Climate change for asset owners

Report Contents

The guide is split into two parts:

• Part 1: The relevance of climate change, covering: why it matters to investors; the science; why government action matters to investors.
• Part 2: Approaches that asset owners should adapt in their (A) Investment process (B) Engagement (C) Disclosures, and: possible actions to be taken; available resources; introductory questions to ask investment managers.

The PRI is working to help investors protect their portfolios from climate-related risks, to identify new opportunities and outline processes to help asset owners engage on the topics. Selected further reading is provided throughout.  For more information on anything in this guide, or climate change more broadly, please get in touch.

The PRI’s key climate collaborations and programmes:

• Climate Action 100+
• The Investor Agenda
• UN-convened Net-Zero Asset Owner Alliance
• Inevitable Policy Response (IPR)
• FSB Taskforce on Climate-Related Financial Disclosure (TCFD)

Part 1: The relevance of climate change

Why does it matter to investors?

Climate change will have significant physical and economic impacts on many different aspects of human activity, as identified by bodies including the Intergovernmental Panel on Climate Change (IPCC), the IMF and the Bank of England.

Climate change is a systemic issue which affects all asset types and sectors. As such, it will impact the portfolio returns, asset valuations and asset allocation processes of asset owners with diversified, global portfolios.

It will provide new investment opportunities. For example, the IPCC forecast that new public and private investment in energy will need to grow to around U$2.4 trillion annually to 2035 – representing around 2.5% of the global GDP.

Climate change also introduces new risks.

Country level:

• Since 2015, failing to adapt to climate change has been cited as a top-five risk by the World Economic Forum.

Sector level:

• The physical changes of climate change have already had tangible financial implications for some sectors, such as insurance. Overall losses from world-wide natural catastrophes in 2019 totalled US$150 billion¹.
• Expected returns on others, such as energy, utilities, consumer staples and telecoms, will also be significantly impacted. According to some consultants and analysts, company or asset valuations will be affected by how corporations choose to respond to climate issues².

These implications coincide with an increasing focus from regulators on the importance of ESG incorporation for fiduciary duty. Some countries have already introduced stricter requirements to consider climate change preferences of clients and beneficiaries, including reporting on how these obligations are implemented.

Asset owners will inevitably invest in assets and sectors whose behaviour and business models have to adapt. Climate change will result in changes to weather, consumer demands and societal expectations, and will result in the development of new regulation and technology – important considerations when setting an investment policy, engaging an asset manager, working with investment consultants and fulfilling fiduciary duty.

Investors cannot avoid climate-related risks, but they can protect their portfolios against them.

The science

The Earth’s temperature is now rising faster than any time in recent history – evident in more numerous and volatile weather events, rising sea levels and warming marine temperatures. Global temperature rises have been particularly marked since the industrial revolution and since the 1970s each subsequent decade has been successively warmer than the last (see Figure 1).

Figure 1: Global temperature change (1850-2019), Show your stripes

Activities such as manufacturing, transport, agriculture and power generation (see Figure 2) increase the atmospheric concentration of greenhouse gas (GHG) emissions, resulting in the greenhouse effect, which traps the sun’s heat and contributes to global temperatures rising.

Human activities are contributing to approximately 1.0°C of global warming above pre-industrial levels. Current emission patterns indicate that this could reach 1.5°C by 2040³.

Figure 2: Global emissions by sector, Accelerating the low-carbon transition, Brookings Institution

Why government action matters to investors

Governments are starting to respond. Based on the IPCC findings, the Paris Agreement is the best example of international action. It binds the 197 countries that ratified the United Nations Framework Convention on Climate Change to a common cause – to undertake ambitious efforts to combat climate change and adapt to its effects, with enhanced support available to assist developing countries. It aims to stop global temperatures rising by more than 2.0°C above pre-industrial levels this century and to limit that increase even further to 1.5°C. 

Figure 3: Ambition mechanism in the Paris Agreement

The Paris Agreement commits governments to a ratchet mechanism which requires a tightening of regulation and action if the science points to a global warming trajectory beyond this central target. A delay in taking action will have significant financial implications; as outlined in the PRI’s Inevitable Policy Response work.

Whilst government action matters, asset owners are responsible for the delivery of their own climate commitments, independent of whether governments meet targets. Given that many asset owners have future liabilities, there is a strong incentive to consider the investment implications of global warming and encourage emissions reductions now, rather than later.

New regulation – such as the EU Taxonomy – will also increase the reporting requirements on investors.

Limiting global warming to 1.5°C needs increased investment and societal changes. To meet these targets, changes are required in the way society and businesses travel, consume resources and generate energy.

Part 2: How should asset owners respond?

A three-step approach to implementing a climate change response

How asset owners will respond to this important challenge will vary, but actions could include:

• introducing a standalone climate policy;
• reviewing investment decisions;
• challenging fund managers; and
• engaging with companies and policymakers.

This section outlines the approaches that asset owners could take to protect their portfolios from the systemic risks posed by climate change.

A. The investment process B. Engagement C. Disclosure Introductory questions to ask investment managers