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What comes after climate risk?

Climate risk

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The climate risk era on Wall Street could be ending before it’s barely even begun.

As capital has flown into ESG strategies over the past few years, the financial community has quickly grown better than it has been at recognizing the risks of climate change. What started as a somewhat simple quest to understand the physical risks of exposure to storms, floods, wildfires, heatwaves and other weird weather patterns driven by climate change has morphed into something much more complex.

Today, there are conversations in financial houses around the globe about climate change triggering operational risk, policy risk, stranded asset risk, underwriting risk, transition risk and technology risk. Bankers, lenders, investors and insurers are studying climate flood and fire maps while running scenarios and planning for stress tests. The fossil fuel sector has plummeted as a portion of the S&P 500, and it turns out that avoiding risky assets has been a pretty decent strategy for marginally — or sometimes markedly — improving investment performance.

Has all this focus on climate risk gotten us anywhere?

Over the past four years, while U.S. policy was stuck in the mud on climate change, financial leaders and regulators have used their leverage to push for more disclosure. According to the Task Force on Climate-Related Financial Disclosures, 42 percent of large companies with market capitalizations over $10 billion are disclosing climate risks today. That number shrinks to just 15 percent at smaller companies with fewer resources — and while a much larger swath of the market is exposed to climate risk, investors increasingly can use this data to adjust their portfolios.

But has all this focus on climate risk gotten us anywhere? And once we’ve gotten really good at measuring the risks, what’s next?

Climate risk was always meant to be just the beginning. Fighting climate change cannot just be a risk management exercise for markets. Nothing illustrates the limits of markets to adapt to climate change more than the frigid crisis in Texas energy markets this month, where a market-led experiment in energy led to underinvestment in resilience, gigantic electricity bills and incredible human suffering.

The cost of inaction

Indeed, most human pain wrought by physical climate risk is poorly captured by financial markets. The areas most exposed to physical climate risk are some of the world’s most impoverished places where most people don’t even have financial assets to affect the market. Even insurance dollars and construction spending following a disaster can boost a recovering region’s economic output — the market doesn’t capture all of the loss.

The traditional advice that you manage what you measure should have turned all of this financial risk measurement into climate action, but lacking political certainty, markets are still just scratching the surface of climate solutions and resilience. When you price climate risk, you essentially put the brakes on investing in risky things — but there’s not a linear path to investing in ways to reduce the risk.

As Dante Disparte warned in this prescient 2017 article, if you think all this new risk analysis showing climate change is expensive, it is much more costly to actually let climate change happen. Just last week, Nobel laureate Joseph Stiglitz and Lord Nicholas Stern warned in a new paper that policymakers are vastly understating the impact of climate change without an appropriate price on carbon. While climate risk disclosure isn’t perfect yet, should we even bother to perfect it? The opportunity cost of focusing our collective financial attention on risk disclosure over impact might be greater than we think.

Of course, not every climate problem has an easy solution. But suddenly, Wall Street has found itself with policy that potentially can drive action faster than finance. Today, the U.S. is back in the Paris Agreement and climate policy is changing rapidly with promises to transform the economy through the energy, auto and transport sectors. After years of measuring risks with increasing precision, ESG is kind of like the dog that caught the car — achieving a long-sought goal but not necessarily with the clarity about what to do next. Hours poring over climate models and pricing climate risk may protect pre-existing wealth, but they don’t necessarily translate into solving the climate crisis.

We are entering the post-climate risk era, and Earth’s clock is ticking.

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