The physical risks of climate change: building a resilient response
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Sponsored article: Investors who manage physical climate risk and grasp the opportunities are likely to be the most secure, writes Ian Simm.
Reflecting on the recent Climate Week 2020, I’m struck by what a crucial period we are entering for our global response to climate change. In advance of the crucial COP26 conference in November 2021, efforts to tackle this critical problem are intensifying and, if the outcomes are to be deemed a success, it’s essential that action is targeted, well-resourced, coordinated and timely.
Against the backdrop of repeated extreme weather events around the world, the year since Climate Week 2019 has seen school children on strike, an unprecedented wave of public climate demonstrations around the world, and sustained media coverage of climate issues. It’s clear: climate change is already here and intensifying, and so are the risks. Everyone is affected—either at first-hand, through floods, hurricanes, drought or extreme temperatures, or through interconnections in global financial, economic and social systems.
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Physical
There is a growing consensus that the physical risks of climate change can no longer be viewed as a distant problem. As Impax outlines in a new report, they pose material and immediate risks to investors. One study from the Grantham Research Institute of Climate Change and the Environment, at the London School of Economics and Political Science, estimates that the “climate value at risk” of global financial assets could reach up to a staggering US$24.2trn by 21001. Additionally, the Carbon Disclosure Project recently reported that 215 of the world’s largest companies expected almost US$1trn of value at risk from climate change within the next five years.
Early action to assess, manage and price the risk transparently and comprehensively will most likely be justified if investments are to remain resilient. Yet, despite rapidly mounting evidence of the need to act, many investors are only now beginning to consider physical climate risks and the potential impact on their portfolios.
For physical climate risk to be assessed and quantified using financial metrics, investors need to understand the degree of uncertainty of model projections and be prepared to alter investment choices as our understanding of future risks improves. Financial decision-making always relies on the forecasting of future events and trends, and while climate risk presents some additional forecasting difficulty, we do know enough to make a start.
Barriers
Key barriers to the development of actionable decisions include the availability of suitable models and comprehensive data sources and the need for disclosure by companies of the physical location of key assets. Impax is working with our peers in the financial sector to improve the dialogue with environmental scientists in this area; I’m hopeful that investors will be able to access better analytical tools in the near future.
As more investors become aware of the potential impacts of physical risks, there is likely to be greater pressure on companies to disclose these risks and their approach to managing them. In many countries, and in part as an effort to implement the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), regulators are already actively encouraging the development of consensus around relevant metrics. An important recent example of this is the UK’s Climate Financial Risk Forum, which made its initial recommendations in June and is now embarking on its second phase of work.
The next decade is going to be decisive. As a changing climate continues to alter the very fabric of economies, societies and environments across the world, the investors that can act now to both manage physical climate risks and understand the opportunities to invest in resilience stand to be in the most secure position over the long-term.
You can read the full report here.
Ian Simm is the founder and chief executive of Impax Asset Management Group plc.
*Based on 2016 USD values
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