Climate Change will increasingly drive future investment strategies – but as yet the impact has been underestimated

2 key global bodies have in the last week each focussed on the impact that climate change will have on the future of the financial market as we know it.

In this short summary, we look at their stark conclusion – that financial markets are “mispricing” climate risk.

The United Nations “Principles of Responsible Investment” team recent analysis shows that only two percent of the 2700 Worldwide signatory base has completed any “strategic” level assessment and reporting of climate risk. This is endorsed in the results of a survey of investors by Bank of New York Mellon – “ninety-three percent of institutional investors believe climate change is not being priced into financial markets”.

Meanwhile at the United Nations Climate Conference (COP25) held in December 2019 in Madrid, 631 institutional investors from around the World – between them managing more than $37 trillion in assets – formally tabled a request to governments everywhere to step up efforts to tackle the global climate crisis and achieve the goals of the Paris Agreement.

It matters that – alongside the wider environmental concerns – financial markets are mispricing climate risk. This exposes global economies to systemic risk and potentially catastrophic financial loss to governments, banks, insurance and investment organisations.

The ‘​Global Investor Statement to Governments on Climate Change​’ – developed by the seven Founding Partners of ​The Investor Agenda​ – urges governments to phase out thermal coal power, put a meaningful price on carbon pollution, end subsidies for fossil fuels, and ​update and strengthen nationally-determined contributions to meet the goals of the Paris Agreement.

Business as usual cannot continue much longer as the realities of climate change catch up – social pressure is mounting. However, the UN concludes that although ‘low carbon solutions’ are getting cheaper, it’s “highly improbable” that governments will act “without being compelled into forceful action” – and this needs to be done soon to avoid the world “gliding to a 2.7 degrees Centigrade rise in temperature”.

The PRI foresee an “inevitable policy response” by 2025. It will be forceful, abrupt and disorderly because of delay. They report that 59% of investors polled also felt this scenario was the most likely outcome.

The implications will “ripple throughout the economy and create considerably greater disruption than many investors and businesses are prepared for today”.

The goal of the Paris Agreement in 2015 was an aspiration to keep global warming to a limit of 1.5 degrees (Centigrade). Since then little action has been evident around the World. Policymakers need strategic guidance on the consequences of their current decisions as the world. Financial market actors also need a more realistic outlook that considers how the future is likely to unfold in a realistic context of what policy makers are capable on achieving in the next few years. In this way investment decisions will begin to drive market and capitalisation values – environmentally ‘positive’ organisations gaining value and environmentally ‘negative’ organisations losing value.

In the absence of a plausible forward-looking business outlook – countries, investors and companies will continue to rely on current business planning and investment.

The PRI say that: “it’s time to get real about policy risks coming down the line in the next few years, and investors need tangible guidance which can help assess this latent risk in their portfolios. Longer term policy will need to push even harder to reach 1.5C.”

They propose a new ‘Forecast Policy Scenario’ which aims to deliver a reality-check to investors who assume that governments will continue to “take limited action on climate change” – while at the same time providing a realistic forecasting tool to navigate this complex and evolving landscape.

FPS is a baseline tool for investors. It aims to inform “forward-looking risk management, strategic asset allocation and company engagement” using a highly-credible, comprehensive and detailed picture of how the “inevitable policy response to climate change will likely unfold – and then models how the global economy will be impacted by the forecasted policies.”

FPS is unlike other climate scenarios that are ‘reverse-engineered’ from a pre-defined temperature goal, such as achieving well below 2°C. FPS starts from a detailed, realistic and probabilistic assessment of policy and technology developments and takes into account current institutional and behavioural limitations. It makes no assumption futuristic ‘Negative Emissions Technologies’ will be developed and deployed. It is, thus, more realistic about the climate challenge to the World and has been built up from implications at the macroeconomic, regional and sector level to a model across the entire global economy.

A parallel message came from Madrid: “The global shift to clean energy is underway, but much more needs to be done by governments to accelerate the low carbon transition and to improve the resilience of our economy, society and the financial system to climate risks.”

