Engagement Essential to Resilient Investments
Systemic nature of physical climate risk requires investors to engage with the enabling environment on adaptation and resilience.
Engagement with policymakers, companies and a wide range of other stakeholders is essential to investor efforts to protect portfolios against the physical risks of climate change, according to a new report.
Guidance from the University of Cambridge’s Institute for Sustainability Leadership (CISL) offers tools and strategies to help investors address issues arising from climate adaptation and resilience.
Investor awareness of adaptation is growing, the report said, but efforts to address physical climate risks remain “fragmented”, leaving portfolios vulnerable. Physical climate risks could impact investors’ portfolios through decreasing production capacity, negative impacts on workers, and increasing operating and capital costs.
As well as taking account of physical risks from the earliest stage of the investment process, the report said investors needed to engage with policymakers, businesses, and the financial sector to drive systemic changes. The report described investor engagement with national and international policy as “essential”.
“Investors should start engaging with the enabling environment on the topic of adaptation and resilience, such as the broader financial systems, governments, and companies themselves,” Mette Gahr, Climate Investment Analyst at Zurich Insurance, told ESG Investor. “With such a two-fold approach, investors can enhance long-term value, mitigate climate risks, and drive sustainable growth.”
Zurich is part of the Investment Leaders Group (ILG), a global network of pension funds, insurers and asset managers with more than US$9 trillion in AUM, which released the guidance in collaboration with CISL.
Physical climate risks have manifested in the recent wildfires in Los Angeles. These have caused estimated damages and economic losses of between US$250 billion and US$275 billion, making it the most expensive natural disaster in US history. The wildfires have forced more than 179,000 people to evacuate and destroyed more than 12,300 structures.
Climate risks also had a significant economic impact last year, with deadly flooding in Valencia in Spain is expected to cost more than €10 billion (US$10.3 billion), while Hurricane Milton cost an estimated US$34 billion in losses in the US state of Florida. Meanwhile, extreme weather events and natural disasters in the Asia Pacific region caused an estimated US$65 billion in losses in 2023.
Enhancing engagement
Daniel Gallagher, Senior Lead, Climate Change at the UN Principles for Responsible Investment (PRI), welcomed the report’s emphasis on engagement with policymakers as part of investor efforts to channel private capital toward adaptation and resilience.
“This report provides good guidance to investors on how to engage, what the opportunities are, and how to support policymakers on building out the case for private financial flows to complement public capital,” said Gallagher. “In the second half of this decisive decade, engagement with policymakers is one of the most effective ways that investors can manage climate risk.”
The PRI has increasingly encouraged institutional investor signatories to participate in policy advocacy and sovereign engagement on physical and transition risks, he said, to enhance understanding on the policy reforms needed to bolster adaptation and resilience.
The CISL report also stressed the role of countries’ nationally determined contributions (NDCs) and national adaptation plans (NAPs), noting that engagement from investors would help to ensure these included ambitious targets and policies to support adaptation and resilience. “NAPs are a critical process to complement and reinforce adaptation strategies within NDCs, ensuring these investments are resilient,” the report said.
It added that investors should capitalise on “innovative financing models” such as blended finance structures, which are seen as vital to achieving the NDCs, to de-risk investments in adaptation and resilience and make them more attractive to investors. This could also mobilise private capital towards climate-vulnerable regions and sectors, particularly emerging markets and developing economies.
“It’s becoming increasingly clear that we are entering unknown territory. The rapidly changing climate poses financial risks to asset valuations, portfolios, and the financial system as a whole,” said Gallagher. “There’s a real need to increase ambition on the transition from investors, companies and, most urgently, policymakers, who need to be the prime movers in the transition.”
Earlier this week, the Financial Stability Board warned of the difficulties of analysing climate shocks – “given their nature and uncertainties around timing and magnitude” – and recommended that financial institutions to use a new set of forward-looking metrics to better identify vulnerabilities.
Mitigation imbalance
The CISL report also noted the importance of engagement between investors and portfolio companies over resilience-building expectations, with climate adaptation and resilience failing to receive the same attention as mitigation efforts. Investors need to engage with portfolio companies during the portfolio construction and monitoring phase, it said, but also maintain post-investment dialogue.
“By measuring how investments contribute to climate resilience and adaptation, investors can better understand the added value their capital brings to communities, ecosystems and economies,” the report said.
The Climate Policy Initiative has previously found that mitigation-focused finance accounted for 90% of climate investments, while financial flows to protect against physical risks need to increase at least ten-fold, and potentially as by as much as 18 times, from current levels. The report also stated that there is a “crucial need” to mobilise private finance to close this adaptation gap.
“Mitigation often takes priority over adaptation due the belief that reducing emissions will reduce the need to prepare for climate impacts, leading to an underinvestment in resilience,” said Eric Nietsch, Head of Sustainable Investment, Asia at Manulife Investment Management. “Unfortunately, current efforts often lack this balance [and] achieving this balance is essential for effective climate risk management.”
Max Richardson, Senior Investment Director at ILG member Rathbones, agreed that there is currently more focus on mitigation than on adaptation, but suggests this is likely to change as physical climate events like wildfires and floods “will see adaptation and resilience rise to the top of the agenda”.
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