Insight & Analysis

Climate change, the financial effect, and what you can do about it

Published: Sep 2019
Polar bears standing in the middle of icebergs

When it comes to identifying the issues created by climate change, not all industries are equal. What can be done to help mitigate the risk? We ask an expert for guidance.

Some industries are further advanced than others, with some still in the identification phase. The banking, insurance, energy, construction, and food and beverage industries are ahead in disclosing their position, which is generally considered representative of where they are in their level of preparedness for climate change issues.

According to David Nayler, Financial Institutions Industry Practice Leader, UK & Ireland at global insurance broking and risk management firm, Marsh, companies’ preparedness can relate to a number of areas or spheres of influence.

For example, these might include:

  • Direct influence: internal decision making about strategy, asset acquisition and management, investment decision making and risk transfer eg via insurance.
  • Indirect influence: diversification and auditing of third-party supply chains, the ability as a buyer of services to influence providers and whether the buyers’ views on climate issues can be “cascaded” through the supply chain. Aggregation of risk in fewer services providers at an industry level can also be a concern. These then raises issues of how this can be audited and managed.
  • Customer resilience: what can be done to identify key reliances and aggregation of customer related climate issues. For example, hotels that were constructed to be resilient and operational as soon as possible after a hurricane had not modelled the total disruption to business that could be caused by airports being unusable.

Investors asking questions

The growth of investor coalitions at both the non-institutional (retail) and institutional investor level (for example, Climate Action 100+ which comprises some 360 investors managing >US$34trn of assets) have started to drive behaviours, notes Nayler.

“Institutional investors have been adding environmental, social and governance (ESG) criteria to their investment management agreements for some time,” he says. Mercer Investments has been at the forefront of analysing institutional investor climate change risks for the past decade. Its most recent report is urging institutional investors to act, as climate change is seen to be posing an impact on returns.

But Nayler notes that lenders are also now mapping the climate change exposure they have on the securities that they have taken. With supply chain management and procurement teams increasingly using ESG criteria within their scoring, any corporate not taking action, at least at a financial level, is taking a huge risk.

The most recent Mercer update to its climate change risk model was described in a report released in April 2019 – Investing in a Time of Climate Change – The Sequel. This report describes a detailed methodology for estimating the financial effects of climate change risks – both physical and transition-related – on diversified investment portfolio return expectations with asset class and industry sector detail.

If there was any doubt that this is a serious business, Nayler explains that Mercer has applied its climate change model to investors with trillions of dollars in portfolio assets since 2011, including CalSTRS, New York City Retirement Systems, New York State Common Retirement Fund, Environment Agency Pension Fund and New Zealand Superannuation Fund. (In regards to statistics on insured versus economic losses, or ‘the protection gap’, there is good material available from the Geneva Association, which relates to the role that insurance plays).

Building resilience in treasury

The extent to which companies economically absorb the stresses created by climate change, and how they can adapt to be better economically prepared for climate change impacts, depends greatly upon the industry, says Nayler. While companies can tackle their direct exposures, the indirect and customer exposures are more challenging to manage and improve.

“We are receiving a growing number of inquiries from treasury departments,” he confirms. “Many corporations are sitting on relatively high levels of cash and are looking for more productive uses of their capital than typical short duration fixed income investments or share buybacks.”

One opportunity which is gaining some traction is applying a sustainable investment lens to treasury investments. This, he says, may include any of the following actions:

  • Moving some existing short duration FI or money market investments into ESG funds.
  • Shifting some commercial banking relationships to work with CDFIs.
  • Making targeted impact investments in housing or renewable energy.
  • Investing directly in carbon negative real assets (eg timberland) as an alternative to buying carbon offsets to help companies meet their decarbonisation goals while also providing a stable return.
  • In addition to these investment-related activities, treasurers can also seek to be responsible issuers and to finance projects via green bonds as applicable.
  • Corporate treasurers also often oversee corporate foundations. While these are typically pretty lightly funded, the capital in these foundations could be invested with a strong ESG/impact lens.
  • Corporate treasurers also often oversee investor relations departments. We have done a couple of projects for IR teams helping them to understand the desires of ESG investors and to streamline their reporting accordingly.

It’s not really happening… it is?

Changes in global temperature are nothing new. In the last 650,000 years there have been seven cycles of glacial advance and retreat. The start of the modern climate era was signalled by the end of last ice age, about 7,000 years ago.

Most of these climate changes are attributed to small variations in Earth’s orbit, subtly altering the amount of solar energy received by Earth. However, according to the Intergovernmental Panel on Climate Change (IPCC) Fifth Assessment Report, the current warming trend has a “greater than 95% probability” of being man-made.

Information gathered by NASA indicates that Earth’s average surface temperature has risen by 0.9°C since the late 19th century. The majority of this increase occurred in the past 35 years, with the five warmest years on record taking place since 2010.

Research by the National Oceanic and Atmospheric Administration shows that our oceans have absorbed much of this extra heat, with the top 700m of ocean having warmed by about 0.2°C since 1969.

Data from NASA and the German Aerospace Centre’s Gravity Recovery and Climate Experiment show Greenland lost an average of 286 billion tons of ice per year between 1993 and 2016. Antarctica lost around 127 billion tons of ice per year in the same time period and its ice mass loss tripled in the last decade.

Today’s sea level is about 20cm higher on average than it was in 1900. Smithsonian Ocean says it had barely changed at all in the previous 2,000 years.

According to the IPCC, “the scientific evidence for warming of the climate system is unequivocal”.

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