During the past few months at Impax we have focused our client communications on COVID-19 related market and portfolio updates. Whilst continuing to generate significant human impact and market uncertainty, the pandemic is also starting to trigger questions around other long predicted risks which seemed too large to tackle or too uncertain in timing to analyse. In this context we focus on climate change adaptation as we start to look forward for known risks against which portfolios can be positioned.
The physical impacts of climate change are already with us, and they are going to get worse. In recent years extreme weather events have occurred more frequently and with greater force than predicted. In 2019 the costs of natural catastrophes totalled US$137 billion. Weather-related events were the main contributor to this figure, with flooding, severe storms and droughts the most significant events. Around a third of that figure was covered by insurance, leaving individuals, governments and companies to carry the costs1.
Number of weather-related events and associated economic losses
The past year is not an outlier. If anything, losses were below the annual average of US$162 billion (in 2019 US$) over the last 10 years, which made the last decade the costliest in the modern record. All indications are that climate change will lead to larger and costlier extreme weather impacts around the world. A report by federal agencies suggests that, in the United States alone, climate-related economic damage could reach 10% of GDP by the end of the century.2
Even if greenhouse gas emissions are stabilised relatively soon, the inertia within the climate system means that global warming and its effects will continue for decades to come. Societies and economies around the world will have to adapt and become more resilient in the face of more extreme weather and rising sea-levels. The current Covid-19 pandemic, while not directly caused by global warming, has underscored the vulnerability of human systems and the need for greater resilience.
Investment in adaptation
Despite the growing awareness of the need for adaptation and the development of resilience to the physical impacts of climate change, investment flows for climate adaptation have been dramatically lower than those for climate mitigation. The Climate Policy Initiative reports that in 2019 only 7% of climate finance was linked to climate adaptation3. Within the private sector in particular, a perceived lack of opportunities has deterred investment in adaptation to the physical risks of climate change.
We would challenge that perception. In real estate, for example, for many years incremental investments have been geared towards resilience in the face of increasing likelihood of flood events; likewise, capital investments by extractive industries have factored in water availability over a multi-decadal timescale. However, such investments have not generally been thought of as “climate adaptation” and have been undertaken on an incremental rather than transformative scale.
As a result, we believe investment flows into climate resilience have been neither large nor fast enough and, in the face of physical climate risk arising much more rapidly than expected, assets remain highly exposed with the adaptation finance gap remaining wide open.
At Impax, we are seeing an emerging suite of investment opportunities with the potential to make both individual companies and society more broadly resilient to the effects of climate change.
Climate adaptation opportunities are garnering growing attention from policymakers. The European Commission identified climate adaptation along with climate mitigation as the two priorities for its sustainable finance taxonomy.4 The Taxonomy identifies which economic activities contribute to climate adaptation (and mitigation), with the goal of encouraging financial flows towards the low-carbon transition.
Opportunities through the Lens
Investing in climate adaptation is in line with our investment approach, which is to invest in companies and assets that are well-positioned for, and can enable or benefit from, the transition to a more sustainable economy.
Impax’s proprietary idea generation tool and analytics framework, the Impax Sustainability Lens, helps to explore opportunities and risks across economic activities and sub-sectors relating to this transition. The Lens highlights that while virtually all sectors of the economy are, to some degree, exposed to physical climate risks, we believe some sectors are also presented with related economic opportunities.
These are the sectors that provide climate adaptation solutions – products or services that help others adapt to increasingly severe extreme weather events and longer-term shifts in climate patterns. Such solutions can help to climate-proof infrastructure, energy systems, water supply, agriculture, aquaculture and forestry. Adaptation systems and services address the need for insightful information and communication systems, climate focused financial products, adaptive healthcare and other related services, such as environmental consultancy.
Climate adaptation related investment opportunities include equity and debt issuance related to a range of company and public financing initiatives. At Impax we consider these within our Climate Adaptation taxonomy including:
- Smart and resilient energy networks enabled by power electronics that can enhance energy network resiliency, with distributed generation and energy storage systems that can offer continuity in the face of external stresses imposed by climate change.
