We often read about the risks of ignoring climate change. Unbearably hot weather, droughts, wildfires, floods, mass migration, starvation, civil unrest, wars — the dangers are numerous and severe.

It seems almost indecent, in view of the risk to human life, to consider the investment risk of turning a blind eye. But it’s an important issue nonetheless, particularly for financial advisers.

So far, the question of ESG and investment risk has focussed mainly on the danger of excluding certain stocks. There’s some concern that not having exposure to big oil and gas companies, for instance, might harm investment returns. 

But the reality, surely, is that not reducing exposure will hurt the end investor more.


“Large-scale reallocation of capital”

As Henry Fernandez, chief executive of the index provider MSCI, recently stated, all investors should incorporate ESG principles in their investments to mitigate the risks of climate change.

‘“The world is rapidly evolving due to dramatic environmental, social and governance shifts,” he said. 

“(This) will significantly impact the pricing of financial assets and the risk and return of investments, and lead to a large-scale reallocation of capital over the next few decades.”

What the main risks are 

The risks investors take by ignoring climate change are set out in a new book by Financial Times journalist Alice Ross, called Investing to Save the Planet.

Global carbon pricing

One of the biggest risks to investors, she says, is the possible introduction of carbon pricing — effectively a tax on the most polluting fossil fuels.

The International Monetary Fund calculates that a $35 per tonne tax on carbon dioxide emissions in 2030 would typically increase prices for coal, electricity and petrol by about 100, 25 and 10% respectively. Yet even that would be nowhere near enough to meet the goals set out in the Paris Agreement.

Carbon pricing is a contentious issue, and is likely to require global cooperation. But there’s still a good chance it will happen, especially after the election of President Biden, and it might come sooner than expected. Discussions on the issue are due to resume at the Glasgow Climate Change Conference in November 2021.


“Policy contagion”

Even if an international system of carbon pricing cannot be formally agreed, UBS has predicted that a global carbon tax could still come about. This would be as a result of what it calls “policy contagion”. 

In other words, individual governments will restrict fossil fuel investment. This would lead to political success that other countries would want to emulate. 

So, regardless of how they come about, what would carbon taxes specifically mean for investments? 


Too little focus

Ross explains how the investment community has been far less attentive than it should have been to the potential consequences. 

She quotes Andy Howard, head of sustainable investment at Schroders. “Far too few people in the industry have focused on really trying to understand the question of what impact carbon prices have on the value of different investments.”

That concern is shared by Jeremy Oppenheim from the environmental research firm Systemiq. He accuses the industry of “lazy” risk analysis.

“The way risk analysis is typically done,” says Oppenheim, “is that it’s backward-looking, based on historic data and it tends to assume the probability distribution of events is stationary.

“If something happens that is normally a 1-in-100-year event, financial risk analysts will still assign it that low risk level in the future too. The problem that climate change poses is it asks you to take all those three points and turn them on their head.”


Tighter rules on greenwashing

Another risk that Ross identifies is the almost inevitable introduction of tighter standards to combat so-called greenwashing, or making your company look more sustainable than it really is.

At the end of 2019, the European Union agreed an historic deal on how to classify green investments. National regulators too are starting to take the issues seriously.

The Italian oil major ENI, for example, was handed a €5m fine for marketing a particular brand of diesel as “green”. In fact, the diesel was made with palm oil, production of which harms the earth’s rainforests. The fine may be modest for a large oil company, but, says Ross, it’s a sign of things to come.


Threat to insurers

Another danger highlighted in Ross’s book is the risk that climate change poses to insurance companies. The former Governor of the Bank of England Mark Carney has warned that general insurers are particularly heavily exposed to climate-related risks.

Those risks are likely to increase as a result of adverse weather events, and the likelihood of more and more claims against insured parties for failing to mitigate climate risk or to comply with regulations.

Consequently, insurance costs are rising, potentially making it harder for some companies to get insurance.


Corporate debt

Finally, the risks of ignoring ESG are not confined to equity investors. Bond investors, says Ross, could also be taking far more risk than they think. 

A study by the consultancy Oliver Wyman warned that oil and gas companies would be two to three times more likely to default on their debt if only a $50-a-tonne carbon tax were introduced. 

Not one single bank, the report claims, has devised a satisfactory strategy of measuring climate change risk in corporate debt. 


Risks you can’t ignore

All of these are very real risks, which advisers and their clients ignore at their peril.

You may not feel as strongly as others do about climate change. Personally, you may be sceptical about some of the starker warnings that climate scientists are issuing.

But, purely from an investing point of view, burying your head in the sand is not an option. The longer you continue to ignore the threat of climate change, the greater the risk you are taking.

MAX TENNANT is a Managing Partner at Global Systematic Investors and the founder of Ifamax Wealth Management.

This article first appeared on the GSI blog.

Alice Ross’s book, Investing to Save the Planet, is published by Penguin. 

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