Climate risks & Net Zero - FIRM March 2021
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PwC has been actively shaping the ESG agenda and contributing with thought leadership and market-leading tools We are actively involved in standard setting (orange letters indicate PwC involvement) We help orchestrating the regulatory agenda and support clients globally Umbrella reporting frameworks Detailed standards Umbrella enablers UK: FCA is consulting on corporate Germany: BaFin published guidance Global reporting initiative (GRI) Environment (E): • Accounting for Sustainability disclosure of climate risks and in December 2019 on how FS firms CDSB, CDP, TCFD, Natural • Corporate Reporting Dialogue is focusing on ‘greenwashing’; should manage sustainability risks Capital Protocol, Greenhouse gas protocol, Science Based • EFRAG BoE plans to introduce climate Integrated Reporting Council (IRC) stress tests Targets • European Commission Hong Kong: Securities & Futures Social (S): • Focus capital for the long term Commission announced Strategic IASB – MD&A project • Impact Measurement Project Framework for Green Finance in 2018 International organisation for EU: EBA Sustainable Finance standardisation (ISO26000), • NGFS (contributions) Action Plan; EU taxonomies, Sustainability Accounting Standards Board UN guiding principles framework • The Capitals Coalition ECB Guide on management of Singapore: MAS exploratory work to UN Global Compact Communication Governance (G): • UN Sust. Development Goals climate risks; various reporting incorporate climate-related stress COSO Framework • UNEP FI and disclosure requirements scenarios • Value Balancing Alliance WEF International Business Compact • World Business Council for Sustainable Development We have developed market-leading tools PwC's “Climate Excellence” tool for climate scenario analysis supports investors and companies in getting We shape global ESG discussions through Thought Leadership their portfolios ready for the risks and opportunities of climate change. Our recent publications/projects include In this way, the potential for value enhancement, adequate risk management and communication with regulators and • Advice and review: UNEP FI PSI work on climate risks in insurance stakeholders can be fully exploited. • The growth opportunity of a century - onset of a paradigm shift in investment Market Recognition: • Network for Greening the Financial System (NGFS) • Sustainable Finance for Asset Managers – a revision to the non-financial • UNEP FI TCFD Pilot at insurers reporting and regulatory requirements based on the EU Green Deal • TCFD Knowledge Hub • UN PRI • “Privatkundenstudie Sustainable Finance” – detailed survey of private customer • Standard and Poor’s expectations on ESG offerings and preferences, and growth opportunities • Kepler Chevreux • Pathways to Paris (in collaboration with WWF): develop transformation tools for • Green and Sustainable Finance Cluster Germany sectoral decarbonization in Germany and connect real economy with financial sector in Germany Climate Risks & Net Zero March 2021 PwC 2
Agenda 1. Why climate? 2. Climate risks and Net Zero – what does it mean? 3. Spotlight on climate risk 4. Spotlight on Net Zero 5. What does it mean for the risk function? March 2021 PwC 3
Even if we are limiting global warming, we will see tangible changes in our world Legend Source: IPCC (2019) SR15 Summary for Policymakers, https://www.ipcc.ch/site/assets/uploads/sites/2/2019/05/SR15_SPM_version_report_LR.pdf Climate Risks & Net Zero March 2021 PwC 5
Awareness is increasing that we will be facing climate risks, no matter what we do More Physical Risks 01 If we do not contain climate change, physical risks will materialize. Floods and Extreme weather Drought higher sea level Heat events Wind More Transition Risks If we embark on a transition path, transition 02 risks will materialize. An orderly transition is preferred over an abrupt and disorderly transition. Technological Climate law and regulation Market Source: Global Carbon Project innovation Climate Risks & Net Zero March 2021 PwC 6
