Weathering the storm of climate risk
Around the globe, weather patterns are changing with extreme weather events occurring more frequently than in the past. The shift in weather patterns has implications for populations, companies and investors alike.
Consider the hurricanes, wildfires, and heatwaves that have filled the news only in the last few months. Hurricane Dorian was the second strongest Atlantic storm in history with gusts reaching 362 kph. Wildfires have raged across the Amazon and Siberia, turning vital carbon “sinks” into carbon emitters. In July, Europe was roasted in a record-breaking heatwave in July and Arctic ice sheets melted away more in a month than in an entire year.
Extreme weather: the costs
As climate change continues to affect the natural ecosystem, more frequent and intense extreme weather events are expected to occur. The implications for well-being of people and the planet are considerable and partially quantified by the NatCatSERVICE, one of the world’s most comprehensive databases for analysing and evaluating natural catastrophes.
In terms of insured losses 2018 was the fourth-costliest year in roughly the last forty years. This was due to severe and costly hurricanes, typhoons, and wildfires in the second half of the year. Notably, around half of these losses were insured, a significantly higher percentage than the long-term average of 28%.
So it was no surprise that in the World Economic Forum’s Global Risks Perception Survey for 2019, extreme weather events were identified as the risk of greatest concern1.
Assessing climate risks for investing
Recognising the human tragedy that these extreme weather events produce, investors also have to consider the financial implications for their portfolios.
Investors should be concerned about the exposure of their investments to the inherent and uncertain characteristics of climate risk. Such risks tend to have a long-term impact, are increasing in frequency and are of unknown severity, and are not simply diversifiable.
Assessing climate risks is a highly complex and still nascent field in the investment industry. Yet, frameworks, tools, and models are rapidly emerging to help to assess, quantify and act on the risks. Below, we highlight a framework that can help investors systematically assess risks to existing assets and new opportunities.
Summary of climate risks
- Physical: damage to land, buildings, stock or infrastructure owing to physical effects of climate-related factors, such as heat waves, drought, sea levels, ocean acidification, storms or flooding
- Secondary: knock-on effects of physical risks, such as falling crop yields, resource shortages, supply chain disruption, as well as migration, political instability or conflict
- Policy: financial impairment arising from local, national or international policy responses to climate change, such as carbon pricing or levies, emission caps or subsidy withdrawal
- Liability: financial liabilities, including insurance claims and legal damages, arising under the law of contract, tort or negligence because of other climate-related risks
- Transition: financial losses arising from disorderly or volatile adjustments to the value of listed and unlisted securities, assets and liabilities in response to other climate-related risks
- Reputational: risks affecting businesses engaging in, or connected with, activities that some stakeholders consider to be inconsistent with addressing climate change.
Source: EY, Climate Change: The investment perspective, 20162
Impact on investment decisions
Opportunities are being created for businesses and industries in the adaptation of the way we live and mitigation of risks required to tackle climate change, offering new possibilities for investors.
A recent report3 estimated that $1.8tn of investment over the next decade in key areas of adapting to climate change alone, could generate up to $7.1tn in economic benefits. As more governments set targets, policies and incentives to achieve their climate change and green growth commitments, such a payback creates a wider range of opportunities to support and spur the businesses and innovation needed.
The adverse effects of climate change on the economy are now starting to hit home. How investments will be affected by climate change factors will depend on likely future actions by governments, regulators, companies and the public.
While climate change is a complex global challenge, every investor’s portfolio faces the risks and opportunities it offers, and, no matter the size, can play a role in preparing for and addressing it.
Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.
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