Accelerating Progress on Climate Risk
Investment management professionals used to focus on portfolio risk and returns. We now must consider returns along three dimensions: risk, return and impact.
Published: January 6, 2020
Sustainable Development Goals: A Misunderstood Market Opportunity?
Emerging Trends and Analysis of the SDG Impact of Companies in the S&P 500®
Published: January 6, 2020
The Big Picture On Climate Risk
While the extent and effectiveness of the global response to climate change remain uncertain, one thing is very clear: Companies and investors must prepare for a range of possible outcomes with diverging transition and physical risks. We look into these risks in our latest research, which debuted at the World Economic Forum in Davos, Switzerland.
Published: January 6, 2020
“With our SDG analytics for financial portfolios we hope we can accelerate global progress towards achieving SDGs by helping investors to understand the positive impact of investment decisions alongside traditional considerations of risk and return. The United Nations SDGs provide critical context to help investors measure their progress on a globally relevant set of ESG considerations adopted by 178 countries. This research is a part of our continued commitment to accelerating progress towards a more sustainable future. We found that the majority of companies do not report on their progress against the SDGs and if they do there is an emphasis on only positive impacts. The launch of SDG Analytics means that market participants can now have balanced view on the progress that companies are making on SDGs in this decade of action.”
Trucost's SDG Analytics for Investor PortfoliosSustainable Development Goals: A Misunderstood Market Opportunity?
It has been four years since the 2030 Agenda for Sustainable Development with its 17 Sustainable Development Goals (SDGs) was adopted at the UN Sustainable Development Summit. During this time, the SDGs have garnered widespread backing among companies and investors who have made modest progress towards aligning business strategies and capital allocation with the SDGs. While challenges prevail in transitioning to transformative action on the SDGs, several trends have emerged that suggest this action is accelerating.
Investors have a growing appetite to benchmark companies against each other in terms of their SDG performance. Where disclosure is absent, other providers have built assessments, indexes and benchmarks to compare corporate action. Information providers increasingly offer investor-focused products for measuring a company’s portfolio towards the SDGs, while indexes have emerged to help investors gain exposure to companies identified as making a contribution to the Goals. The World Benchmarking Alliance has accelerated work in this arena by planning to build science-informed league tables, starting first with a Food and Agriculture Benchmark comprising 300 companies across the food and agricultural value chain.
Aligning Investments with Sustainability Goals
Trucost’s SDG Analytics quantitatively measure the SDG alignment of a company’s products and services, allowing investors to benchmark companies against each other in terms of their SDG performance, and offers portfolio-level metrics to measure risk exposure and SDG‑alignment.
Powering the Markets of the Future
In 2018, S&P Global assessed climate-related
risks and opportunities in accordance with the
recommendations from the Task Force on Climate Related Financial Disclosures (TCFD). Established
in 2016 by the Financial Stability Board (FSB),
the TCFD developed recommendations for more
effective and standardized disclosure of financially
material climate-related risks and opportunities.
The goal of the Task Force is to promote more
informed investment and sustainable markets.
Using four core elements – governance,
strategy, risk management and metrics &
targets – the TCFD assessment shows how an
organization accounts for climate-related risks
and opportunities, as well as strategies for
mitigating risks and realizing opportunities.
The transition to a low carbon economy is vital for a sustainable future. In order to make progress, it is necessary that we understand the material financial implications of climate change on businesses and investments. Therefore, measurement and integration of comparable, consistent, and reliable environmental, social, and governance (ESG) factors is fundamental to making more informed decisions to facilitate long term sustainable growth.
— Ewout Steenbergen, Chief Financial Officer, S&P Global
Original Davos Research
While the extent and effectiveness of the global response to climate change remain uncertain, one thing is very clear: Companies and investors must prepare for a range of possible outcomes with diverging transition and physical risks.
This need for determined action to reduce emissions and limit the effects of climate change poses important transition risks for companies and investors through regulation, changing market dynamics, and technology, among other factors.
As it stands, companies in the benchmark S&P 500 Index own physical assets across 68 countries globally—and 60% of these entities (with a market capitalization of $18 trillion) hold assets that are at high risk of at least one type of climate-change physical risk. And while corporate-level resilience to both transition and physical risk varies greatly within and across sectors, S&P Global data show that heatwaves, wildfires, water stress, and hurricanes linked to increasing average global temperatures represent the biggest physical risks for companies in the S&P 500.
- How physical climate risks can be tracked across corporate operating sites and supply chains – as well as the financial portfolios of investors, banks and insurers
- How these risks can be managed alongside transitional climate risks such as intensifying carbon pricing regulations
- How to develop climate risk targets that align with global climate goals
Climate Index
On the brink of irreversible climate change, a combination of ground-breaking datasets and index innovation is emerging, through which investors will have the choice to align their investments to a future climate scenario compatible with mitigating catastrophic global warming to the planet. This new breed of sustainable climate indices will not only offer solutions that intend to be impactful, but equally aim to provide investors with reduced risks from transitioning to a low-carbon economy and the consequences of physical, environmental events while capturing financial opportunities that arise.
