climate risk assessment.

At Lombard Odier, we recognise and assess the importance of the physical and transitional, as well as reputational and liability risks of climate change within our sustainability framework. We assess exposure to these risks and opportunities at an industry level and our analysts look at susceptibility to these transitions at a company level. Our analysis covers more than 160 individual industries.

 

Economic damage of climate change and weather-related natural disasters (% of world GDP)

 
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Source: Lombard Odier analysis based on Watson and Le Quéré (2018); Aon Benfield (2019).

 

Physical risks

With respect to physical risks, using proprietary geospatial analysis, we assess exposure to the risk of flooding, droughts, cyclones, extreme weather, wildfires and non-weather-related catastrophic events. Our geospatial specialists alert investment teams on a real time basis to physical hazards and conduct horizon scanning surveillance.

 

Assessing the physical impact of Hurricane Laura on energy assets

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Date: 27 August 2020 
Source: National Hurricane Center (NOAA), various asset data providers. KT = knot- speed measure.

 

Transitional risks

With respect to transitional risks, our assessment includes a review of risks related to the mitigation of greenhouse gas emissions, resource efficiency, waste reduction and the need to live within nature's planetary boundaries. Our conclusions have highlighted the exposure of individual industries to these issues. While greenhouse gas emissions are highly material across many industries, we have also identified a number of key industries where other issues, such as mitigation of water scarcity, are equally material (especially in agriculture).

We also believe strongly in the importance of including ‘hard-to-abate’ transitioning industries when investing in the climate transition as these industries will be vital to future economic growth. We do not shy away from investing in the scale of transition required by these important, but carbon-intense, sectors.

In our view, there remains insufficient analysis in the market of the differential exposure of individual industries, companies and securities to climate risks and opportunities. Similarly, we believe that there is insufficient analysis of the financial impact, both from a risk as well as an opportunity perspective, of these transitions. Additionally, we believe the lack of clarity in environmental policy worldwide has hampered such analysis. To remedy these gaps in the market, we have produced our own internal analysis of these issues and seek to address uncertainties through scenario-based, forward-looking judgemental analysis.

We believe strongly in the importance of including ‘hard-to-abate’ transitioning industries when investing in the climate transition as these industries will be vital to future economic growth

In our materiality mapping, we model the exposure of industries to climate change and other megatrends, under three different main scenarios:

  • A business-as-usual scenario, based on current policies;

  • A middle of the road scenario, based on limited improvement in policy ambition (2.6°C) with parameters included to adjust this scenario for a ‘delayed policy response’;

  • A sustainability scenario aligned with the Paris Agreement, based on a temperature increase of 1.8°C.

 

The interim conclusions from our analysis highlights that transitional risks increase in the Paris agreement-aligned scenario, although physical risks are lowered over the long term. In the business-as-usual scenario, transitional costs are lower, but this is offset by the creation of reputational and liability risks, that could pose an existential threat to responsible industries.

We apply socially responsible investing (SRI) restrictions to companies with activities in coal, unconventional oil & gas, limiting investment in companies deriving a substantial part of their revenue from these activities.

Environmental, Social, and Governance (ESG) integration allows us to assess companies' business practices and performance across sectors regarding climate change mitigation (renewable energy use, carbon intensity, environmental policies etc…).

We also believe that stewardship plays a vital role in informing the investment process and enhances the value of clients' assets. We use the Oxford Martin Principles for Climate-Conscious Investment as the guiding framework for our stewardship to ensure companies have understood and incorporated the required global path towards a net-zero economy in their strategy and practices. Our dialogue with companies also informs our investment decision making by seeking disclosure of additionality-based footprint metrics and Task Force on Climate-related Financial Disclosures (TCFD)-aligned reporting.

Additionally, Lombard Odier has forged partnerships with leading independent firms and institutions in the field of sustainability. These include SystemIQ, which is an advisory firm specialising in system-level change related to sustainability challenges, and Oxford University. These partners act as independent, objective advisors to our sustainability and investment teams to exchange knowledge, deepen our understanding of the likely path and implications of the transition, and to provide robust, third-party validation of our research, processes and solutions.