Richard Nesbitt is CEO at the Global Risk Institute
It is now beyond argument that global warming and the various government and private-sector initiatives around it will continue to add an extra layer of risk to the world's financial system. For example, insurance losses from storms, floods and other weather-related disasters have ballooned over the past decade from about $10-billion to $50-billion a year, adjusted for inflation.
Given the global acceptance of the hazards posed by climate change, pension funds could face litigation if they fail to rebalance their portfolios toward green energy and low-carbon technologies. More generally, financial institutions risk the ire of shareholders, employees and suppliers (among others) if they are outflanked by more far-sighted competitors. No business wants to be caught on the wrong side of history, or of a fast-growing market.
Worrying as these costs may be, we should not lose sight of the fact that heightened risk often brings unexpected rewards. And so it will be with climate change. It is time to recognize the significant opportunities that await banks, insurers, pension funds, asset managers and other financial institutions with the foresight to seize them.
Industry leaders have spoken out with growing urgency on the need to put in place long-term business strategies, risk-management processes and proper reporting frameworks that explicitly take account of the costs of global warming.
Mark Carney, governor of the Bank of England, warned recently that "the combination of the weight of scientific evidence and the dynamics of the financial system suggest that, in the fullness of time, climate change will threaten financial resilience and longer-term prosperity. While there is still time to act, the window of opportunity is finite and shrinking."
The governor would have been even more prescient had he used the plural, "windows of opportunity," because climate change offers openings on a host of fronts for financial institutions to improve the way they do business and to reap material benefits.
Let's start with the prospect for improved transparency in the way lenders and insurers assess risk.
Last December's United Nations climate-change conference in Paris took a giant step forward by setting up a task force on climate-related financial disclosures. This high-powered group of corporate leaders has been asked to develop guidelines for companies to report their climate-related risk exposure to investors, lenders and insurers, among others.
If all goes well, the task force's work will greatly enhance financial services firms' transparency in measuring their exposure to climate-change risk and responding to it. The initiative could become a model for other areas where the financial industry faces new and unfamiliar risks.
Numerous firms have already taken steps to improve disclosure. Several insurers and reinsurers, for instance, have collaborated with scientists on research projects, raising awareness among investors and policy holders of the implications of their exposure to climate-change risk.
Beyond improved governance, global warming is creating new investment opportunities in green products and services. Financing these investments, whether in companies or projects, will represent a significant source of new business.
Many banks are already underwriting green bonds, also known as climate bonds, issued by governments or corporations to finance projects that combat or mitigate climate change. Green-bond issuance topped $35-billion (U.S.) in the first six months of this year, not far short of the $41.8-billion raised during the whole of 2015.
On another front, researchers at the University of Cambridge have concluded that climate change could lop as much as 45 per cent off the value of investment portfolios around the world. But they also estimate that about half of these losses can be avoided through thoughtful reallocation of funds. Banks and wealth managers are well-equipped to guide investors in this direction, and are sure to win kudos for doing so.
Pension funds' mammoth portfolios and long-term investment horizons put them in a strong position to encourage the shift toward a low-carbon economy. Besides supporting promising green businesses, they have the credibility to be influential in policy formulation.
Advances in clean technology and low-carbon infrastructure will also open up new sources of premium growth for insurers through products such as renewable-energy project insurance. Similarly, new insurance products related to public policy risk, for example, protection against the unforeseen withdrawal of environmental subsidies, are set to generate extra revenues.
My own organization, the Global Risk Institute, has just issued a paper titled Climate Change: Why Financial Institutions Should Take Note. In addition, we are sponsoring research projects in 2017 and 2018 to support financial institutions in their drive to understand and mitigate the risks posed by climate change.
One project will assess publicly traded portfolios that provide hedges against environmental risk, and design appropriate hedging strategies. The other aims to devise a government-led investment strategy that will minimize climate-change risk, while still achieving a targeted growth rate in national output.
These green pastures (pun intended) all present exciting and potentially rewarding opportunities.
Conversely, any financial services firm that ignores them could end up paying a heavy price.