ESG: the financial costs of climate change

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The financial sector must be doing more to help prevent the material risk of climate change – both for the good of the planet and to mitigate its own exposure.

The financial impact that the undeniable force of climate change is having and will continue to have on an exponential scale is unfathomably high.

The impact can be seen across the world. The recent droughts and wildfires in Australia have had untold effects on the country's economy; hurricanes have been ravaging the Caribbean for several years and Sub-Saharan African cyclones left millions without homes in 2018 – and these are all just the tip of the (melting) iceberg. The list is long and destructive, and each of these instances causes untold damage to affected economies.

Although poorer countries are likely to lose more of their economic output, the financial cost is not localised – but felt across the world. Damage to the US economy rises in tandem with temperature changes, for example, and developing countries have more to lose than they can afford. From a project finance perspective alone, there are hundreds of billions of dollars from the developed world invested in low-income countries where the risk of climate change and natural disaster is high, and prevention measures almost non-existent.

Read our exclusive survey and special report on ESG and finance here

According to Ann van Riel, head of sustainable finance Americas at ING, it’s an existential problem. "I am quite terrified about it," she said. "We are still working on this; there’s not just one solution. Ultimately, every industry needs to transition."

"We signed the Paris agreement and we have to be on the trajectory to bring down global warming and every industry will need to do its part to move towards technologies that are lower emitting," she added.

ING has conducted a lot of research into what sectors are the highest contributors to global CO2 emissions. "There are different solutions for different industries but everybody will need to chip in. It won't be limited to making a couple of wind farms and solar cells on the roof, every industry will need to change its trajectory now."

What can be done?

The Sustainability Accounting Standards Board (SASB) – which is chaired by Michael Bloomberg – reported as long ago as 2016 that 93% of American public companies face a degree of climate risk, but only 12% had disclosed it at the time. According to Audrey Choi, chief sustainability officer at Morgan Stanley, "if you are the investor who understands how to think about climate risk in relation to your business, then that is prudent investing".

Many have long-held assumptions about sustainability and finance: for instance, the view that environment or social aspects must be somehow soft-headed, and create lower returns. "On the contrary, from a study of 11,000 mutual funds on sustainable versus conventional strategies, we found two fascinating things: that sustainable strategies do not deliver discounted returns, and that the downside risk tends to actually be lower."

Making sense of ESG investment capital

"I am yet to meet a trader, investor or person that does not want a strategy that will produce the same return with less risk," she said. "There are so many different examples of that. Increasingly it’s more than just smart investing: understanding environmental or social factors which aren't on the balance sheet today, but perhaps should be."

"What we have focused on, from an accounting and prudent investor perspective, is what the sustainability issues we need to know are, because it could really affect valuations."


The extent to which a company's assets are exposed to climate-related physical risk is crucial, said Richard Mattison, chief executive officer of Trucost, part of S&P Global.

If climate policy is successful, does a company face any risks? And congruously, if it is unsuccessful, does it face risks?

"Out of that comes an opportunity to avoid risk. We need to bring processes into mainstream financial analysis. There are ways to avoid risk, modify strategy and to make more money and increase market share," he said.

ESG: no need to accept lower returns over long term

For instance, many say it is imperative that the world hits peak demand for oil-based energy products by 2025. This would require a wholesale transformation across many different industrial sectors.

"A lot of companies are currently undergoing major reviews, employing futurologists to think through what their business might look like," added Mattison. "A very fast paced, non-linear, disruptive world, is essential."

The important thing is to be prepared for a multitude of potential scenarios. "I would encourage companies to monitor dependencies on nature and natural capital on their supply chains. Many companies wouldn't even know that their actions are in part causing the Amazon fires – yet they may well be," said Mattison.

 Author John Crabb, 10th Jan 2020

This article first appeared in International Financial Law Review here.

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