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Climate Change and Its Effect on the Financial Sector “Our world has entered an era of unprecedented environmental and social challenges. This creates the need to develop economies that are more sustainable and, at the same time, more profitable and competitive” October 2015 Disclaimer This presentation is made by KPMG Kenya, a member firm of the KPMG network of independent firms affiliated with KPMG International, a Swiss cooperative. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. This presentation has been prepared solely and exclusively for the benefit, information and use by the participants of Tanzania Insurance Brokers Association Conference and for the sole and exclusive purposes of communicating material related to the conference. These slides cannot be used by the participants of the conference for any purposes other than as expressly stated herein; neither can these slides be disclosed to, referred to, or used by, any other third party. KPMG accepts no liability or responsibility whatsoever, resulting directly or indirectly from the disclosure of the presentation contents to any third party and/or the reliance of any third party on the contents of the presentation, either in whole or in part, and the participants of the workshop agrees to indemnify KPMG in this respect. ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 1 Contents 01 Introduction 02 Climate change and the financial sector 03 Sustainability megaforces 04 Value at stake and adaptation 05 Climate change threats and opportunities in the financial sector ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 2 1 Introduction Climate change- Definition Climate change…… Is a change in global or regional climate patterns.in particular a change apparent from the mid to late 20th century onwards and attributed largely to the increased levels of atmospheric carbon dioxide produced by the use of fossil fuels. Oxford Dictionary. "Climate change" means a change of climate which is attributed directly or indirectly to human activity that alters the composition of the global atmosphere and which is in addition to natural climate variability observed over comparable time periods. - United Nations ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 4 Drivers of Climate Change The two drivers of climate change are: Human Activities ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Natural Processes Page 5 Drivers of Climate Change Some of these natural processes include: 1 Energy output from the sun 2 Variation in the earth’s orbit and the orientation of its axis 3 The greenhouse effect of water vapour and other trace gases 4 Volcanic and meteorite activity and plate tectonics ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 6 Drivers of Climate Change Burning fossil fuels Farming Deforestation Human activity Waste breakdown & landfill ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Industrial Activities Page 7 Impacts of Climate Change on Natural Resources 1. Reduction of forests and vegetation cover due to drought, forest fires, pests and invasive species present additional stressors to forests 2. Loss of biodiversity due to negative changes in the habitats of native and endangered plant and animal species 3. Scarcity of water available for industrial use, renewable energy production and waterways due to insufficient rainfall 4. Excessive water supply leading to frequent flooding, land erosion, shoreline damage and decreased water quality due to increased runoff and debris 5. Unavailability of fish and wildlife due to harsh environmental conditions 6. Drying up of rivers and wetlands leading to droughts and shifting of plants and animals ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 8 2 Climate change & the financial sector Impacts of Climate Change on the Financial Sector 1. Economic costs of climate change - At a mean global temperature increase of 3°C, conservative assumptions imply moderate economic costs rising to 3% of global GDP annually 2. Shifts in political frameworks - International and national political frameworks to combat climate change have been put in place 3. Shifts in investors’ awareness - Investors are becoming more concerned about climate change and corporate responses to it 4. Macroeconomic impacts such as the expected reduction in productivity and economic growth reducing per capita incomes 5. Direct physical impacts of climate change such as floods and storms affecting assets and investments 6. Indirect and knock-on effects of climate change i.e. adverse weather resulting in a change of the credit worthiness or solvency of clients ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 10 Role of Financial Sector in Climate Change 1. The financial sector presides over a large pool of capital, more of which should be steered towards low carbon, climate resilient activities 2. Capital and investment flows in the financial sector need to shift from high to low carbon activities 3. Financial sector needs to manage risks and capture new opportunities arising from climate change since climate change is a systemic activity impacting all the sectors of the global economy 4. The financial market system must be effective so as to that financial markets can respond better to managing systemic risks such as climate change ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 11 3 Sustainability Megaforces Global Sustainability Mega forces • There is a set of ten global sustainability mega forces that will impact every business over the next two decades • The mega forces were identified based on quality numerical projections, key pressures causing global environmental and social problems and the most significant consequences of those pressures for natural and human security • The mega forces do not function in isolation from each other but act as a complex and unpredictable system, feeding, amplifying or ameliorating the effects of others • Business leaders seeking to manage the risks and harness the opportunities of the future must understand how these megaforces function and how they might affect their own organizations ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 13 Global Sustainability Mega-forces Climate Change Material Resource Scarcity Energy & Fuel Food Security Urbanization Water Scarcity Wealth Population Growth Ecosystem Decline Deforestation ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 14 Climate Change • It is the one global mega force that directly impacts all other global mega forces • Predictions of annual output losses from climate change range between 1% per year, if strong and early action is taken, to at least 5% a year if policymakers fail to act. • There are six key types of risk to businesses from climate change: Physical Risk Social risk Regulatory Risk Litigation Risk Reputational Risk Competitive Risk ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 15 Interaction of Global Sustainability Mega forces The global sustainability mega forces while significant individually, they are also closely interwoven with each other. A few examples of this include: 1 Population Growth and Wealth increase Energy use which drives Climate Change 2 Climate Change increases Water Scarcity and Food insecurity which combine to drive Urbanization as more people head for cities to escape deprivation 3 Climate Change and Material Resource Scarcity drive Deforestation which in turn causes Ecosystem Decline 4 Deforestation circles back to drive Climate Change as there are fewer trees to absorb carbon in the atmosphere ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 16 4 Value at Stake and Adaptation Mega forces impacts by Sector • KPMG performed a quantitative and qualitative review of the business risks and opportunities facing key sectors of the economy in line with the Industry