Risk Management “Completely Inadequate”

A landmark report completed by asset consultants Mercer and 14 global super funds with US$2 trillion invested between them, suggests that the current approach to managing risk is completely inadequate given the likely impacts of climate change and the technology and policy response. Meanwhile, Governments in the Asia-Pacific region face the risk of unprecedented numbers of people displaced by floods, storms and other impacts of climate change, the Asian Development Bank (ADB) said in a report released this month.

Giles Parkinson in Climate Spectator (16 February 2011)

The owners and managers of the trillions of dollars invested to fund our retirements have been able to pretty much ignore climate change up to now.

They have largely dismissed it as a “known unknown”, as our columnist Phil Preston described it, to be addressed at a point in the future. Only a few have finessed a small portion of their portfolios to take advantage of emerging opportunities.

However, a landmark report completed by asset consultants Mercer and 14 global super funds with $2 trillion invested between them, suggests that the current approach to managing risk is completely inadequate given the likely impacts of climate change and the technology and policy response.

The report suggests that traditional methods of managing risk – such as bonds and defensive equities – will be insufficient, and may even cause returns to decline. And it suggests that asset owners will need to migrate up to 40 per cent of their portfolio towards “climate sensitive investments” to capture the upside. These include property, infrastructure, private equity, timberland, agriculture land, carbon, broad and sector focused sustainable equities and unlisted assets in the energy efficiency and renewable sectors.

 “The analysis suggests that under certain scenarios, a typical portfolio seeking a 7 per cent return could manage the risk of climate change by ensuring around 40 per cent of assets are held in climate-sensitive assets,” the report says.

“To manage climate change risks, institutional investors need to think about diversification across sources of risks rather across traditional asset classes.”

Helga Birgden, the head of responsible investment in the Asia Pacific region for Mercer, says traditional approaches don’t take into account the technological and policy changes associated with climate risk. In fact, they effectively ignore them. Past experience – traditionally the fall-back position of the asset management industry – is no longer quite as useful for assessing climate change risk. “It requires new models and new ways of being strategic about it,” she says.

Indeed, the report says this about strategic asset allocation (SAA), which it estimates accounts for more than 90 per cent of the variation in portfolio returns over time. “While standard approaches to SAA rely heavily on historical quantitative analysis, much of the investment risk around climate change requires the addition of qualitative, forward-looking inputs. Given the unclear climate policy environment and uncertainty around the full economic consequences of climate change, historic precedent is not an effective indicator of future.”

Birgden says it’s important that in the face of climate change investors are developing new strategies to ensure their resilience over time. “This region in particular is vulnerable to environmental impacts and is therefore exposed to climate change, as a mega theme, in a range of areas. On the flip side, our region is leading developments in low carbon technology which creates investment opportunities and the potential for economic transformation.”

Nathan Fabian, the CEO of the Investor Group on Climate Change, which represents more than half of the funds under management in Australia, said that anything that represents more than 10 per cent of portfolio risk requires an immediate response from investors.

“The report also shows that waiting forever for countries like the US and Canada to address their emissions is not an option. Investors should be shopping around for countries with credible, long term policy environments. We hope Australia will soon be one of them”

The key findings of the 132 page report were:

1): Technology investments to achieve a low carbon transformation present a new investment opportunity and could accumulate to as much as $5 trillion by 2030. These include energy efficiency, renewable energy, biofuels, nuclear and carbon capture and storage.  But they will also undermine the value of some existing investments that fail to adapt. 

2):  The costs of climate impacts on the physical environment, human health and on food security could accumulate to $4 trillion by 2030.  Some investments may be directly affected by rising risks of climate change related events, such as infrastructure and coastal zone property (floods and storm damage), water availability (drought and flood risk) with knock on impacts on agriculture and health.

3)  Climate policy changes could increase the cost of carbon emissions by as much as $8 trillion by 2030.  The cost of carbon could be as high as $220/tC02e by 2030, with the cost increasing the longer the policy delay and the less well-anticipated and coordinated the policy action. Mercer calculates that climate policy risk currently contributes 10 per cent to long-term portfolio risk for a representative portfolio, with the risk increasing under scenarios of delayed climate policy action.

