Ignoring these three key factors affects the ability of a SEC registrant to understand the nature of climate-change risk, which results in errors in the disclosure process.

by Dr. Pat Harr
Jupiter Intelligence

Increasing alarm about the impacts from climate-related risks throughout financial and economic sectors has prompted the U.S. Securities and Exchange Commission (SEC) to propose disclosures of such risks that cause material impacts to a SEC registrant’s operations, supplies, strategies, and outlooks.

One motivation for disclosure is to avoid a fragmented and inconsistent reporting structure, and expose consistent, comparable, and reliable information that allows better understanding of the nature of climate-related risks by investors and registrants.

What the SEC Specifies ... and What It Doesn't

For disclosure purposes, the SEC categorizes two types of climate-related risks: transition risks, due to the shift to a low-carbon economy, and physical risks, caused by climate-change-related alterations to the physical environment that lead to severe and frequent natural disasters.

Parsing physical risk further, the SEC identifies both acute and chronic risks. The former arise from climate-related disasters that occur over short or immediate time scales (i.e., days, weeks, seasons), such as hurricanes and wildfires. Chronic risks happen over long time scales (i.e., years, decades) and include changing weather patterns and sea-level rise. Droughts can last from weeks (if aided by extreme heat and wind) to years; the SEC classifies them as chronic risks, while EU Taxonomy puts them in the acute category.

By specifically categorizing risk types as physical and transition, and aligning them to definitions contained within the broad Task force on Climate-related Financial Disclosures framework, the SEC certainly addresses the goal of a standardized framework for climate-related risk disclosure.

The SEC does not address the link between physical and transition risk, nor does it explicitly address the complexity of climate change science as it relates to physical risk.

Three Factors Drive Complexity

Non-stationarity, compound factors, and uncertainty contribute to the complexity of climate-related physical risks and the linkage between physical and transition risk.

1. Non-stationarity An overarching aspect of climate change is the principle of non-stationarity, which means that the physical and statistical characterizations of past climates may have no relation to future climates. Non-stationarity requires careful analysis of how processes that contribute to physical risks are being altered under time-varying climate states. Of course, over many millennia, climate has been changing, albeit at a pace such that an assumption of stationarity was acceptable. But the rapid pace of current changes dictates that non-stationary processes cannot be ignored to properly identify acute and chronic physical risks.
2. The compound nature of climate change This second scientific aspect is perhaps the most complex to incorporate in a disclosure framework, because it affects contributions to physical risks and to the decision-making processes that may link physical and transition risks. The compound nature of physical risks arises because often no one specific process, peril, or hazard is responsible for the risk. For example, climate-related changing characteristics of hurricanes constitute changing acute risks from winds AND precipitation AND flood. That compound nature of changing hurricane characteristics affects an acute risk. Whereas, the compound nature of climate processes in general means that acute and chronic risks are likely dependent.
3. Uncertainty A third scientific aspect of climate-change risk analysis applies to the uncertainty in assessing nearly all facets of climate science, risks, and impacts. Furthermore, uncertainty in the future path of climate change is related to the non-stationarity and compound attributes of climate processes that comprise physical risks.

Ignoring these three key factors affects the ability of a SEC registrant to understand the nature of climate-change risk, which results in errors in the disclosure process.

Overcoming These Challenges

The scientific climate analytics employed by Jupiter implement the latest advances in the science of climate change, in addition to advanced statistical and machine learning analyses, to identify the non-stationary, compound, and uncertain characteristics of physical systems that contribute to acute and chronic physical risks.

Because metrics defined by Jupiter inherently incorporate these three key scientific aspects, they lend themselves to scaling of information such that full risk portfolios can be utilized to more accurately understand and disclose a registrant’s climate-related risk.

Dr. Pat Harr is a Jupiter Science Fellow. Jupiter Intelligence is the global leader in climate analytics for resilience and risk management. For further information, please contact us at info@jupiterintel.com.

‍