3
min read

Corporate climate risk is financial risk

Companies are very misvalued due to climate risk not being factored in.

Climate change poses a grave threat to society, business, and the global community as a whole. Climate pledges are advantageous because they represent a genuine commitment by the corporation. Pledges represent a company's recognition of the problem's severity and commitment to finding a solution.

Regardless of if businesses make climate commitments or simply have emissions as part of their day to day business, they create a liability for themselves. There will need to change regardless of if it's voluntary, or externally forced by governments or customers. This transition will inevitably incur expenses, which must be managed by the business. Moreover, there is always the possibility that the company will be unable to meet its climate commitments. This could harm its reputation and reduce its appeal to potential investors.

But we cannot price climate change, can we?

On the topic of climate change costs, there is considerable disagreement, with the majority of investors and government policymakers believing that the costs are significant. Few individuals hold the view that the cost is zero, but opinions on the external cost of carbon vary. Numerous models exist in finance to price unknowns and manage risk. When examining risks that can be priced, traditional risk and finance teams can be of assistance.

15Rock is primarily concerned with pricing and valuing transition risk. 15Rock employs tried-and-true models such as DCF and curve pricing to price companies against various scenarios. Different groups can set their own prices and let the market determine the optimal price. Our models and methods are designed to be adaptable and compatible with a range of inputs.

15Rock's method of valuation permits diverse groups to set their own prices and allows market forces to determine the optimal price. This is significant because it enables companies to more accurately price their own internal projects relative to this benchmark. If they comprehend the impact of valuation on discounted cash flows and/or net income, they can respond to the following questions:

  • Does the project increase or reduce shareholder value?
  • Does inaction diminish shareholder value?

Corporate Climate risk is valuation risk

Risk and valuation analytics are crucial instruments that businesses and investors can use to advance climate risk management. Pricing climate risk is an important step in making it actionable. And by making climate risk actionable, businesses and investors can protect themselves from potential climate change consequences.

Major investors and consumers are increasingly holding corporations accountable for their climate commitments, which influences where they invest their capital. This phenomenon has led to substantial liabilities and a decline in shareholder equity for companies that have not yet made these commitments. For instance, If you take the compliance carbon pricing and price Boeing's climate commitment it resulted in a 13 billion dollar liability on the company's balance sheet and a ten percent decrease in shareholder equity.

If shareholders and companies believe that climate change poses a significant financial risk to the company, the company should delegate liability management to the CSO or other appropriate executives. This would give the company the ability to protect shareholder value and prepare for the financial risks associated with climate change.

The logic is fairly straight forward:

  1. Do you believe to avoid climate change action is required?
  2. If yes, Do you believe companies making pledges are material commitments to those pledges?
  3. If you believe it’s not, it’s efficiently saying the firm is lying about their pledge and misleading customers/investors.
  4. If yes to 1 and 2, then what is the cost of this liability? You can price it in different ways and use many different market experts views but the outcome is a price.

I believe item 3, like company valuations, is going to vary widely but ultimately there is a price - whatever that price is the mispriced valuation that is not being incorporated right now.

Gautam Bakshi

Head of Product & Engineering

Former: MD - Private Markets, Wealth & Asset Management, Manulife. Education: Ryerson University, Seneca College

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