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Aviation, climate risk and the sustainable economy

Aerospace
Climate Risk and Resilience|COVID 19 Coronavirus

December 16, 2020

Exploring climate regulatory frameworks facing the business aviation industry and opportunities to embrace a more sustainable economy.

Respondents to the World Economic Forum’s 2020 Global Risks Perception Survey1 ranked climate change and related environmental issues as the top five risks in terms of likelihood. While the survey was conducted prior to the onset of COVID-19, it was the first time in the survey’s history that one category has occupied all five of the top spots.

COVID-19 caught the world off-guard. While the pandemic outcome has been acute, the prognosis for climate change risk is likely to be chronic and irreversible if left unchallenged. COVID-19 has aptly demonstrated the ability of society to cope with sudden and severe traumatic events. One lesson learned from epidemiological medical science is early and effective action has the greatest efficacy. In this context, the time for businesses to take climate change risk action is now, delayed action will risk creating an enormous problem that may only be mitigated at a much greater cost.

‘Building back better’ is a term that was first officially used in the 2015 United Nations' (UN) Framework for Disaster Risk Reduction. Today, the term ‘build back better’ has become synonymous with sustainable economic recovery policies.

Stimulated by the current COVID-19 pandemic, policy frameworks are being designed to encourage behavioural and investment changes

Stimulated by the current COVID-19 pandemic, policy frameworks are being designed to encourage behavioural and investment changes that aim to reduce the likelihood of future shocks and increase society’s resilience to them when they do occur. Through the auspices of the UN, the Organisation for Economic Co-operation and Development, the World Trade Organisation and the World Bank, policies are being created to reset economic growth while decoupling future prosperity from resource extraction2.

Governments around the world have recognized the need and the opportunity to create a sustainable recovery. For example, in April 2020, the G20 Finance Ministers agreed to “commit to support an environmentally sustainable and inclusive recovery”3. In 2015, the G20 through the Financial Stability Board established the Task Force for Climate-Related Disclosures (“TCFD”). The TCFD has created a set of voluntary, consistent disclosure recommendations for use by companies in providing information to investors, lenders and insurance underwriters about their climate-related financial risks. Today, the TCFD under the leadership of Mark Carney, (the former Governor of the Bank of England), is rapidly becoming the de-facto system for reporting climate related risks.

With society placing a greater value on resilience and sustainability, 126 governments have now committed to net zero

With society placing a greater value on resilience and sustainability, 126 governments have now committed to net zero including three global giants – China, Japan and South Korea. The EU is in the process of establishing a “European Green Deal” to protect natural habitats, biodiversity and the economy for the good of its citizens.

Financial institutions have adopted The Equator Principles (“EPs”). EPs are a risk management framework for determining, assessing and managing environmental and social risk in projects and are primarily intended to provide a minimum standard for due diligence and monitoring to support responsible risk decision-making. Financiers and Institutional investors such as Blackrock and other supporters of the Climate Action100+ initiative, are prioritizing investment towards sustainable projects, while also questioning corporations in which they invest about their Environmental, Social and Governance (“ESG”) policies and principles.

Financiers and Institutional investors such as Blackrock and other supporters of the Climate Action100+ initiative, are prioritizing investment towards sustainable projects

How does this relate to broader risk management and the aviation industry? The UK’s financial market regulators (the PRA and FCA) are in the process of establishing climate related risk management processes, including financial stress testing and scenario analysis. The primary climate related insurance risks are ‘transition’ risk (resulting from reputational risk), that could result in stranded assets, ‘physical’ risk and ‘liability’ risk. Aviation CO2 emissions are likely to be included as a future insurance underwriting risk rating factor, as all PRA/FCA regulated insurers will be required to analyze, aggregate and report climate change related risks on a bi-annual basis4.

Aviation CO2 emissions are likely to be included as a future insurance underwriting risk rating factor

There are significant pressures on the aviation industry to address climate related issues. In 2019 there was heightened focus on ‘flygskam’ otherwise known as flight shaming and saw an increased movement of using other modes of transport including rail with passengers’ self-promotion through Tågskryt translating as “train brag”. Demonstrating some of the social pressures on industry. However, the issue is far deeper than that and the aviation industry is playing its part. For example, as part of its ongoing decarbonization strategy, Rolls-Royce5 is to use 100% sustainable aviation fuel (“SAF”) for the first time in engine ground tests on next-generation engine technology. The EU will also set minimum environmental standards for the production and categorization of SAFs under its European Green Deal taxonomy and ‘ReFuelEU’ initiative6.

