, major bridges and tunnels, five ports, a rail transit system and the World Trade Center.

The agency has a $37bn capital plan to improve existing assets and build new ones. Finance is raised primarily through issuing consolidated bonds, and a portion of the agency’s revenues go towards meeting the bond obligations.

‘Maintaining a strong credit rating is fundamental,’ said the Port Authority’s Josh DeFlorio. His focus is on strategic physical risk mitigation.

Within a year of the devastating impact of Superstorm Sandy in October 2012, PANYNJ spent $60M on 80 flood protection projects. Many of these were superseded by permanent measures as part of the $2.5bn Sandy Recovery Capital Plan, which accessed federal funding for 72 flood resilience projects.

Today the Port Authority takes a more conservative approach to climate risk than demanded by local codes, using a strategy that it calls ‘Code Plus’. Exchange Place Station Headhouse in Jersey City, New Jersey is an example: Whereas local building design requires protection against a 1 in 100-year event (1% probability in any given year), the Authority adds three feet (0.9m) of elevation, to accommodate projected future Sea Level Rise, raising the standard of protection to an estimated 1 in 1,000 years or a 0.1% probability.

The Port Authority is now two years into a rigorous programme of assessing residual and emerging climate change risks to the year 2100 which it calls the Climate Risk Assessment (CRA).

‘Ultimately, this programme [the CRA] needs to be translated to investment and our most significant investment vehicle is our $37bn Capital Plan. So our goal is to deliver an optimised climate risk reduction plan for Capital Plan integration.’

Josh DeFlorio, PANYNJ