Net Zero is a pressing issue for society GOAL to make 1.5C possible: -> Net zero carbon emissions before Transition Pathways: 2050, 50% reduction by 2030. PwC’s Low Carbon Economy Index 2019 The Net Zero tidal wave (since 2019): - >120 countries commit to net zero by 2050, - >450 net zero cities - Ca. 300 net zero global businesses (“Race to Zero”) - WEF and WBCSD membership requirement 1-2yrs - Investors controlling $45Tr AUM commit to net zero by 2050 > quarter of global CO2 emissions and more than half of the global economy covered by net-zero commitments Climate Risks & Net Zero March 2021 PwC 7
The finance sector is impacted by three significant climate- related changes ESG assets perform better The market commits to disclosing The market commits to net zero climate risks and opportunities decarbonization ESG leaders’ equity performed better during the Corona Climate risks and opportunities have become part of the Market participants are increasingly committing to crisis compared to ESG laggards: market and regulatory conversation. decarbonize their portfolios to net zero emissions. >1500 signatories >$12 trillion market 30 signatories capitalization >$9 trillion AuM Source: TCFD Signatories website (December 2020) Source: Net Zero Asset Manaegers Initiative Website (December 2020) 33 signatories >$5 trillion AuM >3000 signatories >$103 trillion AuM Source: UNEP FI Website (December 2020) Source: PRI Signatories website (December 2020) >60 Financials taking action Source: AXA (2020) Coronavirus: How ESG scores signaled resilience in the Q1 market downturn, retrieved here. Source: SBTi Website (December 2020) If we don’t act … … we will lose market share, … … we will not fulfill investee expectations, … … we will not fulfill our commitments. Climate Risks & Net Zero March 2021 PwC 8
Case example: Climate risk heat maps focus attention MSCI world analysis Example: Portfolio Unweighted 1.8°C Scenario The MSCI World could risk losing 5% in profitability if Benefits companies weren’t acting MAINSTREAM: 2019 - 2030 • Understanding financial materiality of climate risks Percentage annual change of EBITDA : in portfolios and focusing the attention going forward as heatmaps highlight Total MSCI World material sectors and Mining geographies -1.41% cumulated growth (2019-2030): + 3.4% in Mainstream • Identification of potential for Utilities reweighting +3.86% - 4.9% in Inaction • Key input into reporting EBITDA CHANGE as compound annual growth rate (CAGR) compared to previous period - 1% +1% Climate Risks & Net Zero Negative financial Positive financial March 2021 impact of scenario impact of scenario PwC 9
Stakeholders are taking a harder look at climate US Asia Europe Climate Risks & Net Zero March 2021 PwC 10
Climate risks and Net Zero – what does it mean? March 2021 PwC 11
TCFD as SBT can conceptually interlock seamlessly with a shared scenario basis: IEA below 2°C 1 Task Force on Climate-Related Financial Disclosures Science-Based Targets Initiative (SBTi) EUR CO2/t Taxonomy 4°C Paper Sector Curve 2°C (based on 2° IEA 1)
Extract Absolute Impact: Net zero does not equal no risk Can a CO2 footprint be a good indicator for risks and opportunities? Comments • Portfolio choice: • Two test portfolios were built based on Europe’s top 20 utilities companies • Test portfolio A chose those 3 out of those 20 companies that showed the highest climate resilience in both scenarios and with and without strategic adaptation assumption (highest EBITDA change) • Test portfolio B chose those 3 out of the 20 companies that had the lowest CO2 footprint • Result: A is a lot more resilient, while growth could be similar in the best case for both, B could experience -0,9% EBITDA change p.a. – average change in A lies at +0,8% p.a. and at +0,2% for B • Rationale: companies in A show a diversified technology Best, average and worst annual earnings performance (EBITDA) portfolio and are globally diversified. Companies in B are of the two test portfolios A and B over the period 2020 to 2050 rather focusing on Europe and mostly have RE, nuclear in their based on a 1.8°C and a 2.7°C climate scenario respectively with mix. and without strategic adaptation of the companies. Source: AbsolutIimpact, Climate Excellence: Bewertung von Klimarisiken und –chancen, Ausgabe 04/2020 Climate Risks & Net Zero March 2021 PwC 13
