The financial risk of climate change

About 15 minutes

FundsTalk team

Published September 2018

The world faces a major challenge to meet commitments made in the Paris agreement to limit the increase in global average temperature to 2 Celsius. This agreement is part of the United Nations Framework Convention on Climate Change and significant investment is required to support the transition to a low carbon economy.

The increasing weight of global institutional money engaging in the climate change debate demonstrates an appreciation that climate change is as much about financial risk as physical risks to buildings, infrastructure and supply chains from extreme weather, rising sea levels or depleted natural resources.

Earlier this year an alliance of investors representing $26 trillion in assets lobbied the G7 summit of world leaders to demand action on climate change in an initiative led by Institutional Investors Group on Climate Change (IIGCC). The objectives of the IIGCC, which Scottish Widows joined in 2018, are: to encourage policies to secure an orderly, efficient transition to a low-carbon economy; and to inform investment practices aimed at preserving and enhancing long-term investment value. Other big investor coalitions such as Climate Action 100+ have added clout to demands for greater transparency and accountability on the financial implications of climate change.

Investors Taking Action

There are signs of investors taking action on climate change. Institutions as diverse as the Church of England, the Japanese Government Pension Investment Fund and the University of Edinburgh have all recently made significant climate change-related investment decisions. Strategies vary widely, from veteran investor Mark Mobius who is raising $1 billion to invest in companies that can deliver improvements in environmental, social and governance (ESG) standards, to shareholder activism targeting companies that fail to disclose or address climate change as a financial risk factor. We’re also seeing cases of wholesale disinvestment from companies involved in fossil fuel or with poor carbon emissions records.

Bank of England Governor Mark Carney and billionaire Michael Bloomberg are among senior financiers leading the Taskforce on Climate-Related Financial Disclosures (a group of institutions responsible for $80 trillion of assets) calling for common standards on financial disclosure.

Climate risk can be broken down into financial, physical, transition-related and legislative-related and these risks are pertinent to almost every sector. This fact is largely acknowledged by chief executives of public companies however they find devising strategies to quantify and respond to these risks tough. Close to one-third of global CEOs responding to PWC’s ‘21st CEO Survey, The Anxious Optimist in the Corner Office’ said they were ‘extremely concerned’ about the threat climate change poses to their organisation’s growth prospects.

Climate change is as much about financial risk as physical risks

Investment Opportunities

Of course climate change presents investment opportunity too, as some sectors and businesses are likely to thrive in a low-carbon economy. Changes are already taking place in the way we generate energy, the homes we build, transport, agriculture and waste disposal that present both risks and opportunities. Game-changing companies can prosper as we transition to a low-carbon economy.

However climate change continues to be seen as a niche issue on a distant horizon. A recent parliamentary inquiry by the Environmental Audit Committee found that less than 50% of the UK’s biggest pension funds considered climate change at board level while 25% had not considered it at all.

This is why Scottish Widows endorsed a recent report from ClientEarth and ShareAction calling on the FCA to provide a clear regulatory framework on this issue. The rationale is simple: people saving into a pension want reassurance that their money has been invested wisely for the long term and that all material financial risks and opportunities, including climate change, have been considered.

Some companies have already taken independent action to address climate change risk within their pension default funds, notably NEST and HSBC. But with detailed regulatory guidance the industry could do more to devise innovative investment products that respond to climate change risks and opportunities. Following widespread lobbying from across the industry, the Financial Conduct Authority (FCA) has announced it will embark on a consultation in the first quarter of 2019 as a prelude to issuing guidance on incorporating financial risk, including ESG and climate change risk, into pension investment strategyWe would like to see the FCA conclude its consultation and issue guidance swiftly so that the pensions industry can move forward decisively.

This move would end a regulatory anomaly whereby The Pensions Regulator has already issued guidance on climate change while the FCA lags behind. FCA guidance is vital to remove regulatory uncertainty on whether ESG factors should be incorporated into pension defaults, and it has the potential to unlock further low carbon product innovation.


Written by

Kaisie Rayner | Senior Manager, Responsible Investment & Fund Development

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Climate change presents investment opportunity too

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