Since the publication of our white paper 'Physical Impacts of Climate Change' in 2018 its content has become all the more relevant. Yet so much has changed in this short time. The paper cites the statement by the Intergovernmental Panel on Climate Change in 2018 that climate change will cause some extreme weather events to become more frequent and intense and refers to the Californian wildfires as the most destructive on record.
Less than a year later, in November 2019, two Australian states declared a state of emergency as bushfires brought a 'catastrophic' threat to communities. We have all heard the overwhelming statistics which continue to rise: currently approximately 10.7 million hectares of land burned, at least 28 people dead, over 1 billion animals killed and 2,000 homes destroyed, and smoke spreading to New Zealand and causing some of the world's highest air pollution levels across major Australian cities.
Last week the Australian Academy of Science released a statement regarding the unprecedented scale of the Australian bush fires and the impact of human induced climate change on extreme weather events. It insisted that the country must:
- reconsider its approach to 'everything', including but not limited to urban planning, building standards, habitat restoration, biodiversity, and land, water and wildlife management;
- improve climate modelling and the ability to understand fire behaviour and other adverse weather events;
- develop its ability to mitigate and adapt to extreme weather events; and
- take stronger action as part of a global commitment to limit global warming to 1.5° C above the long-term average.
What does this mean for investors and what can we do in the face of these unprecedented physical impacts of climate change? Given that we are already experiencing the physical (amongst other) impacts of climate change, the time to act is now. Action taken by investors will be influenced by various factors including the investment approach, asset class and time horizon. Nonetheless, we outline 9 different strategies investors can employ to incorporate the physical risks of climate change into their investment processes.
Climate change is causing a wide range of physical impacts which have serious implications for investors and businesses. Below is a brief summary of the 'The Physical Impacts of Climate Change Whitepaper - the first in a five part series.
Climate change is here
Climate change is causing a wide range of physical impacts with serious implications for investors and businesses. While weather variability and extremes have always existed, satellite and other observations show that temperatures are increasing which is causing extreme weather events to become more frequent and intense. These changes mean that the past is no longer a good guide to the future for assessing company/asset vulnerability to extremes. As a result of these changes and slow action to reduce emissions, the World Economic Forums’ Global Risk Report has become increasingly dominated by environmental and social issues stemming from climate change. In 2019 the risks from extreme weather events, natural disasters, and failure of climate change mitigation and adaptation, were ranked as the most likely and most impactful global risks facing the world economy.
Source: WEF 2019 http://www3.weforum.org/docs/WEF_Global_Risks_Report_2019.pdf
Investment management implications of climate change
For investors various factors will influence the ability to account for and act on the physical risk of climate change. These include:
- Investment approach – Passive vs active investors and investment styles will influence the ability of investors to integrate these factors into investment decision-making and ownership practices. For example active managers with concentrated portfolios are better able to integrate specific company and asset risks than passive managers generally can, due to their very diversified portfolios and lower analyst resources.
- Asset class – Similar to the active vs passive example, investors in unlisted assets are better able to incorporate and manage the physical risks of climate change into their investments because of the more direct influence (and oftentimes board representation) afforded by the typically large stakes acquired by investors in unlisted assets.
Strategies for incorporating climate risk
Investors can incorporate the physical risks of climate change in various ways and are able to influence how companies manage these issues. Strategies investors can employ include:
- Incorporation of physical risks in assessing individual or groups of assets
The need for investment in ‘resilience’ to manage the very significant challenges posed by 1.5°C of warming, let alone higher warming outcomes, will require a mindset shift from many investors. The use of scenario analysis, and recognition that the highest impact risks are possible and in some case probable, will be important risk management tools.
- Assumptions related to capital/operating expenditure
Where a company faces material climate change risks, additional investment will often be required to build resilience in the assets. Investors can monitor and in some cases model these additional capital requirements.
- Assumptions related to demand for goods and services
For some companies including retailers, demands for goods and services may shift as a result of a changing climate. This may particularly impact specialist providers and require changes to inventory management practices. For example, there have already been cases where warmer winters have affected sales of winter clothing and heating appliances.
- Engagement with company management
The results of climate change assessments should be incorporated into engagement plans with companies to help gain confidence in management’s approach to climate risk. As with other ESG issues this can be seen as a proxy for management quality generally and provide competitive advantage to more resilient businesses. Encouraging companies to incorporate good governance and risk management approaches and to play a constructive role in reducing emissions to mitigate climate change can help encourage positive change for individual companies and across markets.
- Assessing supply chain risks
Some companies will face larger risks in their supply chains than in their direct operations. Beyond traditional supply chain analysis, understanding the resilience of critical infrastructure and
communities will provide a more comprehensive understanding of the risks and opportunities. Understanding supply chain risks related to climate change should be seen as part of existing assessments of supply chain resilience already performed by many investors for both listed and unlisted assets.
For a full list of comprehensive strategies, please refer to the Physical Impacts of Climate Change Whitepaper.
Climate change is affecting countries, companies, assets and communities in a variety of ways and these impacts are likely to get worse.
Good stewardship of client assets requires investors to consider these issues with a range of strategies that are relevant for different assets classes.
Given the complexity and wide-reaching nature of the issues posed by climate-breakdown, organisations require an integrated approach which cuts across the business and investment activities.