We are working to reduce climate risk

KLP has been working to understand climate risk, for more than ten years. We have done this through corporate dialogue and influence, by reducing investments in sectors with high CO2 emissions such as coal and oil sands, and by increasing climate-friendly investments, especially in renewable energy. These measures must be seen in the context of KLP’s desire to have a positive impact on climate development, and thereby contribute to a general reduction in climate risk in the market.

The understanding of what climate risk is, and the kind of consequences it can have on society and financial values, has changed a lot in recent years. KLP’s objectives for its work on climate risk are as follows:

Increase knowledge of climate risk within the company and with KLP’s external stakeholders
Develop scenarios and climate risk data to assess significant risk factors and opportunities
Integrate climate risk into established investment and risk management processes in a more systematic way
Make an impact on companies KLP invests in to develop climate risk management and set climate targets in line with the Paris Agreement
Increase KLP’s climate-friendly investments by NOK 6 billion per year.

Now that the physical effects of climate change are becoming more apparent and severe, there is also increased awareness in society of the need to do more to reduce emissions in line with the ambitions of the Paris Agreement. As well as being a consequence of physical climate change, climate risks can also be seen as a result of new policy instruments, technological progress, market developments, issue with access to resources and intangible changes in values and attitudes. All of these affect KLP and the expectations placed on the company. However there is not only financial risk in this, but also opportunities for the company.

Climate risk is challenging

The topic of climate risk is a challenging. It is difficult to say whether a risk will be high or low. That is why we are working to identify and assess several different outcomes to determine whether KLP’s strategy can be considered robust in the face of climate change.

In order for us to analyse, manage and report climate risk as a financial risk, we have been working in a structured way since 2018 to strengthen our expertise in this area. Our strategy is to integrate climate risk into the asset management strategy and the processes for managing risk. This competence is being built up especially through the work of mapping and analysing climate risk within KLP, but also through cooperation with external actors.

Our climate risk reporting

KLP’s climate risk reporting is structured according to the recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD). KLP regards these recommendations as the market standard for climate risk reporting. The TCFD recommends reporting on how climate risk is integrated into corporate governance, risk management, strategy, and methods and objectives.

1. Climate risk in corporate governance

Every year, the Board of KLP carries out a strategic review. They then set out KLP’s overall objectives and strategies. The Board also adopts group-wide strategies for asset management and corporate responsibility. Corporate responsibility is defined as one of the key areas of the corporate strategy, and climate and climate risk work have been identified as a top priority for KLP’s work on corporate responsibility. Climate risk is also addressed and covered in Board-level discussions of Group risk. Climate-related issues are therefore discussed several times a year at Board level, and the Board is being informed on a regular basis of KLP’s mapping and competence-raising work around climate risk, and how the company plans to work on climate risk in the years ahead.

At KLP, Group senior management carries out an annual review process in which it decides how the company should implement the strategy that has been set out by the Board of Directors. The goals for the work on climate risk in 2020 were to continue the work of developing climate risk expertise and integrating climate risk into relevant business processes.

Climate risk is an issue that is increasingly integrated into KLP’s risk management and control functions. For the second year in a row, climate risk was part of KLP’s ORSA report to the Financial Supervisory Authority of Norway in 2020. This includes reporting on results from climate risk analyses, from the property portfolio and from KLP’s investments in listed shares and corporate bonds respectively. We are also working to prepare the organisation for changes in relevant regulations, such as the addition of climate risk assessments and processes to the Solvency II regulations.

2. Managing climate risk as a risk factor

According to KLP’s risk management policy, all significant risk factors should be considered. We regard climate risk as a significant risk factor and therefore we are working on analyzing climate risk and incorporate it into the established risk management and investment processes. Climate risk is also part of the Financial Supervisory Authority of Norway’s strategy, and subject to changes in key regulations which affect KLP.

Since 2018, we have been working to develop expertise by mapping climate risk. In this survey, KLP has focused especially on investments in property and listed shares and corporate bonds. This work continued in 2020.

In the property investments, we have carried out qualitative climate risk analyses where the focus has been on identifying the main risk factors and assessing how these could develop in different future climate scenarios. In 2019, KLP’s property company conducted an analysis of its office building portfolio in Oslo. In 2020, the analysis was extended to include similar analyses of the office building portfolios in Trondheim, Sweden and Denmark, as well as updating the assessment for Oslo. The findings were presented in the ORSA report to the Board of Directors. This way of reporting allows the Board to engage in an ongoing learning process.