Spotlight on climate risk
Minimal input from your side and maximum output provided via the Climate Excellence tool Input of Your Company Output: Financial • NACE codes impact per scenario • ISIN (if listed) • Company • Country of operation/geography (ideally not only headquarters) • Exposure EBITDA 1.8°C • If possible: revenue breakdown of companies by NACE codes Climate 2.0°C Sales Excellence Input Climate Excellence Model 2.7°C • Scenario data • Asset level data • Validation emission-data Climate Risks & Net Zero March 2021 PwC 15
Climate risks are not a separate risk category but have an impact on credit, market and operational risks Credit Risk Market Risk Operational Risk Physical • Revaluation of credit objects and • Rating downgrades and Exchange rate • Physical losses burden balance sheet; Risks collateral losses after catastrophes and by impairment the availability of banking • Rating downgrades creeping sinking productivity services Transition • Stranded assets • Sudden extreme fluctuations in asset • Image damage due to failure to switch Risks • Risk shifts prices; stranded assets to sustainable business practices • Effects on Probability of default (PD) • Long-term price increases due to and losses in the event of default (LGD) environmental and social changes Financial • Affectedness of entire industries and • Market-threatening effects of climate • Reputation damage for entire industries/ Stability markets and environmental damage in an entire entire markets Risks • Economy is no longer insurable at region • Large parts of the financial infrastructure reasonable cost of a Country/Region Source: BaFin Perspektiven Ausgabe 2|2019, pg. 23 Climate Risks & Net Zero March 2021 PwC 16
The tools guides you through the relevant aspects and delivers answers for your specific portfolio Transition risk PF Overview Regional Heatmap Single Asset Benchmark Identify exposures, portfolio Compare sector performances Illustrate differences in Allows separation of winners and Compare risk drivers for a single resilience and potentials for of companies performance across countries losers company and analyze company reshifting in the same segment. within the same sector differentiators. Company Benchmark Regional Performance Single Asset Risk driver Climate Risks & Net Zero March 2021 PwC 17
Spotlight on Net Zero March 2021 PwC 18
Reaching Net Zero: Different frameworks for target setting exist Three target options* for mandatory Asset Classes: Further approaches: 1) Sector Decarbonization Approach Potential Net Zero pathway: Four target options Target for the reduction of the emission (3 mandatory): in Billion tonnes CO2 per year (GtCO2/yr) intensity of individual sectors present in the portfolio 40 • Absolute emissions target for (sub)portfolio 2) Portfolio Coverage 20 • Sector intensity targets Target for the share of portfolio • Engagement targets companies that set themselves a • Financing Transition targets 0 SBT -20 3) Portfolio Temperature Rating 2020 2020 2060 2060 2100 2100 Fossil fuel and industry AFOLU Target for the overall temperature rating (contribution to global warming) of the entire portfolio Climate Risks & Net Zero Sources: IPCC SR1.5; SBTi – Financial sector science-based targets guidance, October 2020; *Real Estate and Project Finance has to be calculated using the SDA March 2021 PwC The Unconvened Net-Zero Asset Owners Alliance 2025 Target Setting Protocol; January 2021 19
How to use the SBTi to set science-based targets What does this mean for the different parts of your business? SBTi method The table shows the SBTi Estimated SBTi Sector Decarbonisation SBT Portfolio Temperature approach mapped to your €bn emissions Coverage Approach Coverage Rating business. Residential Mortgages Optional ✔ ⨯ ⨯ Where an activity is out of scope Property & Construction / Commercial Real Estate > 67% actual ✔ ⨯ ⨯ for SBTi, such as car finance, Electricity generation 100% actual ✔ ⨯ ⨯ Project targets can still be developed and Finance Other n/a ⨯ ⨯ ⨯ set using an appropriate method, Electricity generation 100% actual ✔ ⨯ ⨯ and would