Investors ‘flying blind’ to financial risks of climate litigation

University of Oxford researchers claim investors and regulators are unable to properly assess climate litigation-related financial risk.

Investors and regulators are not fully considering the risks posed by litigation when evaluating firms’ climate-related financial risks, researchers at the University of Oxford Sustainable Law Programme have claimed.

In a paper published in the academic journal Science, the researchers say that while the relevance of legal action to climate risk is widely accepted, the acknowledgment of liability risk as a distinct category of climate risk “has only barely begun to enter technical analyses let alone policy”.

The researchers say that existing standards and approaches fail to properly consider the risk of litigation. The International Sustainability Standards Board (ISSB), they say, considers legal risk as a part of transition risk, while the Network for Greening the Financial System (NGFS) considers it as a subset of both transition and physical risk.

“In contrast to their extensive treatment of physical and transition risks, these bodies provide little or no detail on how to evaluate climate-related legal risk, suggesting its operationalisation is at best peripheral in practice,” they continue.

While some frameworks, such as climate risks disclosure in New Zealand and prudential regulation in the EU, do recognise liability risk as a separate category, they do not give guidance on how firms should evaluate this risk.

The researchers acknowledge that litigation against firms and financial institutions is in its early stages, but note that existing cases – if successful – could have significant ramifications.

The researchers warn that the results of litigation could shift the financial exposure to physical and transition risk between assets. For example, an ongoing case against German utility RWE, which seeks to hold it responsible for a share of adaptation financing due to its contribution to global emissions, could result in the “transfer [of] physical risk exposure to large emitters”.

Similarly, a Dutch ruling where a court mandated Shell to cut its emissions could result in increased transition risk by forcing the acceleration of asset stranding and mitigation activities, the researchers noted.

To better assess the risk posed by litigation, the researchers set out five potential frameworks. These include assessing the movements of stock prices around litigation events and better quantifying the costs to a company of a court-mandated acceleration of its transition.

“Climate risk analysis fails to satisfactorily account for legal developments. Against a backdrop of increasingly impactful climate litigation and regulatory enforcement actions, which shift and amplify climate risks, we argue that current climate risk assessments misrepresent the distribution and scale of climate-related financial risks,” said Thom Wetzer, director of the Oxford Sustainable Law Programme and lead author of the paper.

“Policymakers, investors and companies have accepted the need to understand climate risk exposures. But doing so diligently means engaging with the law through research that combines legal reasoning with financial analysis and climate science. Else, they will continue to fly blind in their treatment of climate risk.”