Understanding risks and rewards in the transition to a sustainable economy
Is climate change material to investment decision making? As asset managers, it’s a question that’s core to our fiduciary duty.
Recently, we’ve heard that requiring climate and other sustainability disclosures constitutes “mission creep” by the US Securities and Exchange Commission (SEC).[1] In our view, that talk is just noise in the system. We consider the SEC’s actions an overdue recognition that climate risks and opportunities are material to investment outcomes.[2]
For 25 years, Impax has analyzed the impact of environmental and social trends on global economic activity and investigated how climate change impacts financial performance.
Our conclusion: climate risks and opportunities are often mispriced by the market. To model the risks accurately, however, investors need companies’ climate disclosures to be both appropriate and comprehensive. Meanwhile, we believe deep research can help us understand the opportunities presented by companies that provide solutions to climate challenges. By avoiding depletive products and processes, these companies enable climate adaptation and mitigation.
Understanding the risks and seizing the opportunities
In our upcoming white paper, The Financial Impacts of Climate Change, we describe the points of consensus emerging from years of academic, industry and government research around two main sets of climate risk: “transition” and “physical” risks.
Transition risks are disruptive economic changes caused by shifts in regulation, technology and consumer preferences. The move toward net zero is creating differentials in corporate competitiveness. From adoption of low-carbon products and services to impairments against assets that are no longer viable, all of this is happening in real time.
The second family of risks - physical risks - is related to damages caused by more frequent and/or severe weather events and chronic conditions. There are acute physical risks like hurricanes and heatwaves; and chronic physical risks like sea level rise and permafrost melt.
As we’ve seen again this year, the consequences of these risks are enormous. Swiss Re estimates for example, that global GDP could be 11-14% lower in 2050 than it would be in a world without climate change.[3]
It is becoming clear that the transition to a more sustainable economy isn’t unaffordable but the hesitation is.[4]
Transition and physical risks have already affected firm-level financial performance and are likely to be much greater than most expect. Insurers have raised prices for fire, flood and drought coverage, dampening real estate markets. Emissions regulations are raising costs for both producers and consumers of carbon-intensive products, and the threat of carbon border adjustment taxes will only add on. Appropriate company disclosures will allow us to better gauge the future ranges of these impacts.
We do expect firms generating solutions to create opportunities for investors in the years ahead. As detailed in our series The Transition Will Not Be Televised, we see clean electricity becoming the new backbone of our energy system, with high-growth firms emerging in upstream, midstream and downstream segments. This has the potential to help deliver a cleaner, safer and more affordable energy system in the US and beyond.
At Impax we aim to price climate risks in every investment we make. Our goal is to make our portfolios resilient to transition and physical risks, while capturing the potential upside from higher growth rates associated with clean technology, renewable energy, and enabling infrastructure. The data, methods and tools at our disposal are not perfect. But despite underlying uncertainties, we are well beyond a binary debate about whether climate change matters. We work toward a more sophisticated, probabilistic view of the magnitude of its financial impacts on assets, firms and portfolios.
To do that we need better company disclosure. Currently, while most large companies in developed markets report certain climate data, it is much more limited amongst smaller companies and those in emerging markets. Moreover, Scope 3 emissions reporting is broadly inadequate for investors to make fair comparisons among peers in any market.
The SEC, the world’s major central banks and recent international guidance all recognize the importance of this data.[5][6] Only with more robust climate disclosure will we be able to gain a more complete picture of our investee companies and ultimately fulfil our fiduciary role.
The statements and opinions expressed are those of the author, as of the date provided, and may not reflect current views. While the author has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third-party information presented herein. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary. References to specific securities are for illustrative purposes only and should not be considered as a recommendation to buy or sell. This material may not be relied upon as constituting any form of investment advice and prospective investors are advised to ensure that they obtain appropriate independent professional advice before making any investment decision.
Hear more from Impax Asset Management, a Gold Partner of Climate Week NYC, September 17-19. Register to attend virtually.
[1] Bloomberg Law, SEC ‘Mission Creep’ on Climate Ups Republican Lawsuit Threats, June 2021 Reuters (Breakingviews: Gina Chon), Gary Gensler has set the SEC on a perilous path, July 2022 National Review, The SEC’s Political Games, January 2023
[2] This view is confirmed by recent IFRS Guidance on Climate-Related Disclosures (July 2023)
[3] Swiss Re Institute, The economics of climate change: no action not an option, April 2021
[4] International Monetary Fund, The Great Carbon Arbitrage, June 2022
[5] The International Financial Reporting Standards Foundation, Guidance on Climate-Related Disclosures, July 2023
[6] Network for Greening the Financial System, Monetary policy and climate change: Key takeaways from the membership survey and areas for further analysis, 2023