provide you with an Fossil fuel** > 95% $ ⨯ ✔ ⨯ opportunity to show leadership by working with the SBTi to pioneer Corporate ✔ Mining and quarrying > 67% $ ✔ ✔ a new methodology. & SME* (iron and steel only) lending Transport, aluminium, cement, pulp and paper, > 67% $ ✔ ✔ ✔ The SBTi are looking to broaden buildings the framework over the coming Other commercial*** > 67% $ ⨯ ✔ ✔ years, with infrastructure and asset finance being considered Common and preferred stock, corporate bonds, Listed exchange traded funds, REITs****, listed real 100% $ ✔ ✔ ✔ for the next twelve months. equity and estate companies, real estate mutual funds bonds For your own operations, Funds of funds Optional ✔ ✔ ✔ financial institutions are Private equity and debt, including venture capital Optional ✔ ✔ ✔ encouraged to set targets for * SME lending is optional scope 1 & 2 emissions. ** Includes Oil & Gas and Coal. SDA approach for oil and gas currently in development *** Other sectors include all service sectors, tech and education, wholesale, agriculture, manufacturing, and retail and hospitality **** REITs: If the FI in question is a REIT, 67% of mortgages need to be covered. If the FI in question is investing in REITs, this investment is considered a listed equity, and 100% of Climate Risks & Net Zero mortgages need to be covered. March 2021 PwC 20
Case example: Achieving net zero requires target setting and active steering Example: Portfolio Energy Relevant questions that need addressing: Benefits 0,60 1. Where are companies I am investing in situated 0,55 relative to the trajectory? • Credible communication 0,50 2. Comparing titles I hold and sell over time, what are of integrated steering 0,45 0,40 relevant assumptions I need to consider? mechanisms tCO2 / MWh 0,35 3. In planning decarbonization of my portfolios what • Initial assessment of 0,30 KPIs do I need to consider in the future? financing universe 0,25 0,20 4. How much decarbonization can I expect to • Setting up a future-proof 0,15 achieve in my portfolios through my holdings’ own steering mechanism by 0,10 decarbonization? understanding 0,05 0,00 5. What are implications on my product portfolio? decarbonization needs in 2020 2025 2030 2035 2040 6. Is the investment universe large enough to explore different sectors Reduction curve from the IEA B2DS Scenario such a decarbonization journey? • Set decarbonization Possible portfolio Illustrative portfolio reduction curve starting points targets and collaborate with clients to achieve them Sector decarbonization curves can be built: Existing Asset Holdings Asset Additions • For different ambition levels (different scenarios) • For different scenario sources Steering options: Steering options: • For a number of different sectors • Engagement with issuers • Choose issuers, who are already aligned • With regional granularity where scenarios provide it • Re-weighting • Choose companies and sectors, who are easy to align • Based on physical or economic intensities • Last resort: sell or have credible commitments • Policies and thresholds Climate Risks & Net Zero March 2021 PwC 21
A steering logic must take into account the development of the existing portfolio and requirements for new business Illustrative: Real Estate Reduction in primary energy demand from the climate scenario for Germany (for comparison). Calculated reduction of primary energy demand (kWh/m²) according to IEA ETP 2017 B2DS 1 RISK Focus on heat pumps and Primary energy (kWh/m²) (1 = 100%) natural gas Lock-in for new buildings to be considered Vulnerability Wie stehe ich of today’s portfolio da? Focus on solar heat and heat pumps → Necessary to reduce energy ~- consumption through renovation 80% Paris-Agreement (Well-below 2°C) 3 SUPPORT TRANSITION The majority of buildings are renovated and use efficient, renewable heat How can I support the transition? Long-term minimum standard? Nearly Zero Energy Buildings (NZEB) 2 STEERING Combining extreme building efficiency with renewable heating. Portfolio starting point „to be aligned“ Source: IEA ETP and Energy Efficiency Strategy Buildings BMWi Climate Risks & Net Zero March 2021 PwC 22
What does it mean for the risk function?
