Be it the catastrophic flooding in Germany and Belgium, the wildfires in southern Europe, the US and Australia, the ‘heat dome’ in North America or the water cascading into New York subway tunnels, there has been no shortage of recent striking images of climate change-related extreme weather events around the world.
Physical climate risks come in two forms:
- Chronic – steadily rising temperatures will increasingly impact the productivity of the land and the people that depend on it for their livelihoods; changing rainfall regimes will result in water stress in more regions; and sea-level rise will impact coastal real estate, industry and, more fundamentally, habitability in low-lying areas.
- Acute – this means there is an increased likelihood of heat extremes; then there are wildfires, droughts and extreme storms – their frequency and intensity are projected to shift to varying degrees in a warming world.
Table 1: Physical climate risks
|Temperature||Precipitation||Sea-level rise||Wind||Water (flood/ drought)||Wildfire||Extreme temp|
How can the financial sector address these risks?
Growing the market for climate adaptation
It’s critical that the market for climate adaptation and resilience financing is expanded, particularly as a certain amount of warming is already ‘baked’ into the Earth’s atmosphere.
Despite current emissions-reduction efforts, there is a relatively high chance we will temporarily exceed the Paris Agreement’s preferred 1.5C temperature threshold at some point over the next five years. While, over the longer term, we may be able to hold warming at this level, climate impacts at 1.5C will still be significant.
This means investments in resilience and adaptation are needed.
Current financing flows for adaptation efforts may have well-documented benefits, with an estimated USD 7.1 trillion return on a theoretical investment of USD 1.8 trillion globally over 10 years. Nevertheless, they are still woefully inadequate – particularly from the private sector.
The cost of climate adaptation is estimated to reach up to USD 300 billion a year in 2030, compared to the USD 30 billion invested in 2017-2018. Just 1.6% of this is coming from private sources.
A variety of innovative financial solutions could be used to fund climate adaptation. These include:
- catastrophe bonds
- environmental impact bonds
- (the more-nascent) resilience bonds.
These vehicles are needed as traditional green and climate-aligned bonds are today largely used to finance climate change mitigation – only 3-5% of issues have been tied to adaptation projects, and these have largely been in the water sector.
The time to scale up these approaches is now, though there are a few hurdles that need to be jumped first.
Barriers to action
Despite the benefits of investing in resilience, access to capital can be an issue when other projects are prioritised due to shorter or better-defined payback periods.
As an example, investing to make buildings hardier against extreme events comes with benefits, including improved energy efficiency and access to alternative (often cleaner) power sources.
However, the high up-front costs along with difficulty in calculating returns, which come over many years, can mean other projects are favoured over such resilience improvements.
Another issue is that the bulk of infrastructure at risk from climate change is publicly owned, with little incentive for commercial entities to support related improvements to benefit communities.
On top of this, public entities overseeing this infrastructure can be over-indebted or lack the technical capacity to plan effectively for climate change resilience which can require complex analytical techniques. A fragmentation in approaches across different types of infrastructure from numerous parties can also stymie climate resilience investment at scale.
Finally, conducting climate risk assessments and integrating climate concerns into conventional cost-benefit analyses is difficult due to the inherent uncertainties around the impact of climate change.
Furthermore, while hazard and vulnerability assessments are improving, the disclosure of relevant and detailed exposure and financial information for asset-level assessments is lacking.
What are the solutions?
It goes without saying that improving the quality of climate-related disclosures across the financial system is a necessity. While more and more institutions are signing up to the principles of the Taskforce on Climate-related Financial Disclosures (TCFD), work is now being undertaken to develop guidance and standards around a common set of metrics for reporting physical climate risks and opportunities. This will take some time.
What is more, there is a need for capacity building, particularly as there are so many actors involved in developing climate-resilient infrastructure. This is the case even for a single building. It becomes significantly more complex on a community-scale.
Collaboration, linking and learning, for example, at city level can help develop a climate-resilient financial system to support these communities. Mission-based ecosystems could be one approach to getting diverse actors together.
Finally, given the nature of infrastructure ownership and the need to attract more private investment into this space globally, but particularly in emerging markets, public-private partnerships can play a key role.
High-income countries promised USD 100 billion per year in climate finance by 2020 to help developing countries adapt to the consequences of climate change. To scale up private commitments in line with this public money, blended finance could play a big part.
Combining these approaches, along with innovative financing techniques, can allow an adequate level of investment to flow into limiting the future extent of climate change and limiting its impacts.
Due to the level of climate change already guaranteed by current and near-term projected emissions, delaying investments in climate adaptation is no longer an option.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
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Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.