Classification Benchmark (ICB) system • The following industry sectors facing the greatest risks from global sustainability mega forces and have the potential to harness the greatest opportunities were identified: Sectors Airlines Industrial Metals & Mining Automobiles Mining Beverages Marine Transportation Chemicals Oil & Gas Electricity Telecommunications & Internet Food Producers ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 18 Environmental Intensity - A Clearer Picture The findings of the KPMG review are: • Industrial Metals has achieved the greatest improvement of the 11 sectors in terms of its environmental intensity, however the sector’s significant growth in earnings over the period helped it to gain this position • Mining has achieved a similar improvement in its environmental intensity but has also recorded the largest increase of all 11 sectors in its external environmental costs • A cluster of sectors – Automobiles, Chemicals and Electricity – have improved their environmental intensity while also achieving negative or low growth in the external environmental costs they incur. This suggests that these three sectors are coming the closest to decoupling their economic growth from environmental impact • Food Producers and Beverages have shown the lowest rates of environmental intensity improvement. Food Producers is the only one of the 11 sectors that, according to the data, has not improved its environmental intensity at all over the last eight years ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 19 Demonstrating the Value at Stake Profits Lost The findings of the KPMG review are: • External environmental costs could account for a considerable proportion of earnings (EBITDA) and thus represent significant business value potentially at stake: across the 11 sectors, the average external environmental costs per dollar of earnings would have been approximately 41 cents in 2010 • According to the data, Food Producers had the largest external environmental cost footprint of the 11 sectors in 2010 at US$200 billion, followed by Electricity at US$195 billion and Oil & Gas at US$152 billion • External environmental costs of the Food Producers could outweigh the sector’s entire earnings. For five other sectors (Electricity, Industrial Metals, Mining, Marine Transportation and Airlines) environmental costs could account for more than half of earnings ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 20 Adapting to Climate Change What is adaptation… • Adaptation refers to activities that reduce harm or risk of harm, or realize benefits associated with climate variability and climate change • The physical risks of climate change and their consequences, pose immediate and long-term threats to operations ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 21 Qualitative Review-Adaptation Finance & Investing • There is a growing need to support adaption measures, particularly in the poorest countries and communities where the physical risks are high and the capacity to respond insufficient • According to the World Bank and UNDP, estimates of the annual adaptation costs in developing countries alone range from $9-41 Billion and up to $86 Billion respectively • The financial sector’s involvement in adaptation finance is currently very small with most involvement from development aid from UNFCCC • The link between development aid and adaptation financing often makes the involvement and role of the private sector more complex • Insurance has a key role to play in assisting industry adapt and respond to climate change risk ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 22 Qualitative Review-Adaptation Finance & Investing The enabling factors for the financial sector to get involved with adaptation finance and investing include: Modelling capabilities • Catastrophe risk capability Financial engineering skills • Weather risk products Better and more accurate climate information and services • International Financial institutions, government , insurance and financial sector partnership • Weather index technology? ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 23 Qualitative Review-Adaptation Finance & Investing Main ways the financial sector can get involved with adaptation finance and investing include: 1. Insurance and reinsurance companies providing insurance solutions to help communities manage climate change related risks (We shall discuss potential threats and opportunities that the insurance industry can realize) (This is already happening) 2. Infrastructure spending projects on adaptation to insure against climate change and to help societies adapt 3. Sensitization on insurable risks emanating from climate change ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 24 4 Climate Change Threats and Opportunities General Insurance • Potential Threats New and existing markets become unviable as climate change increases regional exposure Asset management risks; loss of long-term value in securities affected by adaptation/mitigation regulations and measures Compounding risk across entire portfolio of converging activities (asset management, insurance, reinsurance) ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 26 General Insurance • Potential Opportunities Use of pre-existing insurance tools (e.g. Errors and Omissions insurance to protect against errors in forward selling of climate-influenced contracts; Business Interruption insurance to be better prepared than competitors) Technology insurance and/or contingent capital solutions to guard against nonperformance of clean energy technologies due to engineering failure ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 27 Property / Casualty Insurance • Potential Threats Physical damage to insured property from extreme/more frequent weather events unbalancing insurer’s assets and liabilities Liquidity problems due to same Increases in population and infrastructure densities multiply size of maximum potential losses from extreme weather events Regulatory change, for example relating to design standards ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 28 Property / Casualty Insurance • Potential Opportunities Increase in demand for underwriting services as weather risk increases Insurance of GHG offset and clean energy projects and related financial services e.g. professional indemnity for carbon credit guarantors and certifiers ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 29 Life insurance • Potential Threats Increased risks to human health (thermal stress, vector-borne disease, natural disasters) ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 30 Life insurance • Potential Opportunities Increase in global demand for L/H insurance as human health risk increases ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 31 Other • Potential Threats Business interruption risks becoming unpredictable and more financially relevant Disruptions to construction/transportations sectors Increased losses in agro-insurance Political/regulatory risks surrounding mitigation ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 32 Other • Potential Opportunities Collaboration with others in pooling capital to expedite Kyoto mechanisms Microinsurance Weather derivatives CAT Bonds Consulting/advisory services ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 33 Addition 07 Comment Questions ©2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Page 34 Contact us KPMG Kenya 8th Floor, ABC Towers Waiyaki Way P O Box 40612, 00100 GPO Nairobi, Kenya Tel: 254 (20) 280 6000 254 729 110 597 Fax: 254 (20) 221 5695 www.kpmg.com Contact us David Leahy Partner – Risk Consulting T 254 20 280 6191 E [email protected] Bernard Kiore Senior Advisor – Risk Consulting T +254 20 280 6137 E [email protected] © 2015 KPMG Kenya, a Kenyan partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.