Risk

An explanation of key terms related to climate risk for property-related businesses, including articles answering common questions.

Climate risk refers to financial vulnerabilities stemming from climate change. 

It is broadly classified into physical risks, such as flooding or heatwaves, and transition risks arising from the shift to a low-carbon economy (see below).

It also refers to liability risk arising from claims for compensation from organisations held responsible for loss and damage caused by the changing climate. Organisations also face reputational risk if they fail to mitigate any of these consequences.

All such risk is essentially tied to the level of confidence that stakeholder have that the organisation will be able to protect and grow its finances as expected.

Climate risk should be included as standard in the organisations’ risk assessment framework.

Proactively addressing climate risks, such as promoting energy-efficient retrofits, not only safeguards financial stability but also contributes to meeting broader decarbonisation goals.

Read more:

• How reducing climate risk creates a virtuous circles for lenders, investors and customers
• How reducing climate risk can also reduce capital requirements

Transition risk involves the financial impacts of adapting to a low-carbon economy. 

For mortgage lenders, this can include costs related to regulatory changes, such as stricter energy efficiency standards or the phasing out of high-emission properties. 

For mortgage lenders, managing transition risks effectively requires integrating them into lending criteria, offering green finance options, and staying ahead of policy developments.

Read more:

• How to accurately quantify transition risk

Physical risk encompasses potential financial losses from climate-related events, such as floods, storms, or heatwaves. 

In the UK, the main physical risk for homes comes from flooding. These events could devalue properties in their portfolios or disrupt borrower solvency. Understanding flood risk is crucial for risk assessments, loan pricing, and portfolio management. Businesses should identify high-risk properties and take proactive steps to mitigate the risk of flooding.

Residential mortgage-backed securities (RMBS) is a type of bond which is backed by a set of sustainable assets. Green assets have lower exposure to climate risks, commanding a higher price point than a standard RMBS.

For example, energy inefficient homes may struggle to hold their asset value in future due to price premiums being placed on energy efficient properties. Similarly, at some point legislation will target the housing sector with force, pushing lenders to adhere to a minimum EPC C standard and making EPC D-G homes high risk assets.

Investors increasingly see green assets as low-risk investments with the potential to see higher returns.

Read more:

• How poor EPC data is preventing green RMBS
• How green RMBS benefits lenders, homeowners and investors