Climate change is not only an environmental issue; it’s a financial one. Like any global structural change, transitioning to a low-carbon economy will have winners and losers, including in the UAE.
Industries that do not adapt are at risk of declining or disappearing. Countries that do not act are at risk of deterioration. So too are investors’ portfolios holding investments in related assets.
At Barclays Private Bank, we’re talking with business owners and investors about the risks, and opportunities from climate change that may arise sooner than expected. Here we introduce how these climate factors, which the Task Force on Climate-Related Financial Disclosures (TCFD) categorises as either “physical” or “transition”, matter from a financial perspective; and provide actionable insights to help you position your assets effectively.
Understanding physical climate risks
Physical climate risks encompass both acute events and chronic changes, such as heatwaves and floods, which can quickly disrupt businesses, supply chains and infrastructure, which often lead to financial losses and lower asset returns.
“Understanding and preparing for climate risks is crucial to protect and grow your assets”
Chronic changes, such as rising sea levels and temperature shifts, also pose long-term challenges to local industries like tourism, real estate, and energy, affecting the viability and value of specific assets in the region over the long term. For this reason, the UAE government’s climate plans highlight the consequences of climate change on health, energy, infrastructure and the environment.
Understanding transition climate risks
With the global movement towards a low-carbon economy, transition risks arise in four ways: policy and legal changes, technological advancements, market shifts and reputational factors.
Transition risks can be more subtle than the physical impacts. However, changes in consumers’, corporates and governments’ behaviours across these four factors can still be significant. For example, policy changes in the UAE around waste and waste management are reshaping what is recycled, reused, or redesigned across multiple industries. Companies or investors that fail to recognise and adapt to these drivers may see their assets become obsolete, while those that lead in greening their businesses or portfolios stand to benefit.
Moreover, transition risks will rise as the government implements more policies to deliver its “Net Zero by 2050 Strategic Initiative” which made the UAE the first GCC state in 2021 with a net zero commitment and “The UAE’s First Long-Term Strategy”, an ambitious plan intended to guide the nation’s climate actions.
How climate risks affect industries
Both the physical effects of climate change and the efforts to transition to a low-carbon economy can affect companies’ revenues and profits. The extent and nature, though, will vary by industry, company and asset.
For example, in the UAE’s real estate sector, physical risks can affect properties in coastal areas that are vulnerable to sea-level rises and storm surges. These can lead to potential property damage, additional investment needed to protect properties, and higher insurance premiums. In the related construction sector, extreme heat may affect worker productivity or water scarcity may increase operating costs for heating, ventilation, and air conditioning (HVAC).
“Companies or investors that fail to recognise and adapt to these drivers may see their assets become obsolete”
Similarly, transition risks pose challenges for “hard to abate” sectors in the UAE that find it tougher to reduce their carbon footprint. For example, fossil fuel, steel or cement industries face greater transition risks, which will require investment in technology changes or paying for emissions that increase costs.
Even apparently unrelated industries, such as fashion, food, or tourism, will also be affected. For example, increasing consumer preference for eco-friendly tourism will drive changing demand in the UAE for more sustainable options. Without these, tourists may go elsewhere impacting hotel occupancy rates and activity revenues.
Approaches to assess climate risks
To mitigate physical and transition risks, several practical strategies can be adopted:
1. Conduct comprehensive risk assessments: Evaluate the exposure of climate risks across different sectors, regions and assets of your portfolio or business.
To identify assets vulnerable to physical impact, consider factors such as geographical location, infrastructure resilience and climate data. For transition risks, assess R&D and capital investments and transition plans as well as interdependencies across all four transition risks.
2. Utilise climate-scenario analysis: Model physical climate change scenarios and potential faster or slower policy change scenarios. Then, assess their impact on the potential financial performance of your assets.
Physical risk factors such as changes in extreme weather patterns, sea-level rise projections, and temperature increases can help to gauge portfolio resilience and identify mitigation strategies. From a transition risk perspective consider how orderly policy changes will be made against the risk of a disorderly process, perhaps where global policies are delayed or divergent from UAE policies.
3. Assess transition targets, plans and reporting: Review current sustainability commitments, corporate information or disclosures on climate exposure and stated transition strategies and pathways. Establish or evaluate the credibility of transition plans and assess corporate capabilities to deliver large-scale, business-model transformation programmes.
4. Monitor regulatory developments: Stay informed about global and local regulatory changes and policy developments related to climate change. Regularly review how new regulations could affect specific industries, both domestically and for imports and exports, as well as how the changes might drive investment flows.
5. Integrate climate risk metrics: Incorporate climate risk metrics, such as physical risk scores and climate stress tests, and transition-risk metrics, such as changes in energy costs or carbon pricing, into investment decision-making processes. Evaluate the scale and nature of climate risks on financial performance using quantitative tools and models and adjust asset allocations accordingly.
Prepare your portfolio for tomorrow’s world
Investors and business owners in the UAE should be concerned about their exposure to the likely, but uncertain, physical and transition risks of climate change. Like all risks, you face a choice – continue to maintain your current positioning or act either to mitigate the risks or address their root causes.
From a behavioural finance perspective, it’s easy to fall victim to a status quo bias – to continue with your existing approach rather than make a change, especially given the complexity of climate change and the narrative that climate change impact will only be years, or even decades away. However, with the physical impacts of global warming occurring earlier than many expected and increasing global governmental, corporate and consumer action, this may not be a prudent course.
Understanding and preparing for climate risks is crucial to protect and grow your assets. By doing so, you not only safeguard your financial interests today; you also contribute to a sustainable future for your future generations tomorrow.
