By Elisa Jiménez Alonso
Climate change poses a threat to assets and investments. The biggest risks come from impacts on the economy, regulatory pressures, the transition to a low-carbon economy, and, of course, physical climate change impacts. With long-term value creation in mind, asset managers have recognised these risks and are asking businesses to disclose them and climate-proof their portfolios.
Asset managers leading the way
Recently, BlackRock, the world’s largest asset manager, publicly voiced concern over climate change risks to financial portfolios. A BlackRock report from September 2016 stated that climate change is a significant risk and “climate-proofing portfolios is a key consideration for all asset owners,” adding, “risks are under appreciated, yet could soon start to unfold.”
BlackRock also pointed out lucrative investment opportunities, especially in infrastructure investments. With both the private and the public sector spending on climate resilient infrastructure, investors could take advantage of many opportunities to realise high returns. Asset owners are advised to use the growing suite of climate-related investment tools and strategies to manage climate risks to their portfolios and improve their market exposure.
BlackRock also emphasises that, “The longer an asset owner’s time horizon, the more climate-related risks compound. Yet even short-term investors can be affected by regulatory and policy developments, the effect of rapid technological change or an extreme weather event.” BlackRock’s Scientific Active Equity team found that US companies with higher ‘climate scores’ (calculated from data about a company’s resource efficiency, climate risks and opportunities) are more profitable and generate higher returns on their assets.
Unpacking climate risks to financial institutions
Climate risks to the economy come in many different forms. BlackRock distinguishes four types of risks: physical, technological, regulatory and social.
Physical risks refer to more frequent and extreme weather events, as well as rises in global temperatures and sea level. Investing in impact indices and reducing portfolio’s carbon footprints are broad tools that can be applied to mitigate these risks and take advantage of opportunities.
Technological risks mainly refer to the rise of renewables and associated technologies, which are putting existing, fossil-fuel-based business models under pressure. Financial markets need to consider the risk associated with a transition to a low-carbon economy. As Fiona Morrison, President of the Institute and Faculty of Actuaries, stated in a letter to the Financial Times, “the transition to a low carbon economy is a significant change for the financial sector and investors are not currently given the necessary information in a regular and transparent manner in order to factor in these risks into decisions in a meaningful or proactive fashion.”
Regulatory risks stem from increasing efforts to mitigate and adapt to climate change; governments are putting new policies and regulations in place, and the pace at which they are doing so is increasing too. More regulations can lead to a rise in compliance failures that can trigger large fines, legal bills, and make asset prices implode. Policymakers are pushing asset owners more and more to disclose climate risks, measure and test for climate factors. This is leading to climate awareness being part of good corporate governance.
The social dimension of climate risk includes social and corporate awareness of climate change. Warming trends and climate records are leading to changes in consumer behaviour with two thirds of consumers stating they are willing to pay more for sustainable brands. Groups of NGOs, shareholders, activists, and consumers are demanding for portfolios to be ‘decarbonised’ and for companies to adhere to principles of sustainability.
Disclosing climate risks
In addition to BlackRock, other asset managers are also calling on businesses to act. StateStreet Corp, who manage about $2.5 trillion worth in assets, is pressing companies to disclose climate change risks to their businesses. To help businesses disclose their climate change risks, the Financial Stability Board’s Task Force on Climate-related Financial Disclosures published a set of recommendations on how and what to integrate in their financial climate risk disclosure. The seven principles for effective disclosures are:
- Disclosures should represent relevant information
- Disclosures should be specific and complete
- Disclosures should be clear, balanced, and understandable
- Disclosures should be consistent over time
- Disclosures should be comparable among companies within a sector, industry, or portfolio
- Disclosures should be reliable, verifiable, and objective
- Disclosures should be provided on a timely basis
Investor pressure is an important step towards encouraging companies to take their climate risk exposure seriously. The financial sector increasinly recognises climate change as an important driver of risk and has made it clear to businesses that this can no longer be ignored. This growing awareness has seen major players like BlackRock take an active role in shaping the sector’s stance on climate change, companies should head these signs and act.
Acclimatise is a partner in the Horizon2020 project EU-MACS (EUropean MArket for Climate Services), which analyses the climate services market structures and drivers, obstacles and opportunities from scientific, technical, legal, ethical, governance and socioeconomic vantage points. As part of that study, Acclimatise is engaging with the financial sector to understand if and how the sector uses climate services, how it acquires them, and if the current supply of climate services products is appropriate for the sector. Learn more by clicking here.