- Flood control solutions that help prevent or reduce the impacts of flooding and storm water surges and run-offs.
- Satellite and telecoms services that deliver weather monitoring, forecasting and early warning systems enable preparedness and response planning.
- Business continuity software solutions that can help companies manage their operations in the face of disruptions, for example by enabling flexible and adaptive supply chains by using predictive analysis to model for climate-induced future shocks. Smart working solutions, such as video conferencing, webinar and other digital co-working infrastructure, support a virtual workforce and thereby alleviate the dependency on office locations in case these are themselves impaired by physical climate hazards. The COVID-19 pandemic offered a reminder of the essential role played by business continuity solutions.
- Reinsurance of climate-enhanced nonlife insurance, which transfers climate risk from those unable to bear the exposure to pools of capital that are comfortable with the risk. As key enablers of primary insurance cover, we believe reinsurers can help to close the insurance protection gap and are well-positioned as adaptation solution providers.
- Providers of global healthcare infrastructure. . Global warming and changing climate patterns are predicted to have increasingly severe health impacts. Heat stress and other extreme weather-related disasters are already major causes of health issues and fatalities. In addition, climate change is expected to increase the spread and range of water and vector-borne communicable diseases such as malaria5 and dengue and to increase the risk of pandemics. While the current crisis is not directly linked to climate change, it does highlight, however, that the prevalence of such shocks will place a significant burden on the global healthcare system. To address these challenges, the footprint of genetic sequencing and diagnostic solutions for climate-exacerbated conditions and diseases must expand significantly. In conjunction, we anticipate a renewed focus on the rapid development of vaccines, new antibiotics, and novel therapeutics for these diseases, which we believe will benefit drug discovery supply chains.
Do no harm
It is important to be aware, however, that we face a number of sustainability challenges, and seeking to meet one environmental objective can risk undermining others. When identifying adaptation solutions providers, it is important to ensure the economic activity enabling climate adaptation does not cause significant harm to any other environmental objective.
In practice, this means construction materials used to reinforce key parts of our infrastructure should be sourced from providers offering smart, lower-carbon alternatives rather than being based on high emission intensity materials such as steel and cement.
Similarly, a power generation solution generating emission free power should not leave a legacy of radioactive waste for future generations to manage.
Impax has for some time followed this balanced approach when evaluating new additions to the Environmental Markets universe. The EU Taxonomy mirrors this approach with its ‘Do No Significant Harm’ criteria, reinforcing the need to undertake rigorous company-specific analysis when seeking to identify Taxonomy-aligned investments. It is about carefully identifying solution providers that have strong climate adaptation-related opportunities whilst balancing the broader sustainable development objectives.
The World Economic Forum’s 2020 Risk Report framed it well: “The 2020s, the decade of delivery for the Sustainable Development Goals, needs to also be the resilience decade for climate”.
1AON. 2020. “Weather, Climate & Catastrophe Insight 2019 – Annual Report”. http://thoughtleadership.aon.com/Documents/20200122-if-natcat2020.pdf
2NCA (National Climate Assessment). 2018. “Fourth National Climate Assessment. Volume II: Impacts, Risks, and Adaptation in the United States”. https://nca2018.globalchange.gov/
3CPI (Climate Policy Initiative). 2019. Global Landscape of Climate Finance 2019 https://climatepolicyinitiative.org/publication/global-landscape-of-climate-finance-2019/
4EU. 2020. “Taxonomy: Final report of the Technical Expert Group on Sustainable Finance”. Climate adaptation, p.23. https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/200309-sustainable-finance-teg-final-report-taxonomy_en.pdf
5A WHO assessment, taking into account only a subset of the possible health impacts, and assuming continued economic growth and health progress, concluded that climate change is expected to cause approximately 250,000 additional deaths per year between 2030 and 2050; 38,000 due to heat exposure in elderly people, 48,000 due to diarrhoea, 60,000 due to malaria, and 95,000 due to childhood under-nutrition (https://www.who.int/news-room/fact-sheets/detail/climate-change-and-health)