Climate pragmatism in a fragmented world

ACHIEVING net zero as soon as possible is critical for safeguarding our economy and society. Yet, doing so by 2050 through a finance-led transition now seems out of reach. As a result, investment institutions, banks and insurers are getting pragmatic: preparing for the worst while still aiming for the best, under the circumstances.

The circumstances are that our world is increasingly fragmented. Physical impacts differ drastically by location, climate policies differ substantially by markets, as do energy mix and cleantech adoption.

Pinpointing exposures

Glimmers of what “the worst” might look like are coming into view. The cost of hurricanes, severe thunderstorms and floods amplified by a warming climate has topped US$100 billion for five years running.

Modelling by MSCI finds that within the US$9 trillion market for mortgage-backed securities in the US, properties exposed to high hazard-loss ratios are lagging in home price appreciation and losing insurance policy renewals at twice the rate as those in lower-risk areas.

Investors, lenders, insurers and companies alike now seek to integrate risk analytics that capture location data in geospatial detail. Knowing which facilities face which hazards across potentially millions of assets in a portfolio is essential for modelling financial impacts under multiple climate scenarios.

Investors have traditionally viewed their geographic exposures based on companies’ headquarters or major revenue segments, which cluster in economic hubs. Yet, physical risk can lie elsewhere – along supply routes or at sites of production, storage and logistics.

Furthermore, physical hazards, nature dependencies or changes in ecosystems increasingly overlap, impacting business decisions on where to build plants and how to reconfigure supply chains, while challenging assumptions about asset resilience and productivity.

More than one-third of corporate facilities in the US are located in areas that have very high exposure to water scarcity, for example, and 41 per cent of the world’s listed companies face at least one high nature-related risk, such as air or soil condition.

Transition-focused

Preparing for the worst does not mean giving up on accelerating decarbonisation. Assets in transition funds, including strategies that invest in emissions-intensive sectors, rose 20 per cent last year and now account for nearly 40 per cent of publicly listed climate funds.

The shift to financing the harder-to-decarbonise parts of the economy is a sign that investors have become more targeted with maximising the impact of their climate capital, both in reducing emissions levels and pursuing transition-focused opportunities.

The world’s listed companies are on track to overshoot their collective carbon budget for staying under the Paris Agreement goal within the next two years, aligning with a warming trajectory of about 2.7 degrees Celsius above pre-industrial levels, based on their targets and emissions trajectories.

The aggregate temperature masks divergence. Even before the flare-up of trade tensions, differences in national climate policies drove investors to differentiate the pace and scope of energy transition investment opportunities among countries and sectors.

As geopolitical shifts further fragment different markets’ transition trajectories, investors are seeking indicators that help them navigate differences in risks and opportunities, while financing decarbonisation in the economy’s critical sectors.

Those include a mosaic of market factors such as policy incentives and the availability of commercially feasible technologies for different sectors, as well as company-specific factors to gauge companies’ readiness for the transition.

Climate-proofing

Somewhere between aiming for the best and preparing for the worst is an emerging pragmatism about a growing investment opportunity in serving the inevitable need for households, businesses and communities to prepare for, adapt to and recover from rising physical impacts.

Some areas in Asia, for example, are warming at triple the global average, endangering the health of vast urban populations.

Investors are beginning to explore ways to gain exposure to adaptation and resilience product solutions – a category that encompasses everything from hybrid seeds and heat-resistant clothing to water management and sustainable real estate.

A series of industry frameworks have emerged to help guide investors looking to identify the relevant businesses, including the Climate Resilience Investments in Solutions Principles (Crisp) framework developed by the investor-led Global Adaptation and Resilience Investment working group.

Our institute is using artificial intelligence large language models to identify companies within the global investment universe with exposure to resilience solutions that potentially fall within the Crisp framework.

A warming world and the unevenness of the energy transition pose both material risk and profound opportunity. For investors, it is a moment to embrace the complexity and contradictions while positioning for what is next. In other words, to adapt. OMFIF

The writer is founding director of the MSCI Sustainability Institute