Challenges in finalizing climate risk rules

Soapbox Nerd Rant #4: No climate solution gets a free pass from accounting rules. I’ve been noticing another persistent fallacy in climate solution conversations; many people seem to think that some climate solutions are immune to accounting challenges such as additionality, durability, and/or leakage. For example, many in the verified carbon market think that tree planting doesn’t need to prove its additional benefit over natural forest regrowth, and even the UNFCCC seems to think that durability applies only to removals. This is false. Accounting rules work because they apply across the board. Believe me, after 15 years of work in this space, I get that these rules can be annoying . But that doesn’t mean they can and should be evaded. It sounds pedantic, but it’s true: functional markets and societies are built on the foundation of good rules. After decades of trial, error and effort in climate solution accounting, we have a pretty good sense of the base ruleset. That’s not to say we don’t need to refine and continue stress-testing these rules; we absolutely do. There’s tons of work needed to innovate accounting for rigor and efficiency. But the base requirements are well-known and universal: 1) The Additionality Rule: To claim any impact (aka a “credit), you need to demonstrate your actions are additional against a counterfactual (or baseline). 2) The Durability Rule: To ensure durable impact, you need to keep checking for it. 3) The Leakage Rule: To ensure your impact doesn’t have unintended consequences, you need to evaluate spillover effects (leakage). There are other rules to consider, but nobody gets a free pass from these three. In December, a group of scientists convened to take a hard look art these accounting rules and investigate ways to refine and stress test them for rigor and efficiency. We call ourselves Science for High Integrity Frameworks to Transform the Carbon Market, or SHIFT-CM. If you're a natural climate solution crediting geek, join us! https://lnkd.in/ghaT9ArP In upcoming posts, in the spirit of the SHIFT-CM science endeavor, I will unpack these (and other) climate solution accounting challenges, flag pitfalls and misconceptions, and suggest some innovations for the future. If you’d like to listen in on the next Soapbox Nerd conversation, pull up a chair in the LinkedIn village square (aka follow me). And the next time you are asked to evaluate the credibility of a project, don’t be afraid to ask: how have you accounted for additionality, durability, and leakage? @NaturalClimateSolutions Nature4Climate

After two years, the EU climate risk assessment is finally out. It shows the range of climate risks Europe is already facing and the consequences of not adapting (fast enough) in the future. Climate risks are increasingly urgent as they compound and cascade across European sectors, regions, and vulnerable groups. The adaptation gap is growing as the rate of action is not keeping up with the rate of climate change. This key message from the report has been picked up by the media, but there are a few other things in the report that I feel deserve some attention: - Urgency to act is not solely determined by climatic hazards; it also hinges on the readiness of our institutions and their current actions to address the varying time horizons. Many plans exist and several express high ambitions, but they often lack concrete and meaningful actions. - Maladaptation poses a significant concern: in some cases, people are adapting to climate risks, but without careful consideration, they may inadvertently shift the problem to other sectors, regions, or social groups, exacerbating the issue over time. - A clear yet often overlooked 'transition risk' exists: the process of transforming systems to better withstand future climate risks necessitates substantial investments and challenges existing regulations and practices. - Inequalities and vulnerabilities perpetuate a vicious circle where each exacerbates the other. Addressing climate risks = addressing structural inequalities and vulnerabilities. Existing European policies and plans often recognize the importance but offer limited focus on just resilience. - Litigation related to climate risks and adaptation, wherein citizens hold state and non-state actors accountable for the lack of progress on adaptation, is likely to increase across Europe. There are many more valuable insights in the underlying 300+ page report that informs the future of climate risk and adaptation in Europe. Read it here: https://lnkd.in/eU7ema5r

One of the wicked problems in climate risk disclosures whether to comply with TCFD, ISSB, ESRS or for strategic reasons, is quantification of climate transition risks. While the financial sector and some companies themselves have developed methodologies for transition risk quantification, these methodologies have often not been publicly disclosed, are not based on any peer-reviewed methodology and are not standardized across the economy or industry or sector. Bringing some standardization to transition risk quantification will be imperative to make risk disclosures comparable and meaningful. In our new paper, myself, David Carlin, Edward Byers and Keywan Riahi propose fundamental principles that are based in the science of climate scenarios, and should be followed when doing company level climate transition risk quantifications. These principles include;  1. Climate risks are more than just carbon emissions and won’t be mitigated by emissions reduction only. 2. At least two scenarios should be used for one risk disclosure statement. Risk has to be measured against a ‘business-as-usual’ scenario. 3. There should be transparency around which transition risks are assessed quantitatively and qualitatively, and which are excluded. 4. Lack of extreme events coverage should be acknowledged in the disclosures. 5. Risk model assumptions should not differ from underlying climate scenario assumptions. It would be important to build fora to standardize risk quantification and expand on this set of principles and methodologies. If you want to contribute to this important exercise please don’t hesitate to reach out. You can read the complete paper at https://lnkd.in/dHWsAyER

The “Climate-related Risks and Accounting” report by the European Systemic Risk Board (#ESRB) provides a comprehensive analysis of how #climaterisks are incorporated into IFRS (International Financial Reporting Standards (IFRS 9 ) and their implications for #financialstability. This report emphasizes the urgency for financial reporting frameworks to adapt to the growing significance of climate-related risks and their impact on #assetvaluations and liabilities. Key Findings: 1. Market Pricing Inconsistencies: The report identifies that climate-related risks are often not fully reflected in market prices, which may lead to the overvaluation of assets and undervaluation of liabilities. This mispricing poses a risk to financial stability as it can distort the assessment of financial institutions’ health. 2. Asset Valuation Challenges: Climate risks significantly affect the initial and ongoing valuation of non-financial assets and liabilities. The report discusses how failure to adequately account for these risks can lead to substantial financial losses. 3. Incorporation in Financial Models: The report emphasizes the need to integrate climate factors into models estimating expected credit losses (under IFRS 9) and cash flows from insurance contracts (under IFRS 17). This integration is essential for accurately assessing #financialrisks associated with #climatechange. 4. Disclosure Requirements: Enhanced disclosures regarding climate-related risks are critical. The report advocates for clearer guidelines on what constitutes material climate-related information that firms must disclose, thus enabling #stakeholders to make informed decisions. Recommendations: • Amend IFRS Standards: The ESRB suggests specific amendments to existing IFRS standards to better incorporate climate-related risks: • Strengthening the materiality principle in IAS 1 to ensure significant climate risks are reported. • Including climate factors in impairment assessments under IAS 36. • Clarifying the application of IAS 37 regarding provisions related to climate risks. • Focus on Carbon Pricing: The report also highlights the need to prioritize the accounting treatment of #carbonpricing mechanisms, recognizing their potential impact on financial statements and disclosures. This report underscores the need for urgent reforms in financial reporting practices to address the growing influence of climate-related risks on the #economy. By aligning accounting practices with the realities of #climatechange, stakeholders can better mitigate #financialrisks and enhance overall #marketstability