The climate risk juggernaut
The dirty little secret about investor returns? Climate change puts them in harm's way.
Attentive readers — all of you, I’m certain — will note that over the past few months we’ve been ramping up our coverage of the financial side of corporate sustainability — things such as environmental, social and governance (ESG) issues and reporting under the guidelines of the Task Force on Climate-Related Financial Disclosures (TCFD). There’s also the new generation of financial products, notably bonds, pegged to climate change, the Sustainable Development Goals and other attributes of sustainability.
It is, for my money, one of the most interesting and engaging areas of sustainable business today.
There’s good reason for the uptick in green finance issues, or GreenFin, as we’ve dubbed it: Investors are simply following the money. And the money, at least for longer-term investors, is leading them to consider climate change and other environmental and social risks as never before.
Such efforts — by large pension funds and some of the world’s largest asset managers, including BlackRock, State Street and Vanguard — are the logical extension of shareholder activism that dates to the 1980s. Back then, activist investors — Carl Icahn, Kirk Kerkorian and T. Boone Pickens Jr., among the better-known — forced companies to take action to improve value or protect themselves against rebel intruders that might disassemble a large company and sell off its parts.
Those efforts largely centered on risk to companies’ long-term value — their ability to remain competitive in the face of dynamic global economics, shifting markets and other trend lines.
Today, a growing focus of long-term investor risk is on climate change, which stands to upend the fortunes of investors across a range of markets over time. Many of today’s investor activists view climate change as existential for companies, potentially roiling markets, disrupting supply chains and rendering population-dense regions — the places where employees, suppliers and customers live, and where facilities, transportation corridors or shipping hubs are sited — uninhabitable.
This is no political campaign. This is about investor returns, plain and simple. It is about understanding and mitigating risk, no less so than the way a company’s credit rating affects its ability to grow or stay solvent or how any number of market risks, such as recession, inflation or changing interest rates, can affect investor returns.
And it matters: Fitch Ratings announced last week that it has launched a new integrated scoring system that shows how ESG factors affect individual credit rating decisions. According to the firm’s research, about 3 percent of its current ratings actions have been directly triggered by an ESG issue. Nineteen percent were influenced by at least one.
Meanwhile, a new report by FM Global, a mutual insurance company, calls on CFOs to spell out the risks for their companies’ operations, future cash flow and market valuations. "CFOs really need to think about how vulnerable their businesses are," Eric Jones, global manager for business risk consulting at FM Global, told The Wall Street Journal.
Helping companies and their largest investors deal with growing investor concerns is becoming a cottage industry in both the sustainability and investing worlds, as NGOs, consultancies and others jump in to guide companies through the thicket of transparency and disclosure guidelines — or, in some places, mandates. There are conferences, websites, newsletters and all of the other things that typically pop up to provide companies with guidance or implementation help on hot-button issues.
With real money, real risks and real opportunities at stake — not to mention governments around the world seeking to accelerate climate action — disclosing climate risks increasingly will become mandatory for publicly traded firms.
TCFD is becoming the principal vehicle for companies to do this. And reporting under the guidelines is no check-the-box activity, as BSR’s David Wei and Giulio Berruti make crystal clear in this terrific overview. It requires companies to take a hard look at their strategy and governance structure, as well as to conduct scenario analyses detailing risks under several temperature-rise scenarios and to make those analyses public.
(More on this in our forthcoming State of Green Business report, which will be published Feb. 5 with a free webcast on the topic.)
Richard Mattison, CEO of Trucost, part of S&P Global, points out that TCFD is already widely embraced in the financial community, supported by eight of the world’s 10 largest asset managers, three-quarters of the global "systemically important" banks, all the major credit rating agencies and many large pension funds.
"Investors increasingly want to understand how companies are using future carbon pricing scenarios to mitigate risk and direct capital to innovations that will succeed in the transition to a low-carbon economy," he says.
Fortunately, there's a business case for companies to think more deeply about their climate risks, and to engage with investors generally on ESG matters, as sustainable investing pioneer Julie Gorte notes in a GreenBiz essay:
"Integrating ESG practices has been shown by many studies — including ones from Bank of America, Morgan Stanley (PDF), JPMorgan and Deutsche Bank (PDF) — to produce competitive or better risk-adjusted performance compared with so-called mainstream peers.”
Higher performance, lower risk. Follow the money, indeed.