This paper describes an S&P Dow Jones Indices (S&P DJI) concept for the eurozone region, which is aligned with the more stringent of the two new climate benchmarks: the Paris-Aligned Benchmark.
What’s the Deal with the 2-Degree Scenario? Under the 2015 Paris Agreement, nearly 200 countries agreed to limit global warming to no more than 2 degrees Celsius by 2100, and to aim for a no more than 1.5 degrees Celsius increase. The 2-degree scenario is widely seen as the global community’s accepted limitation of temperature growth to avoid significant and potentially catastrophic changes to the planet.
Read More about the 2-Degree Scenario
Analysis
Policy changes introduced as economies adapt to climate change could wipe between $1.6 trillion to $2.3 trillion off the value of major global companies by 2025, and investors need to reflect that policy risk in their strategies, according to research conducted for the U.N.-backed group, Principles for Responsible Investment.
According to an analysis by consultants Vivid Economics and Energy Transition Advisors, policy changes would reduce by 3.1% to 4.5% the value of companies on the benchmark global equity MSCI ACWI index, or the equivalent of the total value of the largest 12 to 33 companies on the London Stock Exchange's FTSE100.
The future financial and social consequences of climate change are becoming increasingly apparent to companies, investors and policy makers. Strong action to reduce emissions and limit climate change may avoid the worst physical impacts of climate change but presents significant market, technology and regulatory transition risks for market participants. Conversely, failure to adequately reduce greenhouse gas emissions may limit transition risks but will result in increasing climate change and associated physical risks.
Read more about Physical Risks
Accounting for Climate
As more and more companies and investors conclude that sustainable practices make for sustainable returns, the assessment of corporations’ environmental, social, and governance (ESG) footprints has moved from a simple measure of corporate responsibility to an investment proposition. While this general focus on ESG policies is undeniably beneficial, companies today are presented with the additional challenge of actively planning for climate risk. With a growing consensus around climate science, companies and investors must plan for a number of different scenarios, depending on the extent and impact of global climate change. However, an absence of shared terminology, benchmarks, and policies threaten to stymie investors and companies as they attempt to account for climate risk.
Key Takeaways
- As investors and companies increasingly weigh climate risk into their investment decisions and strategic direction, the question persists whether regulatory or market-based solutions offer a better path forward.
- Scenario analysis based on scientific research indicates that climate risk will begin to impact global growth in the near future.
- An uncoordinated regulatory response creates confusion and doubt in the markets. But market-based solutions are also plagued by inconsistent standards and terminology.
- S&P Global believes effective and standardized ESG disclosure is needed to foster this growth. This presents an opportunity for governments and regulators to work with market leaders.
Infrastructure
Global infrastructure spending has remained resilient in an environment of financial instability, underpinned mainly by interest from private sector investors. Private investors seeking long-term, stable returns are keen to fund infrastructure projects ranging from energy, to transport, to water infrastructure. These investors are providing support to governments facing a growing infrastructure funding gap. Yet, the sector is now awakening to the threats and opportunities that sustainability brings to realizing this long-term source of finance. Long-term climate risks are unlikely to leave any sector untouched as governments worldwide seek to maintain warming below 1.5 degrees Celsius under the 2015 Paris Agreement. This may force infrastructure projects to address energy use concerns, particularly as urban infrastructure consumes approximately two-thirds of global energy. Further, concerns over the recoupling of resource consumption and economic growth continue to grow. This adds pressure to address the resource-intensity of infrastructure often associated with the "take, make, and dispose" model under the linear economy.
Key Takeaways
- S&P Global Ratings has considered how pursuing a circular economy strategy could be compatible with the low-carbon transition and may also lead to significant benefits for infrastructure developers and investors.
- Despite circular innovation's traditional focus on the manufacturing and electronics' sectors, we expect infrastructure investors and projects increasingly to view the circular economy as an effective strategy given the pressures to address the triple bottom line--concerning social and environmental impact beyond financial returns.
- For investors focused on achieving long-term value creation, the circular economy may be beneficial to realizing increased value upon decommissioning.
Insurance
Insurance coverage for some risks is becoming rarer and more costly as climate change alters the risk landscape, according to Zurich Insurance Group AG's chief risk officer.
Speaking to S&P Global Market Intelligence following the release of the World Economic Forum's 2020 Global Risks Report, Peter Giger said certain perils are becoming increasingly expensive, and that while those price increases are justifiable, they are hitting communities affected by climate change.
Key Takeaways
- Climate change concerns took the five top spots in the World Economic Forum's 2020 list of the most likely global risks over the next 10 years for the first time in the ranking's 15-year history.
- Climate-related concerns also occupied positions three to five in the ranking of the most severe risks. The issue of extreme weather events and the failure to mitigate or adapt to climate change stood at the top of the list of the most strongly connected global risks.
- Where risks become uninsurable because of climate change, more of the burden will move away from insurance companies. If, for example, land was rendered infertile by climate change, crop insurance would become ineffective because it would be triggered every year.