Act of God, Foreseeable Risk, or Hedging Opportunity?

Act of God, Foreseeable Risk, or Hedging Opportunity?

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Original Published in CFO
 | | US

Whether you’re in a domestic enterprise or a multinational conglomerate, climate change will impact what you do. In fact, it’s already happening.

Climate change influences a majority of the most fundamental activities performed by CFOs. Why? Because climate change can damage assets, impact the availability of natural resources, disrupt transportation, and hinder agriculture, among many other effects. Each one of those can disrupt cash flow, operations, the ability to obtain and repay long-term debt, and a lot of other things that are of concern to CFOs.

Recent developments in attribution sciencevoluntary standards, and the law have combined to make the physical and financial effects of climate change more foreseeable and have better defined its impacts — so much so that what constitutes reasonable and prudent practice has changed.

Specific classes of weather events can now regularly be attributed to climate change with greater than 50% certainty and in many cases greater than 90% certainty. This makes foreseeable some extreme events that may have previously been considered black swans or Acts of God. And the understanding of the relationship between extreme events and climate change will likely only improve over time.

Just as scientists have developed processes to diagnose and explain changes in the climate, corporate executives need to incorporate knowledge of these changes into their business processes in order to properly manage risk, achieve stability, and meet shareholder obligations.

The foreseeability of weather events also frames the concept of what knowledge a reasonable professional would be expected to consider in response to such information when being evaluated in a court of law in the context of negligence litigation.

Such liability evaluation may consider compliance with weather or hazard-related statutory requirements, such as a spill prevention control and counter-measure (SPCC) plans, land-use restrictions, or building codes.

But mere compliance with statutory requirements does not eliminate liability for negligence or liability under other theorems or schema, such as those relevant to directors and officers. This limitation is especially relevant in the many statutes that use weather-related and climate-related standards that don’t reflect current scientific knowledge.

For example, a quick scan of the Internet or peer-reviewed publications will confirm that flood-zone designations set forth by FEMA, as well as expected-rainfall tables embedded in modeling and related construction standards established by federal, state, and local governments, rarely reflect either actual current or expected future flood-hazard or scientific literature.

In other words, if all you do is evaluate the flood-risk exposure of your corporate assets, supply chains, and operations using FEMA maps, you may not have considered appropriate inputs into your enterprise or other operational risk-management processes. You may underestimate risk significantly, creating an unwanted or excessive exposure.

Climate change alters what we should expect and how we should plan. For example, for large greenhouse gas emitters and entities with assets significantly exposed to weather events made more severe by climate change, climate change may change actions required to mitigate risk and increase value to shareholders, as well as any associated mandatory disclosures.

CFOs have a clear opportunity to identify, manage, and hedge the risk of climate change. This opportunity arises from the combination of many factors: rapid improvements in our understanding of the impacts of climate change; the increasing speed of electronic discovery; the development of voluntary disclosure standards, like those established by the Financial Stability Board’s Task Force on Climate-related Financial Disclosures; and an ever-increasing variety of directly experienced extreme weather events.

Seizing this opportunity will improve shareholders’ profits and corporate financial stability. Failure to take advantage of it could create risk for a CFO that’s far weightier than that posed by mere extreme weather events.

Lindene Patton is a partner at Earth & Water Law, LLC, with specialty practice areas in risk management, financial services, and technology.

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