Lot's Wife Edition 4 2021

Lot’s Wife • Edition Four
Lot’s Wife • Edition Four
Climate Change: Simply
a Risk to the Earth’s
Climate?
Word by Anna Thompson, UNIT Research Analyst
Climate change, one of the most defining challenges
in this century, is a long-term alteration of temperature
and weather patterns that define the Earth’s climates.
Science tells us that further alteration and warming is
inevitable in both the short and long run. Thus, in this
uncertain environment, climate change has recently
and rapidly transformed from being a corporate
social responsibility issue to one of top regulatory
importance. The Paris Agreement is a legally binding
international treaty concerning climate change
and was ratified in 2016 by a number of signatories
including Australia. As a result of this agreement, the
issue of climate change has become more prominent.
A number of regulatory initiatives, such as the Task
Force for Climate-related Financial Disclosures
(TCFD), have been enforced in the past decade. The
initiatives have made asset managers responsible for
incorporating climate risk considerations into their
investment decision making, governance and risk
management. Asset managers are now responsible for
reporting on the administration, strategy, climate risk
and measures concerning such.Thus, they will want to
examine the exposure of their firm to climate risk and
ensure the processes for capturing this exposure are
current and foolproof.
According to the TCFD, climate risk is “a combination
of physical and transition risks which may pose
financial and reputational damage to financial and
non-financial services firms.” Investment risk is the
potential for investment returns to differ from an
expected return. With a multitude of possible future
climate change scenarios existing, there are multiple
possible consequences on investments and therefore
climate risk feeds into this investment risk. Reasonable
expectations could be set by investors concerning the
future climate, yet there is still the risk that it will differ
from expectations. Climate risk is typically separated
into physical and transition risk.
Physical Risk
Physical risks concern the possibility of weather
and climate-related damage affecting asset prices.
For example, a one-off event such as a flood that
damages properties or crops, or the impact of
long-term effects of climate change. These events
impose costs by damaging existing assets, stock,
and disrupting demand and operations. Certain
investments are more sensitive to physical risks - for
example, agricultural companies have a higher risk
of drought-related costs than an accounting firm. If
portfolios and funds are not created in a way that
manages and mitigates this risk, these investments are
exposed to increased valuation risk.
Stranded Assets
Stranded assets are those which are unexpectedly
devalued as a result of climate related events. When
physical risks, such as the risk of climate events
destroying particular physical inventories or certain
sectors becoming obsolete as a result of a regulatory
or societal retreat from activities which contribute to
climate change, materialise, they can result in assets
becoming stranded.
Stranded assets pose risks to investments and are
often used as the general unit of measurement when
debating the possible financial impacts of climate risk.
The London School of Economics estimated the value
of global financial assets that are at risk from climate
change as being US$2.5 trillion, while The Economist
estimated it as being US$4.2 trillion. Stranded assets
are important in managing financial risk to attempt to
avoid loss after an asset has become a liability. Asset
managers are expected to be wary of the possibility of
investing portfolios or funds in companies or sectors
prone to stranded asset risk. However, re-positioning
portfolios due to possible stranded assets needs to be
adequately explained by asset managers due to the
possibility of incurring unnecessary costs for investors
and compromising their returns.
Transition Risk
As discussed above, there is mounting regulatory
pressure on companies to alter their operations and
activities in order to mitigate negative environmental
externalities. Coupled with heightened social pressure,
risks arise as a resulting shift towards a greener, lowcarbon
economy.
This is the transition risk. As climate change worsens,
market participants are likely to change their
attitudes: governments may become more open to
taxing emissions, and consumers may shift their
demand towards more environmentally friendly
products. This creates transition risk such as:
• The risk of consumers switching to invest in firms
with more environmentally-friendly track records;
• The risk of firms with high carbon emissions
facing high future regulatory costs;
• Or the risk of media announcements regarding
harmful environmental practices that can
negatively affect a company’s market value.
Conclusion
Climate risk is persistent and will continue to evolve
into the distant future. As a result, institutions must
integrate considerations of this risk into their business
strategies, and risk management and governance
processes in order to not only keep up with the
increasing regulations but also ensure their business
can survive in the long-term. As climate change
is a problem that will persist long into the future,
addressing climate risk is something that needs to be
integrated into everyday decision-making, rather than
being a one-off process.
Monash students can be aware and informed of
the impacts of climate risk and the signs of a firm
adequately handling this risk and having a forwardlooking
attitude. This will assist in making informed
financial decisions.
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