Twenty European aviation and travel associations have called for a joint commitment between industry and policymakers to achieve net zero CO2 emissions from all flights within and departing from the EU by 2050

Twenty European aviation and travel associations including the European Business Aviation Association (“EBAA”) and the European Regions Airline Association (“ERA”) have called for a joint commitment between industry and policymakers to achieve net zero CO2 emissions from all flights within and departing from the EU by 2050. As signatories to an ‘Aviation Round Table Report’, they have urged EU leaders to join and actively support an ‘EU pact for sustainable aviation’ by the end of 2021 by contributing to a policy and financial framework they see as vital to enable the aviation sector to deliver on its sustainability commitments.

Some airlines and commercial corporate jet operators are taking advantage of passenger demand for sustainable aviation by investing in carbon sinks, promoting the utilization of SAF and improving fleet management and flight scheduling. Being a good corporate climate citizen is rapidly becoming best practice for all businesses. Clients have increasing sustainable expectations of the companies they transact with and early adopters of climate related reporting are better positioned to take advantage of new business opportunities. Environmentally aware and sustainable businesses also present a better risk management profile to insurers and will align to regulatory reforms in force now and expected in the future.

Early adapters to climate change risk mitigation are those who are most likely to benefit from a global economic recovery. Clients and passengers are becoming more discerning and many are requiring to be given the choice of flying carbon neutral or even carbon negative where possible. Airlines and business aviation operators are responding to customer sustainability demands and are continuing to find creative solutions to retain existing clients and attract new business.

It can be a complex procedure in accounting for carbon footprint and one of the first steps of managing risk is measuring risk. Calculating aviation Green House Gas (GHG) emissions is not straightforward due to complicated data reporting metrics and calculations. However, data analytics platforms are available to provide accurate TCFD reporting. While the reporting and disclosure of company CO2 emissions under TCFD is currently voluntary, Rishi Sunak, UK Chancellor Exchequer stated at the Green Horizon Summit in early November 2020, that the UK Government has committed that all listed corporates and financial services firms will be mandated to become TCFD compliant by 2025. In order to comply with financial regulator reporting, financiers, investors and insurers will increasingly require transparent emissions disclosures through TCFD reporting from 2022. The production of annual TCFD reports will also open up avenues to innovative financing solutions, such as green loans, green bonds and green leases.

In order to comply with financial regulator reporting, financiers, investors and insurers will increasingly require transparent emissions disclosures through TCFD reporting from 2022

These reforms and compliance of regulations continue to pose increase cost implications. Further under the EU Emissions Trading System7 (“EU ETS”), the European Union is likely to tighten the cap and reduce free allowances for aircraft operators under Phase IV of scheme when it commences on 1 January 2021. Ideally the increased use of SAF will help offset additional financial costs created by emissions trading schemes and proposed introduction of EU wide aviation fuel taxes.

The requirements of aviation operators and their pathway to climate sustainability is not final. The baseline calculation for International Civil Aviation Organisation’s (ICAO) Carbon Offsetting and Reduction scheme for International Aviation8 (“CORSIA”) was adjusted and aircraft operators are unlikely to have a carbon offsetting obligation under the scheme until after aviation activity exceeds 2019 levels. That may take at least five or six years to achieve and so CORSIA faces a significant reputational risk. There is also a growing expectation that international aviation will move away from ICAO’s carbon neutral growth strategy. It is widely expected that aviation and shipping will be brought into alignment with Paris Agreement carbon reduction pathways and also the carbon reduction trajectories presently being formulated under the European Green Deal. Future aircraft financing and leases are likely to be subject to transparent emissions reporting and identifiable greenhouse gas reduction measures.

In conclusion, aviation has always been an innovative industry. Since its very beginning, it has attracted pioneers and entrepreneurs who have succeeded by applying brilliant minds and creating first to market advantage. Sustainable aviation presents similar challenges and opportunities and will have a significant part to play in building back a better future.

Footnotes

1 https://www.weforum.org/reports/the-global-risks-report-2020

2 http://www.oecd.org/coronavirus/policy-responses/building-back-better-a-sustainable-resilient-recovery-after-covid-19-52b869f5/

3 https://g20.org/en/media/Documents/G20_FMCBG_Communiqu%C3%A9_EN%20(2).pdf

4 https://www.fca.org.uk/publication/corporate/climate-financial-risk-forum-guide-2020-disclosures-chapter.pdf

5 https://www.rolls-royce.com/media/press-releases/2020/12-11-2020-rr-to-test-100-percent-sustainable-aviation-fuel-in-next-generation-engine-demonstrator.aspx

6 https://ec.europa.eu/info/law/better-regulation/have-your-say/initiatives/12303-ReFuelEU-Aviation-Sustainable-Aviation-Fuels

7 https://ec.europa.eu/clima/policies/ets_en

8 https://www.icao.int/environmental-protection/CORSIA/Pages/default.aspx

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Executive Director, Corporate Aviation

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