I am beginning to think so.
The Intergovernmental Panel on Climate Change (IPCC), tasked with assessing the science relating to climate change, has recently warned that the rise in average global temperature to less than 2˚C above pre-industrial levels in this century (à la the 2015 Paris Agreement) will require dramatic changes in the way energy is produced and distributed to pre-empt irreversible damage.
In Dr. Mark Carney’s 2015 landmark speech ‘Breaking the tragedy of the horizon’, as the former Governor of the Bank of England, he singled out various climate risks that could have a material impact on companies and their stock market valuations.
He highlighted the following: extreme and frequent weather events, as global warming continues apace; stranded assets, as fossil fuels are phased out over time; and liability risks, as third parties seek compensation for collateral damage.
Until recently, capital markets have been slow in factoring these risks into securities’ prices. But in hindsight, COVID-19 might well prove a game changer.
This is because I have been struck by how it delivered a devastating reminder of the unbalanced relationship between humans and nature. It has given investors a real taste of how environmental shocks – unlike economic ones – can roil the markets and whipsaw their portfolios at a speed once unimaginable.
In a recent report by KPMG International and Eversheds Sutherland ‘Climate change and corporate value’, 46 percent of leaders from some of the world’s leading organizations stated that COVID-19 has led to a better understanding of what it means to be climate resilient.
It has moved many of the old ‘unknown unknowns’ of climate change impacts into the realm of experience. No wonder funds centred on climate change have emerged as star performers amid the stock market carnage of March 2020.
Two years ago, no major economy was committed to net-zero carbon emissions. Unsurprisingly, now eight of the top 12 economic nations are: Canada, China, France, Germany, Italy, Japan, South Korea and the UK. The US will soon join under President Joe Biden.
Dark tunnel, bright light
My research has revealed two reasons why markets were slow to price in climate risks until recently.
The first is the lack of a robust template – with consistent definitions and reliable data – that permits statistical modelling of the risks singled out by Dr. Carney.
On the upside, though, rating agencies and a new generation of data vendors have recently been racing to fill the void. For its part, the European Commission’s Sustainable Finance Action Plan has provided a pioneering policy approach to aligning financial systems with the goals of the Paris Agreement. It provides a blueprint for other regions to emulate.
The second – and more challenging – reason is the difficulty in establishing direct line of sight between climate change and investment outcomes. Quite simply, in climate change, the unknowns are overwhelmed by the unknowables.
The former are factors to which it is possible to attach outcome probabilities: e.g. regulatory or societal responses and the rise of renewables. The unknowables, on the other hand, are wholly conjectural about the most likely climate change trajectory: how quickly the planet will warm up and the timepoint at which it will take the average global temperature above the Paris Agreement target if appropriate actions are not taken.
However, as more nations are migrating towards a low-carbon future, investors are now able to construct scenarios that provide actionable narratives and investible insights into future threats and opportunities.
This is in marked contrast to the past practice of treating natural disasters such as floods, droughts, hurricanes and typhoons as one-off events from which affected regions may have a V-shaped recovery. Climate risks are now taken seriously, especially since the frequency and severity of natural disasters have intensified dramatically.
I am not surprised, therefore, that capital markets have already started to price the risks in sectors such as power generation and fossil fuels, as the economics of renewable energy is constantly improving with innovation and regulatory push. Fresh inflows of capital are now pouring into renewables: they are boosting not only the sector’s own market valuations, but also those of its commercial users by reducing their carbon footprint.
Carbon producers who are unable to migrate to green energy risk ending up with stranded assets exposed to a significant loss in value well ahead of their anticipated economic life. Another positive development has been the steep rise last year in the price of carbon credits.
To cap it all, ever more investors are joining forces under the auspices of Climate Action 100+, a global initiative involving over 500 signatories responsible for more than USD$47 trillion assets under management.
It is engaging with those investee companies classed as major greenhouse gas polluters globally to deliver three explicit goals: emissions reductions aligned with the Paris Agreement, strong climate governance frameworks and improved climate-related disclosures. Their extensive engagement rests on the belief that those who are part of the problem can also be part of the solution. If engagement does not work, divestment becomes the nuclear option. This carrot and stick approach is gaining traction.
The winds of change are evident. Hence my optimism.