Current government commitments leave an “ambition gap” that will not prevent global average temperature from rising beyond the 1.5 degree threshold – the accepted trigger point for “catastrophic and irreversible effects of climate change.”

The investor-driven call to action was highlighted by United Nations Secretary-General António Guterres in his remarks to Heads of State and Government at COP25. “I see the business community and the finance community very active…leaders of asset management entities are asking political leaders to enhance climate action, to end subsidies to fossil fuels, to put a price on carbon.”

Background to the Madrid intervention from investment companies

Signing the Global Investor Statement to Governments on Climate Change is an action item in the Policy Advocacy focus area of the ​“The Investor Agenda​” – launched in 2018 by seven Founding Partners. The Investor Agenda is a collaborative initiative that aims to accelerate and scale up the investor actions worldwide, that are critical to tackling climate change and achieving the goals of the Paris Agreement with the aim of keeping global average temperature rise to no more than 1.5-degrees Celsius.

It provides investors with a set of actions that they can take in four key focus areas: Investment, Corporate Engagement, Investor Disclosure and Policy Advocacy.

Mindy Lubber, Ceres CEO and President: “Investors with $37 trillion in assets under management calling for our government leaders to act quickly and boldly on the global climate crisis is quite extraordinary. With the immense influence that these investors hold in our economy, government leaders ought to respond to this collective call to action with the urgency and ambition required to power a net-zero emissions economy.”

Stephanie Pfeifer, CEO of the Institutional Investors Group on Climate Change (IIGCC): “Investors are clear that governments should be much more ambitious in addressing climate change…the science shows we need to achieve climate neutrality by 2050 at the latest. Several leading economies have already set net-zero emissions targets and other countries must now follow their lead.”

​Rebecca Mikula-Wright, Director, Asia Investor Group on Climate Change (AIGCC)​: “As investors in Asia and all regions are increasingly looking to allocate more capital into low carbon investments, they are urging governments and policy makers to unlock the barriers to enable the necessary transition to net-zero carbon economies…The Investor Agenda has a pivotal role to play as a platform for supporting investors to lead ambition and catalyse sustainable investment, while promoting engagement across all regions and jurisdictions.”

Emma Herd, Chief Executive Officer, Investor Group on Climate Change (IGCC)​: “Global investors could not be clearer, governments must step up and deliver the policy ambition needed to manage the costs of climate change. Without ambitious climate goals, supported by investable policy, climate change as a risk to financial stability will continue to ratchet.”

Paul Simpson, CDP CEO: “The Investor Agenda provides an unprecedented global forum for investors to accelerate action on climate change and drive transformation of capital markets to deliver a 1.5-degrees Celsius economy. To do that investors need to take further action themselves, but also require stronger incentives from government.”

Fiona Reynolds, CEO of Principles for Responsible Investment (PRI): “The Investor Agenda has a critical role to play in compelling investors to act and bring about lasting change around climate…ambition and meaningful action from governments, business and the financial sector is imperative to curb the current trajectory of global warming. These groups must act now to curb the climate emergency the world is facing by reaching the goals of the Paris Agreement to realise 1.5-degrees Celsius.”

Eric Usher, Head of UNEP Finance Initiative: “There is a growing urgency for investors and corporations to act on climate change goals. As of today, temperatures have risen 1-degree Celsius above pre-industrial levels…to keep the rise to within 1.5-degrees Celsius globally, leadership from within the investor community will be key. The Investor Agenda is a critical platform in supporting investors in their individual actions.”

By the time that the United Nations Climate Change met as COP 25 in Madrid in December 2019, nearly 1,200 investor organisations have taken action in one or more of the focus areas of the ‘Investor Agenda’ since its inception in 2018; 750 investors have engaged with or directly influenced companies to act on climate change; over 400 investors have stepped up their own disclosure on climate change; and more than 260 investors have set a climate target for their investments.