Climate Chaos - It’s getting physical
“Climate change is affecting us now, particularly the poorest and most vulnerable, and will only become worse. It is imperative that the finance sector identifies market vulnerabilities and manages climate risks as we adapt to a warmer world."
Eric Usher, Head of UNEP FI
Physical risks, which were once perceived as distant concerns, are now becoming more tangible as we witness the present impacts of climate change in 2023. This month, global average temperatures have reached unparalleled levels, and it is expected that this record will soon be broken again as we continue to experience extraordinary weather. [i]
Physical risks are impacting investor portfolios today
The investment industry has been slow to integrate assessments of physical risks exposure, barring few select asset managers and asset owners leading the way. Today, we focus on two key challenges facing the investment industry.
Physical risks are being underestimated
Investor modelling of climate-related physical risks are likely under-representing the economic cost to portfolios. With complex climate models necessarily simplified for investor deployment, the focus is on linear relationships between temperatures and economic outcomes, which largely ignore climate tipping points (and within the Isio climate model, we scale up physical risks in response). The below box sets out the issue in more detail.
What are the climate experts saying about climate tipping points?
Climate tipping points are irreversible changes in the climate system. For example, permanent ice sheets melting, releasing carbon/methane into the atmosphere and increasing global average temperatures beyond a level at which permanent ice sheets can naturally occur. Typically, climate tipping points are at risk of occurring where global average temperatures rise by ~2⁰C above pre-industrial levels, but there is also a low level of risk below this threshold. Under a 4⁰C scenario, equivalent to widespread global failure to respond to the climate emergency, pivotal climate studies by Nordhaus and Weitzman cite an economic cost of ~4% to ~9% a year by the end of the century (measured in annual GDP losses). Neither of these studies account for climate tipping points, and by incorporating these changes the economic cost would rise to ~50%, according to Dietz and Stern. There will also be social tipping points, with mass migration as areas of the Earth become uninhabitable, for example, which we will address in a future blog.
Investors need pinpoint accuracy, but climate systems are not granular
Physical risks will not be evenly distributed across regions, and climate change will disproportionately threaten some of the poorest economies and people.[viii] With investor preparedness being key, we need an understanding of the geographic distribution of physical risks. Obtaining portfolio pinpoint accuracy of physical risks is however at odds with climate models that capture regional/global phenomena.
Some leading climate scientists are trying to translate global phenomena to local outcomes. For example, the Woodwell Climate Research Center has developed an understanding on the types of physical risks and where these could be felt most, which asset managers and owners are deploying. This includes sector-specific analysis (e.g. localised water availability impacting on agricultural productivity can be used to understand how individual investee companies’ bottom lines might be affected.[ix]
- Understanding portfolio risks, including climate modelling to understand impacts on asset classes (scaling physical risks to account for climate tipping points), or granular physical data to identify company or real asset laggards
- Assessing investment managers on physical risk management processes, and identify potential areas of improvement
- Engaging to raise the profile of physical risk resilience, including engagements with investment managers and investee companies, as well as collaborative initiatives[xiii]
- Disclosing and improving the approach over time, as the data and science continue to evolve
With widespread physical resiliency needed, there is growing investor momentum. Any response to physical risks will necessarily be commensurate with the scale of your portfolio assets and associated timeframes. Regardless, our collective response to physical risks will need to ramp up, from today.
Get in touch
Charles PringleSustainable Investment Specialist
Deputy Head of Sustainable Investment Insight
[iv] Scottish Forestry, Scottish Forestry - Bonn Challenge
[vi] NASA Earth Science & Remote Sensing Unit, International Disaster Charter Activations (nasa.gov)
[vii] United Nations Office for Disaster Risk Reduction, GAR2022: Our World at Risk (GAR) | UNDRR
[ix] Woodwell Climate Research Centre, Woodwell & Wellington - Woodwell Climate
[x] Woodwell Climate Research Centre, in-person meeting March 2023
[xi] UNDRR & Climate Bonds Init., UNDRR and Climate Bonds begin an ambitious journey into climate resilience finance | Climate Bonds Initiative
[xii] UNDRR & Climate Bonds Init., UNDRR and Climate Bonds begin an ambitious journey into climate resilience finance | Climate Bonds Initiative
Adaptation definition: loosely based on IPCC, SYRAR5-Glossary_en.pdf (ipcc.ch)
Box references: Nordhaus, Estimates of the Social Cost of Carbon: Concepts and Results from the DICE-2013R Model and Alternative Approaches (jstor.org), Weitzman, GHG Targets as Insurance Against Catastrophic Climate Damages (harvard.edu), Dietz & Stern, lse.ac.uk/granthaminstitute/wp-content/uploads/2014/06/Working-Paper-159-Dietz-and-Stern-20141.pdf