In 2019, we conducted a climate risk analysis of investments in listed shares and corporate bonds. In the analysis, we looked at possible mispricing of equities and bonds, and whether climate risk factors had been included in the cash flow analysis. We used recognized methods, but the analysis nevertheless showed weaknesses and uncertainties. This is what we did:

In 2020, we tried to update and rectify the analysis in three areas:

We adjusted the holdings list of investments so that they take in to account that KLP no longer investing in coal and oilsands. The purpose of the adjustment was to see whether the analysis model would produce a different climate risk profile for KLP. The results showed a very small difference, but well within the margin of error for the analysis.
We stress-tested KLP’s holdings against multiple scenarios for carbon price paths, rather than using only one price path, as in the 2019 analysis. This follows from the requirements for climate risk analysis and reporting, which ask financial institutions to stress-test against different scenarios for carbon pricing and other variables. The findings showed that carbon price paths have a significant impact within the parameters of the analysis model.
We tested the portfolio in two different risk models. The outcome was that the two risk models produced very different results for KLP’s portfolio from 2017 to 2019. We believe there is little reason to believe that the climate risk profile has changed dramatically during this period. The findings therefore show that climate risk models still need to mature, as better data becomes available and understanding of the phenomenon improves.

Climate risk analyzes need to gradually improve if we are to use them as a basis for decision-making. Nevertheless, we are working to integrate climate risk into different parts of the organization in a more systematic way, based on the analyzes we carry out and the understanding of climate risk that we, and the industry as a whole, develop.

KLP will make regular assessments as to how climate risk can be integrated into risk management going forward. It will be especially important to ensure that knowledge of risk improves over time, that climate risk analyses are sufficiently trustworthy, and that KLP has an adequate understanding of the uncertainty in the analysis.

As part of this, KLP is working with external agents such as investors, researchers and multilateral organisations to develop better data and knowledge about climate risk. An important cooperation in this area is KLP’s involvement in the research project “Climate Futures”. The project is managed by the Bjerknes Centre for Climate Research at the University of Bergen and, along with KLP, includes municipalities, county authorities, academic institutions and other actors from the world of business. The purpose of the project is to improve climate predictions in the short term. The project is supported by the Research Council of Norway and has been given the status of a Centre for Research-Driven Innovation.

3. Climate risk as part of the strategy

As a natural consequence of these strategic priorities, KLP has significant activity in the climate area. In 2020, we worked to identify and test a framework for setting climate targets. This framework links KLP’s emissions from all investments to an emission path consistent with the 1.5-degree target from the intergovernmental Panel on Climate Change. We have also mapped the latest developments in methods and data for climate risk analyses, based partly on the international partnership between central banks which is working to centralize e knowledge of climate risk, the Network on Greening the Financial System.

As things stand, the most important strategic priority is to improve our climate risk analyses and increase our understanding of these internally.

Going forward, based on the analyses that have now been done, we will have to decide whether KLP’s asset management strategy is effective in managing climate risk. For analyses of investments in listed equities and corporate bonds, the results suggest that the total risk exposure from these instruments is relatively low, and that KLP’s broad investment portfolio produces good risk diversification. The analyses contain a large degree of uncertainty, which is why we believe that they do not yet provide sufficient assurance as to whether KLP’s asset management strategy effectively addresses climate risk. Nevertheless, we assume that the asset management strategy, with its broad and diversified portfolios, could have a positive effect on KLP’s climate risk exposure.

We will conduct new climate risk analyses in 2021, with the aim of further integrating climate risk into KLP’s risk processes and asset management strategy.

4. Methods we use to measure climate risk

In “KLP Sustainability Accounts”, under “Climate profile of the investments”, we present measurements of emissions and carbon intensity in KLP’s listed equity and corporate bond investments. These are reported according to the TCFD’s recommendations.

We have based the indicators on scope 1 and 2 emissions, and on emissions in scope 1-3, in the companies KLP invests in. This data allows us to compare how well KLP’s investments are doing against a representative benchmark index. For more on how these are calculated, see the notes in KLP Sustainability Accounts. The indicators are not necessarily the best measurement parameters for expressing climate risk.

In order to reduce emissions and try to counter climate change, it is essential to put good reporting in place. At the same time, we believe that companies’ emissions reporting, currently provides a relatively narrow basis for assessing climate risk. Emissions data should therefore be viewed in conjunction with other indicators as part of a broader assessment of different types of climate risk. KLP currently reports on emission indicators based on the TCFD’s recommendations, but in the future, we will also consider whether there are other and better ways to quantify and report climate risk.