Climate Risks in the UAE

Philip Lloyd, Consultant Climate Change Risk in 4pi points out that banks and financial institutions may be assuming indirect exposure through their counterparties, but that recognising climate change as a strategic and financial risk can help prepare businesses mitigate future problems.

With the 26th UN Climate Change Conference (‘COP26’) fast approaching, there has been a sustained and global regulatory push for companies to recognise the effects of Climate Change on their businesses and to explore strategies for managing this instability. The UAE’s harsh climate is expected to see even higher mean temperatures, drought, and more frequent storm activity – including dust and sandstorms. These direct climactic manifestations of Climate Change are examples of what is called Physical Risk. Less appreciated however are Transition Risks: fundamental changes to the business environment – legislative or technological developments, for example – that result from the transition to zero-carbon economies.

Together, Physical and Transition Risks present a complex and novel set of challenges for business that require urgent consideration.

The UAE Context

In 2019, the UAE Ministry of Climate Change and Environment explored the ways in which Physical Risk would affect UAE businesses in the coming decades. Their findings included property endangerment, reduced labour productivity, and infrastructure damage.[i] Separately, the UAE Central Bank (‘CB UAE’) has recommended that firms increasingly embed climate considerations into their risk management frameworks to accommodate incoming legislation, guided by the Government’s broad ‘UAE Green Agenda 2030’ policy.[ii]

Firms within the UAE Financial Sector – acting as financiers and investors – assume an indirect exposure to these developments through their counterparties. The financial implications are broad and diverse in nature. From a Credit Risk perspective, a mortgage book’s collateralised assets may require devaluation to reflect increased flood risk probabilities, potentially affecting 6% of the UAE’s developed coastline. For Corporate Loan portfolios, the green transition will challenge the business models of some loan counterparties, necessitating an awareness of these risks at origination. Conversely, Green Finance will present opportunities across new sectors and technologies.

An embedded firm-wide strategy for identifying and measuring climate threats will allow risks to be managed and help identify opportunities as they arise.

Case Study: Europe and the UK

Increasingly stringent Climate Risk Reporting requirements are being progressively imposed on the EU and UK Financial Services sectors by Governments, Central Banks and market regulators. Their collective experiences therefore provide some insight into the likely journey the UAE Financial Services sector will face as pressures build to implement similar requirements and disclosures, domestically.

The 2017 recommendations of the Task Force for Climate Related Financial Disclosures provided an initial impetus for firms to voluntarily disclosure Climate Risk exposures. By 2020, UK Treasury had outlined a roadmap for the mandating of such disclosures by 2025, with most companies in-scope by 2023. A comparable EU commitment was announced in June of this year. Further, Central Banks across both jurisdictions have initiated Climate Stress Tests requiring firms to model their operational and financial health through climate-focussed scenarios. Results from a further Climate Stress Test in 2022

by the European Banking Authority are expected to inform future amendments to banks’ capital adequacy requirements.

Addressing these regulations has necessitated a change to the way EU and UK companies think about their modelling and forecasting capabilities. Climate Risks require new modelling approaches, longer forecasting horizons, and methods for translating non-traditional data sources (such as GHG emission volumes) into financial metrics. It has been a challenging, but constructive journey.

UAE: Go Forward

Whilst international Climate Risk Reporting precedents will already affect many companies, there is evidence too that UAE domestic requirements are to be imminently expanded.

Under the Government’s broad ‘UAE Green Agenda Programs (2015-2030)’, many new initiatives are being implemented.  The recent Climate Risk Awareness stocktake survey from the CB UAE forewarns plans to develop a wider swathe of measures including Climate Risk stress tests, scenario modelling and reporting. Ultimately, the findings could inform a future regulatory roadmap for the UAE Financial Services sector to implement strategies for sustainable business activities and risk management capabilities.[1]

In May of this year, the UAE formally tendered a bid to host the COP28 meeting, to be held in 2026. Expectations will be for the UAE to continue to push hard in fields such as green energy technology, but also necessary will be a step change in the mentality of UAE companies to measure and manage Climate Risks in their everyday operations. The Financial Sector will play a key role in the facilitation of this step change. Recognising Climate Change as a board-level strategic and financial risk now will ensure your companies are prepared to mitigate those risks in the coming years.

[1] Abu Dhabi Sustainable Finance Forum (2020) ‘Guiding Principles on Sustainable Finance in the UAE’

[i] United Arab Emirates Ministry of Climate Change & Environment (2019) ‘UAE Climate Risk Assessment & Adaptation Measures in Key Sectors: Health, Energy, Infrastructure & Environment’, pp15-16

[ii] Central Bank of the U.A.E (2020) ‘Financial Stability Report, 2020’, p39