Disclosing compound and cascading climate risks in food system portfolios

Climate change, and associated increased weather variability and extreme events, will have a major impact on food systems and consequently on financial institutions with a large portfolio in food system investments. Without taking appropriate risk mitigation measures, climate-related shocks across food systems will adversely affect these financial institutions. Through various transmission mechanisms of the food and financial systems, this can have consequences for the wider economy. The financial sector has gradually come to understand that climate change will seriously impact food systems, which are often high-input intensive, with substantial uncertainty and tail-risk. There is growing evidence that climate change events and their impacts manifest in complex, non-linear, non-uniform ways, often through compound and cascading climate risks. Climate change has the greatest impact in the primary stage of a food system in which production depends on growing conditions during the season. Compound risks arise from the simultaneous or sequential occurrence of multiple climate hazards, such as heatwaves coinciding with droughts, amplifying overall impacts (e.g., reduced crop yields). Cascading risks emerge when climate-related impacts propagate through interconnected social, economic, and natural systems, crossing the agricultural sector and borders, thus triggering wider chains of consequences. In this article we will lay out how climate risk assessment (CRA) frameworks are integrated into financial sector regulation and into the corresponding industry standards (including the standards for agricultural portfolios). We start with the global CRA frameworks and then zoom into the various EU policy instruments to address climate-related financial sector risks. Subsequently, we focus on the implementation of CRA frameworks. While the CRA frameworks do not explicitly mention compound and cascading risks, further reading in professional literature illustrates how to include these risk types through scenario analysis. Therefore, the scope of the subsequent analysis is to link compound and cascading risks with scenario analysis. We conclude that there is currently limited rigor in incorporating compound and cascading climate risks into CRA frameworks and disclosures, although the topic is emerging. This calls for deeper engagement in the coming years, from regulators financial industry, food system actors and academia.