The Multi-Trillion Dollar Impact of Climate Change (and Why ESG Isn’t Enough)

Loading up on renewable energy stocks may not be enough to save your investments in the event of extreme global warming, according to new research.

The asset management industry and its clients have failed to recognise that they stand to lose trillions of dollars through the impact of climate change—even if they hedge risks and buy all the right things, research has claimed.

“Asset managers cannot simply avoid climate risks
by moving out of vulnerable asset classes if climate change has a primarily macroeconomic impact.” 
—The Economist
Intelligence Unit
A report by The Economist Intelligence Unit has claimed trillions of dollars would be wiped off all stock markets around the world if the ambient temperature rises by more than 3°C.

“Direct impacts vary geographically; economic sectors and asset classes that are concerned with physical assets or natural resources are the most vulnerable to climate change, such as real estate, infrastructure, timber, agriculture, and tourism,” the report said. “However, our analysis suggests that much of the impact on future assets will come through weaker growth and lower asset returns across the board.”

These indirect impacts will affect the entire economy, the report claimed and calculated what this would mean in monetary terms.

“Warming of 5°C could result in $7 trillion in losses—more than the total market capitalisation of the London Stock Exchange,” it said, “while 6°C of warming could lead to a present value loss of $13.8 trillion of manageable financial assets, roughly 10% of the global total.”

The report’s authors said the above calculations were based on private investor discount rates. When using government rates, the figures were much higher.

While several industry players—both managers and their clients—were praised for the activity in hedging out carbon-related risks and buying into renewable energy, the report warned that this would not be enough to prevent losses.

“Asset managers cannot simply avoid climate risks by moving out of vulnerable asset classes if climate change has a primarily macroeconomic impact, affecting their entire portfolio of assets,” the report said. “In effect, total global output will be lower in a future with more climate change, rather than one with mitigation, and accordingly the size of the future stock of manageable assets will also be lower.”

Additionally, the report warned pension funds to not wait until risks manifest themselves as “the options they will have to deal with them will be significantly reduced”. The authors reiterated figures from the Asset Owners Disclosure Project that claimed only 7% of asset owners had calculated the carbon footprint of their portfolios, and only 1.4% had an explicit target to reduce it.

“If investment managers are aware of the extent of climate risk to the long-term value of the portfolios they manage, then it could be argued that to ignore it is a breach of their fiduciary duty,” the report said. 

And while fiduciaries have an obligation to reduce the climate risk in their portfolios, the authors argued only a few have tried to measure the amount of risk, let alone mitigate them.

The full report can be viewed from The Economist website.

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