3 Forces Shaping Global Climate Risk in the Year Ahead: Gro’s 2023 Watchlist

A year ago we at Gro saw the likelihood that climate policy would be driven mainly by financial regulators in Europe and the US, with the potential that elevated energy and agricultural prices, as well as the US midterm elections, could impact the energy transition on both sides of the Atlantic. 

In 2022, we saw all of that, but also unanticipated impacts from the Russian invasion of Ukraine, a fresh surge in energy costs, and a plethora of extreme weather events that cost human life and disrupted economies worldwide. 

Looking ahead, Gro sees the following core themes for the coming year:

Increased focus on adaptation and physical climate risks:

• Gro continues to see a growing need for leaders in finance, government, and business to understand — and begin adapting to — the physical risk that a warming climate is already bringing with it.
• This year, as in 2022, developments in climate policy will increasingly force such risk assessments to occur. But more than ever before, so too will the business impact of climate-driven weather events on markets and supply chains around the world.

Europe continuing to drive global progress in 2023 on: 

• Green investing 
• Deforestation-free marketplaces, and
• Sustainability and climate-related risk disclosure

Slowed progress in the US:  

• A new Republican majority in the House of Representatives will likely add to the headwinds that have stalled federal climate policy aimed at reducing US emissions.
• And while the Securities and Exchange Commission is expected to finalize new climate-risk disclosure rules by May, the proposed rules are likely to face legal challenges brought by various state attorneys general. 

At Gro, we have the data and analytics to help financial institutions, governments, and corporate risk managers identify, address, and adapt to a warming climate and its many effects. Contact a member of our team to learn more.

Here are the Top 3 climate risk developments that Gro will be watching in 2023: 

Europe Will (Continue to) Drive Global Progress

In pursuit of climate goals enshrined variously in law and binding policy across the EU, European regulators have steadily rolled out a series of proposed and final regulations that Gro expects will begin to drive real change in the EU marketplace — and beyond — starting in 2023.  

Green investing: In reaction to the finalization of the EU Taxonomy for Sustainable Activities regulation in mid-2020, funds with assets on the order of US$140 billion have been voluntarily reclassified — mostly downgraded — in regard to marketing claims of environmental, social, governance (ESG) investment practices. (Most recently, Banque Pictet & Cie downgraded funds worth US$14 billion from Article 9 to lower-tier Article 8 status.) 

• Look for that reclassification trend to continue, and perhaps accelerate, in the coming year as the Taxonomy expands past climate-related issues to cover additional sustainability subjects — including water and marine resources use and protection; pollution prevention and control; and biodiversity and ecosystems protection.

Deforestation-free marketplace: Newly agreed upon anti-deforestation rules are expected to come into effect in the EU in the second quarter of 2023. The rules will require larger European companies selling “palm oil, cattle, soy, coffee, cocoa, and timber, as well as derived products, such as beef, chocolate, furniture, charcoal, and printed paper products” to certify — starting in 2024 — that their products are (a) “deforestation-free,” meaning they are produced on land that was not subject to deforestation or forest degradation after Dec. 31, 2020; and (b) compliant with all relevant applicable laws in force in the country of production, including human rights and Indigenous peoples’ rights laws.  

• We expect this year will be one of meaningful action from companies subject to these rules aimed at understanding the extent of deforestation impacts in their supply chains.

Sustainability and climate-related risk disclosure: In June, shortly after the anti-deforestation rules are expected to be finalized, we expect the new European Sustainability Reporting Standards (ESRS) to also be finalized. The rules will require some of the most extensive and detailed corporate sustainability-risk and impact reporting in the world. 

• The rules set 2024 as the first required reporting year, and Gro expects 2023 will see a significant amount of preparatory activity across all large and most listed EU companies, large EU subsidiaries of non-EU parents, and non-EU companies with a turnover in the EU of more than 150 million euros.

Disclosure of carbon embedded in imports: The EU’s Carbon Border Adjustment Mechanism (CBAM) is expected to be finalized in October 2023, with 2024 primed to be the first reporting year and 2026 as the first financial compliance year. The CBAM will initially require EU importers of iron and steel, cement, fertilizers, aluminum, electricity, and hydrogen to report the amount of carbon embedded in the products they import for sale in Europe. Starting in 2026, carbon-based fees will be imposed on such imports to “level the playing field” between EU businesses and those outside the EU that are not subject to the European Emissions Trading (ETS) scheme.

