Climate change represents a clear and present danger to long-term shareholder value. Responsible investors who represent trillions of dollars in assets under management (AUM) have recognized this for more than a decade and have worked to incorporate environmental, social and governance (ESG) factors into their investment decisions. For investors and their financial advisors, reliable data and tools are essential for understanding the risks and opportunities associated with climate change.
The potential impacts of climate change on the global economy are immense. A recent report from The Economist Intelligence Unit estimated that US$4.2 trillion in the current value of the world's AUM is at risk from a four-degree celsius rise in global temperatures by 2100. In a scenario in which the global temperature rises by six degrees, that amount grows to almost US$13.8 trillion, or roughly 10% of the value of the world's AUM.
"Our analysis suggests that much of the impact on future assets will come through weaker growth and lower asset returns across the board. These indirect impacts will affect the entire economy," the report noted. "Asset managers cannot simply avoid climate risks by moving out of vulnerable asset classes if climate change has a primarily macroeconomic impact."
As a result there will be winners and losers across all sectors, so investors need reliable information about how each company is managing its exposure to climate risks. Accordingly, it is vital to understand what climate risks are and how they might affect businesses. Mark Carney, governor of the Bank of England and chairman of the Financial Stability Board, outlined three categories of climate risk in a speech to U.K. insurers:
The first, and most obvious, are the physical risks that organizations face related to climate- and weather-related events. For example, floods and storms can damage property values, while changing weather patterns and rising sea levels can cause significant, sometimes irreparable, disruptions to trade and supply chains.
The second are liability risks, which include "the impacts that could arise tomorrow if parties who have suffered loss or damage from the effects of climate change seek compensation from those they hold responsible," according to Carney. A recent lawsuit filed in California serves as an early example of liability risk: three jurisdictions have sued 37 fossil fuel companies and trade groups, claiming that their actions have intensified climate change and exacerbated a costly rise in sea levels.
The third are transition risks, which refers to the financial risks generated by the process of adjustment toward a lower-carbon economy. Policy, regulatory and technological changes could combine with physical risks to trigger a revaluation of a wide range of assets.
Mitigating climate change would be the most prudent fiduciary course. The Economist Intelligent Unit's report noted that keeping the planet to less than two degrees celsius of warming could cut projected losses in half, while extreme losses could be reduced by 75%. For this kind of trajectory, however, the report suggested that investors and asset managers need more reliable, thorough, and comparable information about companies' exposure to climate-related risk factors.
Fortunately, regulators and key players in the financial services sector are beginning to recognize the economic significance of climate change and positioning themselves to support improved climate-related disclosure. In March, the Canadian Securities Administrators launched a review of the current state of climate-change disclosure in Canada. The move aims to examine whether issuers are providing appropriate disclosure about risks and financial impacts associated with climate change — and whether additional regulation is needed.
Then, in June, the international Task Force on Climate-related Financial Disclosures, chaired by former New York City mayor Michael Bloomberg, released a voluntary framework for companies to disclose climate-related information in their financial filings. The framework calls for companies to describe how their governance, strategy, risk-management and business metrics address climate risks and opportunities. The task force also recommended that companies conduct scenario analysis to identify and assess the potential implications of a range of plausible climate-related scenarios on their business.
Responsible investors attuned to these developments are among the best positioned to gain from the various opportunities initiatives of this nature could bring. In fact, many are on the leading edge of this transition. In July, 390 responsible investors representing more than US$22 trillion in AUM called on the G20 to adopt policies that drive investment into the transition to a low-carbon economy, to remain committed to the Paris Climate Accord, and to implement climate-related financial reporting frameworks such as those the Task Force on Climate-related Financial Disclosures presented.
"It is imperative that the public and private sectors work closely together to get the signalling and incentives right to shift the trillions of capital required across the global economy," said the letter signed by key players in responsible investing, including many members of the Responsible Investment Association.
Ultimately, awareness of climate risks and opportunities is critical to protecting and enhancing long-term shareholder value. The key is to have the information necessary to make sound investment decisions. That disclosure needs to come sooner rather than later.