4): Increasing exposure to “climate sensitive” assets can help to capture the upside and protect against the downside risks of climate change at the total portfolio level.

5): The EU and China/East Asia expected to emerge as “leaders” because they are more likely to pre-emptively find alternative sources of energy, improve efficiency, reduce carbon emissions and invest in new technology.

The report was put together by a 29-strong team at Mercer and included input from 19 other researchers, including the London School of Economics and the Grantham Research Institute, with input from the World Bank, the International Finance Corp and the Carbon Trust.

The investors that participated in the report manage more than $2 trillion in assets, and include two Australian funds, AustralianSuper and VicSuper. Other participants were AP1 (Sweden), APG and PGGM (Netherlands), British Columbia Investment Management Corporation  and Ontario Municipal Employees Retirement System, (Canada), British Telecom Pension Scheme, CalPERS (US), CalSTRS (US), Environment Agency Pension Scheme (UK), Government of Singapore Investment Corporation, Maryland State Retirement and Pension System (US), and the Norwegian Government Pension Fund.

Source: www.climatespectator.com.au

Reuters report in Green Business Times (9 February 2011):

Governments in the Asia-Pacific region face the risk of unprecedented numbers of people displaced by floods, storms and other impacts of climate change, the Asian Development Bank (ADB) said in a report released earlier this month.

The bank and climate scientists said the region, home to 4 billion people, will be among the regions most affected by the impacts of climate change, leading to major migration both within and between nations, stretching resources.

The draft report, “Migration due to climate change demands attention” also said no international mechanism has been created to manage millions of people on the move.

“Protection and assistance schemes remain inadequate, poorly coordinated, and scattered. National governments and the international community must urgently address this issue in a proactive manner,” it said.

Failure to do so risked costly humanitarian disasters, the report concluded.

The report for policymakers reviewed climate threats and the complex nature of migration, of which climate change is only one of many drivers, including greater numbers of people moving to cities to seek jobs.

It pointed to impacts such as higher temperatures, changing rainfall patterns, greater monsoon variability, rising sea levels, floods, and more intense tropical cyclones.

Last year’s floods in Pakistan led to the temporary or permanent dislocation of millions of people, while Sri Lanka is suffering its second wave of floods in less than a month, threatening up to 90 percent of the rice crop. More than 250,000 are seeking refuge in temporary shelters.

“The Pacific is particularly vulnerable because of its high degree of exposure to environmental risks and high population density. As a result, it could experience population displacements of unprecedented scale in the coming decades,” the ADB report said.

Climate-induced migration would affect poor and vulnerable people more than others, said Bart W. Edes, director of ADB’s Poverty Reduction, Gender, and Social Development Division.

“Those who stay in their communities will struggle to maintain livelihoods in risk-prone settings at the mercy of nature’s whims,” he said in a statement.

The report highlights Asia’s booming megacities as being particularly vulnerable to disasters, such as floods, rising seas and cyclones.

“Megacities will often lack the carrying capacity to accommodate the influx of climate migrants on top of those moving for other reasons,” said the report, adding that massive influxes of migrants could lead to conflict over resources.

According to UN data, only about 17 percent of, or 230 million people in, the Asia-Pacific lived in towns and cities in 1950. By 2005, it had reached 39 percent (1.5 billion) and was expected to hit 50 percent by 2025. By 2050, more than 3 billion people in the region will live in urban areas.

“The massive growth in megacities in coastal areas significantly increases the population exposed to the risks posed by climate change,” said the report, pointing to Mumbai’s population, forecast to reach 26.4 million by 2025. Dhaka’s was set to hit 22 million and Shanghai’s 19.4 million by the same year.

South Asia was most vulnerable to climate change impacts, such as rising sea levels and storm surges from cyclones, which were expected to become more powerful, threatening Bangladesh and India in particular, it said.

Other vulnerable areas were the densely populated low-lying coast of China, southern Pakistan, the deltas of the Mekong, Red and Irrawaddy rivers and the Pacific island states of Kiribati and Tuvalu.

Source: www.greenbusinesstimes.com