Climate Is Reshaping Finance
Carolina Angarita
Carolina Angarita
Senior Investment Analyst

We’ve known about climate change for over 40 years. Hearing Shell’s CEO admit to Time Magazine earlier in the month “we knew, everyone knew [that burning fossil fuels was warming the planet], and somehow we all ignored it” didn’t come as a surprise.  Today, after 40 years, we still refuse to take necessary action to avert the worst effects of climate change.  Emissions continue to rise, while leaders in certain countries openly claim that climate change is a hoax – despite the undeniable evidence.

But change is coming. From millions of children marching on the streets to hundreds of climate and wildlife scientists endorsing mass civil disobedience to demand climate action, the way in which society is responding to the climate crisis is unprecedented. BlackRock, the world’s largest asset manager, recently pledged to incorporate environmental concerns into its investment processes, as investors and consumers demand more action to address pressing social and economic issues. This level of pressure and insistence from society and from investors, is putting companies’ social licence to operate at risk.

While social licence to operate (SLO) is not a new term as such, it is growing in prominence. It reflects the level of acceptance or approval given to a business by its community, in producing and selling its products and can affect a company’s ability to attract investors, and in some cases to avoid public backlash. Take fossil fuel companies and the divestment campaign for example. The issue is so controversial that by now investors are likely to have either divested from fossil fuels or are using their voting rights to ensure oil and gas (O&G) corporations are acting to remediate the climate emergency. There’s little middle ground here as O&G companies are subjected to ever increasing scrutiny.

The global divestment movement, started by students in 2011 as a call to climate action, has reached $6.24 trillion in assets under management (AUM). Active shareholder engagement, meanwhile, is gaining significant traction ensuring O&G companies adapt their business model to the demands of a carbon-restrained world. Why? Because the value at risk of carbon-related assets is increasing, as the world moves towards imminent low-carbon regulations and policies. This is known as transition risk. Today, investor-led initiatives such as Climate Action 100+, representing more than $41 trillion in AUM, seek to ensure the world’s largest corporate greenhouse gas emitters commit to achieving net zero emissions by 2050.

“Climate is Reshaping Finance”

The above were the words of BlackRock CEO Larry Fink in his recent letter to CEOs. On the surface, climate inaction represents a reputational threat to companies such as BlackRock, compromising their social licence to operate.  However, at its core, climate change poses more insidious social, economic and environmental risks. We are all aware of the physical manifestations of climate change. The wildfires and floods speak for themselves, threatening property owners, banks and insurance companies.  In Ireland for example, two thirds of banks’ loan exposure is secured on property. Property damage also affects insurance companies. According to data by Munich Re, weather-related insured losses have increased from an average of around US$10 billion per annum in the 1980s to an average of around US$58 billion per annum so far this decade.

In addition to these direct financial risks, transition risk refers to the impact that an abrupt transition to a low carbon economy can have on asset values. The magnitude of emission reductions required in this decade will be a key driver of policymaking, which is expected to lead to a major repricing in markets. Currently the preferred tool for understanding climate-related risks is the use of forward-looking scenario-based analysis of the effect that different degrees of warming can have on asset prices. This analysis can provide a company with a science-based reduction target aimed at ensuring that the growth of the business can decouple from emissions output, and ensuring alignment with the Paris Agreement, thus helping insulate the business (and its stock value) against transition risk.

Climate change and sustainability have moved to the top of the agenda and this was clear during the 50th World Economic Forum in Davos. This means those in the business of creating long-term value should be planning and investing with the climate in mind. Disclosure of climate-related risks by the private sector is extremely important. The more data that becomes available the more refined and reliable it will become, and the better positioned we will be to deal with the complexity and uncertainty of investing in the era of climate action.

Carolina Angarita is Senior Investment Analyst with the L&P team at Cantor Fitzgerald, which provides ethical investment management and stewardship advisory services to non-profit clients.

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