The physical risks of climate change can no longer be viewed as a distant problem. Extreme weather and record temperatures are now understood to be events that can be anticipated and incorporated into investment decisions.
Physical climate risks are both acute or chronic. Acute risks include droughts, floods, extreme precipitation and wildfires. Chronic risks include rising temperatures, the expansion of tropical pests and diseases into temperate zones, and an accelerating loss of biodiversity. These threats pose both idiosyncratic and systemic risks to investors. The physical impacts of climate change are increasingly obvious and expensive.
One study estimated that the ‘climate value at risk’ of global financial assets could reach up to US$24.2tr by 2100.1 CDP recently reported that 215 of the world’s largest companies expected to see almost US$1tr in value at risk from climate change within the next five years.2 Losses could be significantly higher over the long term across all asset classes.
Alarming as they are, these estimates are all likely to be underestimates. Recent reports suggesting that existing economic forecasts of climate value at risk are too low because they fail to incorporate tipping points and risks of conflict and mass migration.3
We do not have climate models that can pinpoint specific future events in time or place. However, it is possible for investors to use what is known about the likelihood of future climate hazards, to forecast the potential impacts of physical climate risk on their portfolios. Failing to do so will subject investors to a series of increasingly frequent and severe surprises. Using existing knowledge from climate modeling can help investors avoid or price in these physical climate risks.
The toolsets available to help investors understand and assess the value at risk from climate change’s physical impacts are developing rapidly. Continued progress will be informed by investor views on what constitutes decision-useful information, and will lead to new, better tools which can more accurately price the physical risks of climate change.
Concluding Impax View
Physical climate risks are complex, but tools to assess and analyse these risks are improving. In the meantime, investors should make the best use of what is available and incorporate pricing of risks into investment decisions where analysis is sufficiently robust.
We encourage others to join the conversation and support initiatives like The Task Force on Climate-related Financial Disclosures (TCFD) that will ultimately integrate this key risk into standard investment practice, creating a more resilient financial system ahead of the inevitable turmoil of the next several decades.
1Nature Climate Change https://www.nature.com/articles/nclimate2972
2CDP is a not for profit charity that runs carbon disclosure systems. https://www.cdp.net/en/articles/media/worlds-biggest-companies-face-1-trillion-in-climate-change-risks