Getting Climate Risk Right in Investment Portfolios

Julius Pasay, The Climate Trust
Weekly Policy and Finance Update – April 16, 2018

THE BOTTOM LINE.

By under-estimating physical risks to assets, under-appreciating future value in low-carbon investments, and overlooking climate regulation liabilities, many investors are mispricing climate risks and opportunities in their portfolios. Growing recognition of the threat that this poses to the financial system has spurred financial regulators to begin discussing ways to increase climate-risk oversight, and forward-thinking companies and investors to begin analyzing and disclosing climate risks.

Last week, central bank governors from several European nations came together to discuss how to increase regulatory oversight to address climate risk to the financial system. Carbon stress tests, compulsory disclosures, and penalties for investing in assets linked to high emissions were all topics of discussion. While the details of how financial regulators can best increase climate-risk oversight are still being debated, many companies and financial institutions are voluntarily getting ahead of the curve.

For example, climate-risk analysis and disclosure are being implemented by an increasing number of organizations. Many of these organizations are utilizing recommendations and frameworks recently developed by the Task Force on Climate-Related Financial Disclosure to assist them. The Financial Times reports that over 230 companies and financial institutions with $80tn in assets under management have signed up for voluntary disclosures recommended by The Task Force.

Another financial tool available to investors to manage climate-related risk are low-carbon indexes, which provide important data to support low-carbon investing and reporting. In 2014, MSCI developed the first Low Carbon Leaders Indexes, piloting a strategy that has grown popular with investors such as the New York State Common Retirement Fund, Japan’s Government Pension Investment Fund, Canada’s second largest pension fund CDPQ, and insurer AXA SA.

As awareness and understanding of the influence that climate change has on investments grows, we will begin to see asset repricing and increased portfolio diversification into low climate-risk and carbon offset investments.

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Image credit: Flickr/Mark Jensen