Innovest Strategic Value Advisors, Inc.

Climate Change & the Financial Services Industry - Module 1 - Threats and Opportunities


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Climate change represents an unprecedented and highly complex threat to long-term economic interests across the spectrum of finance and insurance industry activities. The Intergovernmental Panel on Climate Change has confirmed that the combined effect of increasingly severe climatic events and underlying socio-economic trends (such as population growth and unplanned urbanization) have the potential to undermine the value of business assets, diminish investment viability and stress insurers, reinsurers, and banks to the point of impaired profitability and even insolvency. In the extreme case, whole regions may become unviable for commercial financial services. At present, worldwide economic losses due to natural disasters appear to be doubling every ten years, and have reached almost $1 trillion over the past 15 years. If current trends persist, the annual loss amounts will, within the next decade, come close to US$150 billion.  At the same time, actions taken to reduce greenhouse gas (GHG) emissions by government policymakers and business leaders are already creating new threats and opportunities across the entire spectrum of the financial services and insurance industry.  Intensifying regulatory and competitive pressures on industrial GHG emitters may well have serious implications for credit risk, investment performance and shareholder value creation, particularly in emissions-intensive sectors.
As the potential economic consequences of climate change come into focus, company directors, executives, pension fund trustees, and institutional investors will be increasingly compelled to respond. Financial institutions will need to estimate the full extent of consolidated financial liabilities – throughout all sectors of the economy and in all regions of the world - to fully inform their investment banking, asset management, equity research and portfolio risk management activities.  To date, a major impediment to concerted global action on reducing GHG emissions has been the uncertain politics and economics of climate change. Recently, these uncertainties have begun to fade. Politically, government support for mitigative action has been forthcoming and the negotiations around the Kyoto Protocol have begun to accelerate the creation of climate-friendly markets. Looking towards the long-term, the agreement of an international policy framework that addresses the fundamental social, environmental, technological and economic issues at stake, and that is based on the principles of precaution, equity and economic efficiency is clearly critical. Economically, there is a growing realization that solutions exist that need not cause the dislocation initially feared by some economists. Indeed, there is strong belief that the right blend of policies, if skillfully introduced, can substantially reduce the direct and indirect costs of mitigation and perhaps even produce a net economic benefit.

Creating the conditions that are conducive to the kind of clean technology futures that bring about substantial GHG emissions reductions is a concrete step that all major market participants – investors, industrial companies, policymakers, consumers – can make together now. Commercially-viable technologies exist today whose introduction could go a long way towards reducing GHG emissions in the short term, while more developmental clean technologies are brought to the market. The nascent markets for GHG Market Framework Study – Module 1 5 UNEP FI July 2002 Innovest SVA catastrophic event (CAT) bonds, weather derivatives and microfinance/microinsurance also hold substantial promise for forward-looking finance and insurance companies.  Several leading insurance and fund management companies are have already begun to adapt to these changing business conditions. These companies are developing a range of risk management programs and innovative new solutions that not only promote GHG emissions reductions but also provide new business opportunities. The facilitation of emissions trading markets, and the renewables and clean power technology sectors represent the key strategic theaters. The latter, for example, could generate turnover in the range $234 to $625 billion by 2010, and as much as $1,900 billion by 2020.  In this transition to a cleaner economy, it is becoming increasingly clear that institutional investors have a crucial role to play. With over $26 trillion in assets under management, these investors wield significant influence over future economic development and industrial management pathways and, therefore, the pattern of future global GHG emissions. Aligning the interests of the political and investment communities to spur corporate GHG mitigation activities and expedite the development and distribution of cleaner technologies would accelerate this process to the benefit of all.

The study’s major conclusions are that in order to engage the finance and insurance services sector more fully in addressing the climate change issue, policymakers should

  • Commit to clear GHG emissions reduction targets via policies and measures consistent with the Kyoto Protocol that establish a clear value on carbon
  • Accelerate the introduction of policies and measures that influence the flow of capital, particularly investment capital from institutional investors, so as to encourage sustainable energy production and consumption patterns
  • Alert the financial community to the possible economic implications of climate change through awareness raising measures to ensure that adaptation and mitigation programmes are fully effective
  • Grasp the urgency of attaining long-term climate stability in accordance with the UN Framework Convention on Climate Change, and reach consensus on a long-term policy framework for achieving this goal based on the principles of precaution, equity and cost-effectiveness.

And that the wider financial community should

  • Become better informed on the climate change issue as a whole in order to overcome the fundamental cognitive barriers to action and realize the competitive imperatives associated with the issue.
  • Work directly with policymakers at all levels, in public-private partnerships and in other ways, to develop effective strategies for adaptation and mitigation in the respective subsegments of the financial services industry,
  • Incorporate climate change considerations into corporate planning, stakeholder communications, product and investment strategy, and operational policy.

Module 2 of this study provides more detail on the practical implications of implementing these recommendations, in the light of the recent experience of the finance sector, and the various barriers to action that presently exist.

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