Capital markets react swiftly to acute threats or events such as epidemics or natural catastrophes. While global threats unfold, discussions continue on how to best prepare for emerging risks, such as climate change, in the future.
The Global Risks Report 2020 by the World Economic Forum (WEF) (published Jan 2020) outlines the most relevant risks the world will be facing the coming year. One of the key messages of the Global Risks Report 2020 is that global economy is facing greater risk of stagnation, and climate change – in addition to all other risks such as infectious diseases and breakdown of information infrastructure – strikes harder. The particular concern is that these listed greatest risks demand immediate collective action, but the capacity of the global community to address these very challenges is showing signs of fractures.
The report meticulously articulates the case for preparedness. Risk prevention and preparedness are more effective ways to address risks. Response to unfolding risks is both expensive, and may cause other risks. The much needed collective action to mitigate and prepare for risks is chronically under-resourced. Real threat is, however, that political support for on-time management of known risks may actually be weakening.
The risks are assessed in terms of impact and likelihood. Risks with high impact can materialize unexpectedly, create market disruptions and have severe economic and societal consequences at a local, regional or global scale. Risks with high likelihood are rated more likely to take place.
On a longer time frame, climate change indisputably comes out as a common theme ranking high on the risk list in both likelihood and impact. According to the WEF report, threats such as extreme weather, climate action failure, natural disasters and biodiversity loss are topping the risk outlook. These hazards are linked with climate change, and when materialised, likely to generate large negative impact on economy, societies and environment.
Climate risks steer investments
Similarly to global risk outlook, climate change has become an increasingly relevant topic on investor agenda. Climate risks affect both long-term and short-term risk profiles of companies as well as investment portfolios. The negative impact of climate change can be seen for example locally in the form of increased frequency and severity of flooding or globally through the increased volatility in commodity prices.
Major institutional investors such as pension funds are starting to include climate change as a fundamental topic of engagement – demonstrated by global initiatives such as Climate Action 100+. Investments across industries are to be screened for potential negative impact by risks related to physical and transition effects of climate change. This is relevant not only via changes in policies and technologies, or increased severity of natural disasters, but also due to potential decreased availability of raw materials and disruption of supply chains.
Recently, a group of large global asset owners communicated their commitment to long-term value creation via sustainable investments. Asset owner commitments such as these translate into expectations towards asset managers to integrate environmental, social and governance (ESG) factors consistently as part of investment process, as well as to companies to disclose on ESG aspects.
As client demand for more sustainable and climate-resilient products and services grows, private sector aspires to develop new approaches in line with the transition to a low-carbon economy. By integrating ESG and climate risk analysis as part of strategy and decision-making investors will have the opportunity to act as a catalysts for sustainable and climate-resilient business and development.
Industry crosscutting partnerships and collaboration are crucial in embedding sustainable practices in strategic business and investment decisions. The EU regulation on sustainability-related disclosures in the financial services sector, as well as the EU Technical Expert Group (TEG) on Sustainable Finance work on the EU green taxonomy continue the path of bringing ESG and climate issues on the wider business agenda.
These efforts are important, yet urge stakeholders from asset owners, asset managers, banks, and government entities to act and integrate the guidance in practice. Investors, businesses and policy makers who address these issues early on, are the ones benefiting from the opportunities instead of facing the risks materialising ever more drastically.