Climate change could expose investors to a host of systemic financial risks if unaddressed, according to Wilshire Associates.
The consulting firm, along with CIO columnist Angelo Calvello, argued that climate change and associated regulatory policies could directly affect asset class prices. Understanding and preparing against future climate change risks will take “wise, informed, and timely advice” as well as traditional risk management, they wrote.
Take rising sea levels, for example. Wilshire argued that an increase in sea level has “significant and direct economic implications” for many coastal regions, and furthermore can incur “large-scale losses” in real estate and infrastructure.
“Climate change and associated policy and regulatory changes have the potential to affect all asset classes, putting at risk exposures in equities, fixed income, real estate, infrastructure, real assets, commodities, and currencies,” the paper stated. “Such risks may not be entirely avoidable.”
The change to low- and no-carbon emission energy sources will continue to curb oil prices, Wilshire continued. Add in geopolitical risks in countries like Saudi Arabia and one can expect nearly $2 trillion of capital expenditure at risk, according to the report.
There are also secondary systemic risks brought on by climate change.
Oil, gas, and utilities companies are significantly financed through debt, making up nearly one-third of the $2.6 trillion global leveraged loan market, Wilshire said. A substantial change in these asset prices could prompt “debt repricing and credit losses… [affecting] financial lending institutions, leading to possible ‘knock-on’ effects through the financial system,” the paper continued.
“Investors need to make decisions about a changing world where complete knowledge is impossible,” Wilshire wrote. “This is indeed the essence of risk management, since all risk is embedded with probabilistic considerations.”
Most likely investors will soon face “a new normal,” the consulting firm said, as some of climate change’s long-term consequences “cannot be undone.”
This new investing world would require much more than simple risk management, Wilshire warned.
“ESG issues are not merely collateral considerations or tiebreakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices,” the paper concluded.