PRI in Person: Physical risks of climate change 'underappreciated'

Investors should focus less on carbon footprints and “so-called transition risk” and more on the physical impacts of climate change, according to the head of Deutsche Asset Management.

Addressing delegates at the PRI in Person conference in Berlin, Nicolas Moreau – speaking in a personal capacity rather than on behalf of Deutsche Asset Management, at the PRI’s request – said he was encouraged by investors beginning to understand and manage their climate exposure.

However, he urged investors to prioritise “pricing physical risk properly in our portfolios” instead of monitoring their carbon intensity, given that the global target of a maximum climate warming of 2°C was unlikely to be met.

“I believe that the investment industry should reject the recommendation that investors disclose their carbon portfolio intensity,” he said.

He suggested that the Montreal Carbon Pledge – a high-profile initiative in the history of the institutional investment industry’s engagement with climate change – was no longer fit for purpose.

“The Montreal pledge provided an important impetus to the Paris Agreement and I salute those at the forefront of this effort,” he said. “However, we need to move beyond carbon footprinting with a more sophisticated approach to climate risk assessment.”

It was therefore positive that the PRI and its signatories were aiming to develop common stress test scenarios for climate risk, he added.

Launched at PRI in Person’s Montreal conference in 2014, the pledge, according to its initiators, “allows investors to formalise their commitment to the goals of the Portfolio Decarbonization Coalition (PDC), which mobilises investors to measure, disclose and reduce their portfolio carbon footprints”.

A joint initiative between the UN Environment Finance Initiative, Sweden’s AP4, Amundi and CDP, the PDC counts 29 investor members, who between them control over $3trn (€2.5trn) in assets and have pledged to gradually decarbonise their portfolios by a total of $600bn.

The Task Force on Climate-related Financial Disclosures (TCFD), a high profile body running under the auspices of the Financial Stability Board, has recommended that asset owners and managers report the weighted average carbon intensity associated with their investments, although it acknowledged that “such metrics should not necessarily be interpreted as risk metrics”.

Transition risk

Most portfolio managers expend too much effort worrying about “so-called transition risk” and not enough about “what more actual hurricanes mean for valuations”.

“That is crazy considering that new research from the academic journal Nature Climate Change estimates there is only 5% chance of keeping global warming to below two degrees centigrade,” he said.

Even if carbon emissions were dramatically reduced tomorrow, stronger and more frequent extreme weather would be very likely over the next 10-20 years, he continued.

Investors have “no place to hide” from the physical impacts of climate change and the disruption to property and trade flows. “If something is unavoidable you have to get organised to prepare yourself,” he said, citing how the Dutch have been building protection against rising sea levels for years.

Companies need to ensure they protect themselves against the potential disruption from severe weather events, Moreau said, and investors were responsible for making sure these protections are in place to ensure their risk exposure is well managed.

Moreau expressed disappointment that the TCFD had not made stronger recommendations on physical climate risk.

“I believe the investment industry needs to champion the disclosure of the one in 100 years, one in 20 years as well as annual disaster risk exposures,” he said. “Such metrics helped the insurance companies in the 1990s and there’s no reason why every sector should not disclose its physical climate risk.”

He highlighted Willis Towers Watson’s “1-in-100” initiative, which was launched in 2014 at a UN Climate Summit and is aimed at integrating natural disaster and climate risk into financial regulation globally, including solvency stress tests for portfolios. Moreau called for more support for this idea, “to ensure it catches on”.