The ambition level defines the way forward for risk integration Do I want to decarbonize my portfolios as well? Need to integrate on both sides and ensure consistency of approaches. What is my decarbonization ambition? How many scenarios do I want to analyze? Qualitative/quantitative integration Start with most material sectors Climate Risks & Net Zero March 2021 PwC 24
Different key pathways for risk integration exist Metrics for Net Zero need to be integrated as well and depend on method decision Model integration Factor model Qualitative integration • Quantitative results integration into • Determination of risk drivers across • Qualitative integration into current current assumptions and existing scenarios assumptions and considerations models • Define a sector and company characteristic-specific weighting • Approximation in the risk model Selection criteria: • Ambition level • Simplicity in implementation • Transaction and data costs under construction • Integration capability into the overall control system Climate Risks & Net Zero March 2021 PwC 25
Today’s production portfolio and strategy separates winners from losers in a 2°C climate scenario EBITDA developments from steel production up to 2050 in relation to 2016 status Comment 150% 150% 150% 144% • ArcelorMittal is transitioning to a 140% 140% 140% 133% regionally and technologically diverse 130% 130% 130% (BOF, EAF & DRI) asset base that makes it 119% resilient to climate change scenarios 120% 120% 120% 113% 110% 110% 110% • thyssenkrupp’s earnings from its steel 100% 100% 99% 100% 100% 100% 100% division could fall until 2030E, due to a EBITDA [100% in 2016] EBITDA [100% in 2016] EBITDA [100% in 2016] 93% 89% lack of regional and technological diversity. 90% 90% 90% Economic use of CCS technology (w/o 80% 80% 80% hydrogen) only in a time window from 2030 70% 70% 70% 68% to 2040 64% 60% 60% 60% • voestalpine’s earnings could rise by 33% 50% 50% 50% to 2050 as a result of a long-term BOF 40% 40% 40% divestment strategy, towards DRI-based steel production (ACT) and can turn highly 30% 30% 30% profitable for voestalpine 20% 20% 20% 10% 10% 10% 0% 0% 0% 2016 2020 2030 2050 2016 2020 2030 2050 2016 2020 2030 2050 S. AMERICA + S. AFRICA N. AMERICA EUROPE GERMANY UNITED STATES AUSTRIA Source: Kepler Cheuvreux, The CO-Firm. The CO-Firm’s team and tool are now part of PwC EAF DRI BOF Climate Risks & Net Zero March 2021 PwC 26
Your contact person Dr. Nicole Röttmer Climate Leader PwC Deutschland Partner, Hamburg +49 151 40803712 nicole.roettmer@pwc.com Climate Risks & Net Zero March 2021 PwC 27
Develop a future-proof climate strategy with us! Thank you.
Coverage in the licensed tool version will include… ALL sectors (NACE up to 4th digit) Open for all scenarios A - Agriculture, Forestry K – Financial and All business-related scenarios can be analyzed. E - Construction And Fishing Insurance activities Focus right now lies on (Integrated) Energy Sectors System Models B - Mining and Quarrying C - Manufacturing L – Real Estate Activties • 1.8°C based on IEA ETP B2DS • 2.0°C based on IEA ETP 2DS D - Electricity H – Transport and Storage All remaining NACE* • 2.7°C based on IEA ETP RTS Financial Assets Listed corporate bonds, listed equity Coverage Companies More than ~70,000 companies; beyond that covering unlisted companies based on sectoral split Physical Assets > 230,000 physical assets e.g. power plants (wind, solar farms), oil fields, automotive production lines Adaptation measures >135 unique technical adaptation measure packages across sectors per industry Countries Global Coverage with more than 50 countries in depth *Our primary analysis is performed based on NAICS classification, as it provides more granularity for the analysis. We provide a mapping for NAICS to NACE. Climate Risks & Net Zero March 2021 PwC 29
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