The climate crisis is expected to increase the probability and severity of many climatic hazards such as floods, heatwaves, and droughts, which translates into shocks for economies and financial markets. Climate crisis risks are real for equity investors, although they are not being addressed as robustly as they should be.
The most recent International Monetary Fund (IMF) Global Financial Stability Report points out that physical risk — loss of life and property as well as disruptions to economic activity — is already difficult for equity investors, and climate crisis pricing increases make it even more so.
The IMP says equity investors have several factors they need to weigh:
- the likelihood of various climate scenarios
- the implications of those scenarios for physical risk at the firm level based on climate science
- expected mitigation efforts
- anticipated adaptation actions
- time horizons for these changes
Together, these bode poorly for investors, as the impact of climate change physical risk on financial stability is likely already much worse than is currently understood.
The IPCC offered a foreboding report in 2018 that future anthropogenic greenhouse gas emissions would lead to warming of about 3 degrees Celsius by the end of the century. The report offered alternative scenarios, too, through stabilizing the global temperature increase below 1.5°C versus higher levels. The result? The planet would suffer less negative impacts on intensity and frequency of extreme events. Resources, ecosystems, biodiversity, food security, cities, and tourism would be much less significantly affected.
So countries around the world have begun to offer long-term solutions to the climate crisis. However, even considering currently stated mitigation policies, climate change induced by anticipated levels of warming is expected to:
- adversely impact the world’s stock of natural assets
- lead to a significant rise in sea level
- increase the frequency and severity of extreme weather events
As a result, asset prices fail to reflect these risks and may cost $1 trillion annually starting in 2050, the IMF outlined.
The IMF makes several suggestions to manage risks from uncertain weather and other climate events.
- Developing global mandatory climate change physical risk disclosure standards could be an important step to preserve financial stability.
- Granular, firm-specific information on current and future exposures and vulnerabilities to climate shocks would help lenders, insurers, and investors to better grasp this risk.
- Climate-change stress testing can provide financial firms and their supervisors with a better understanding of the size of their exposures and the associated physical risk.
- And, “without a doubt,” the most effective remedy will be strong global policy action to reduce greenhouse gas emissions, address the cause of global warming in a sustainable way, and conferring benefits that extend well beyond the realm of financial stability.
In pursuit of a greener future, we must better understand the connection between climate change and the financial system. Countries with more fiscal space will be able to deploy a swift response to the disaster in the form of financial relief and reconstruction efforts. Also, well-developed risk-sharing mechanisms such as insurance reduce or redistribute the disasters’ losses and limit the impact on domestic equity prices.
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