Scrutinising environmental risk in portfolios: time for action

A CONSULTATION exercise by the Monetary Authority in Singapore in June has put the fund management industry on notice that environmental risk assessment will be put front and centre of portfolio management and overall governance.

Based on a set of guidelines, consideration of environmental risk will have broad implications across a range of activities including research and portfolio construction, risk management and stewardship. For some firms with a major global presence such as BlackRock and Amundi, which are already at the forefront of efforts to integrate sustainability and environmental, social and governance (ESG) factors into security selection, MAS' guidelines are likely par for the course. But for smaller firms, compliance may be a bigger challenge. An environmental risk framework for fund management is, however, arguably an imperative if Singapore is to become a centre for sustainable finance.

As the consultation paper explains, physical and transition risks affect portfolio companies' operating costs, profitability and even viability in the medium to long run. By extension, these will impact investors' risks and returns. Physical risks include extreme weather events and water scarcity brought on by climate change. Transition risks include regulatory changes and consumer preferences as the world moves inexorably towards more sustainable economies and policies. Fossil fuel companies such as coal mines, for instance, may have to mark down the value of millions of dollars of 'stranded' assets, which are no longer feasible to develop or run, as governments take a tighter stance on pollutive industries. There is also reputational risk for managers who deploy capital into environmentally damaging sectors.