• As with the ESRS, Gro expects 2023 to be a year of active preparation for companies subject to the CBAM and their non-EU suppliers in anticipation of mandatory embedded carbon reporting starting in 2024.

Taken as a whole, 2023 is poised to be the year when sustainability becomes a material concern for corporate risk managers across Europe — the year the “rubber meets the road” for non-financial corporate risk assessment and disclosure in the EU. Importantly, due to their scope and breadth, these expected, first-mover European developments have the potential to drive spillover effects globally, forcing companies around the world that trade with the EU to conduct assessments and helping to shape the climate risk reporting ecosystem, as well as future national disclosure frameworks, worldwide. 

US Climate Progress Stalled by Partisanship

The fallout from last year’s politics in the US threatens to maintain — and likely to increase the strength of — the headwinds that have been keeping federal climate policy aimed at reducing US emissions stalled. The November 2022 midterm elections put the House of Representatives under the control of a fractured Republican Party that has stymied climate action and ESG investing standards generally, and specifically the US Securities and Exchange Commission’s (SEC) proposed climate-related financial disclosure rules. Meanwhile, President Biden’s ability to exercise executive action on climate initiatives has been newly limited as a result of the US Supreme Court’s decision in West Virginia v. EPA, No. 20-1530.

• As Congress gets back to business, Gro expects the House will work to frustrate Biden administration climate initiatives, including implementation of the US$700 billion Inflation Reduction Act (IRA) of 2022, one of the administration’s marquee accomplishments. 
• We also expect House Republicans to try to slow the spread of climate and ESG investing on Wall Street by prosecuting a recently announced investigation into whether major climate groups that spearhead the ESG investing movement are violating antitrust laws.

Outside of Congress, it is expected that the SEC will, sometime this year, finalize new climate-risk disclosure rules largely consistent with, but almost certainly somewhat reduced from, those proposed in draft form last March. 

• Republican state attorneys general can be counted on to quickly launch a legal challenge to the SEC rules. In a letter to the SEC last summer, 24 attorneys general, most of whom are still in office, previewed what appears to be their planned legal attack that includes the winning argument from last year’s West Virginia v. EPA Supreme Court case. 
• We also expect that if such a challenge is filed in court, a stay pending decision, which would prevent implementation of the rule, will be requested and likely granted.

Proactive Adaptation to “Baked-in” Climate Change

As we highlighted in our Climate Watchlist last year, the Earth currently appears to be on an emissions trajectory where, despite steady emissions-reduction progress in Europe, global average temperatures will exceed 2°C above pre-industrial levels by 2100. And even if we were to bend the trajectory curve substantially in the coming decade, the next 30 years of expected climate change will remain largely unchanged as emissions already in the atmosphere will drive them. As a result, extreme weather events are expected to increasingly underscore the business risk of climate change — the need for businesses to seriously engage in climate adaptation — regardless of related policy or regulations.

In 2022, the world experienced a series of off-the-charts extreme weather events: record European heat and drought; sustained drought that suggested the “desertification” of the US West (with record low water levels in Hoover Dam’s Lake Mead); economy-disrupting record low river levels in Europe and for the Mississippi; catastrophic flooding in Pakistan; and Hurricane Ian in Florida, which is tied as the fifth-strongest hurricane on record to make landfall in the contiguous United States.

What level of climate change-driven impact we’ll see in 2023 is difficult to forecast. But preparing for at least a similar level of impacts as we saw last year seems prudent, as the occurrence of global weather disasters has trended higher in this century — in the past five years the world has averaged 2.4 mega-disasters (those costing US$20 billion or more) annually, up from 1.6 such events on average for the five years before that.

Climate adaptation will therefore be central to operational risk management across all enterprises. This adaptation, in order to be financially feasible, will require climate intelligence that is local, probabilistic, and based on commonly understood and utilized scenario projections. It will also need to be communicated both to meet coming regulatory requirements and to provide guidance and comfort to investors and other stakeholders. Accordingly, investors will need new and better tools to independently access the physical risk profile of their investments as well as the suitability of those investments’ asset protections and adaptations.