Climate Change: A new risk metric for Wall Street

JUN 1, 2020

Chetan Srivastava, YSEC consultant

In the wake of climate issues ranging from heatwaves to gradually rising sea levels over the years, an increasing number of analysts, advisory firms, and investors are emphasizing how these issues are impacting revenues and profits across the United States. Greater importance is shifting to the action taken by firms to mitigate the threats posed by climate change.

A recent Reuters analysis showed that in Q3-2019, upwards of 70 firms highlighted the impact of climate change in their activities as a part of their quarterly filings with the Securities and Exchange Commission (SEC). This number is twice as much as the year before and greater than any year since 2014.

Conventionally, fund managers and research analysts have seldom incorporated environmental and climate related factors while analysing or valuing a company. However, over the past decade, there has been a deeper interest in the geographical location of properties, plants, and equipment of companies and how they may be at a higher risk of being affected by environmental factors. Fund managers are now having serious discussions with companies and advising parties to set aside a sizeable chunk of revenues to effectively deal with climate change without compromising long-term business strategies. These funds, often called “ESG Funds”, are specifically targeted to focus on and minimise the physical risks of climate change.

The market is now more bullish towards companies incorporating these environmental, social, and governance (ESG) factors into their business pursuits. During Q1-2019, a Real Estate Investment Trust (REIT) headquartered in Chicago revealed in its earnings call that it will be evaluating the impact of rising water levels while acquiring new marinas. The shares of the company closed at a high of 46% for FY-2019. Investors are now significantly more enticed by companies which are addressing climate change in their business models.

Last year, more than a dozen weather and climate-related catastrophes struck North America. This resulted in more than USD 1 billion in damages. These figures are more than twice the average between 1981 and 2018. Insurance claims by companies are on the rise and draining large insurance companies with money tied up in stocks, bonds, and other interest-bearing accounts. Withdrawing these funds to make claim payments has had a crippling effect on the stock prices of these insurance companies and has also led to a bearish short-term outlook towards them.

Many research firms including Trucost, a division of S&P Global have announced products like Climate Risk Analytics which assist investors with determining the climate risks faced by companies. Climate Risk Analytics focused companies in the Silicon Valley have closed multiple rounds of funding to broaden their services which provide investors with key data related to both long and short-term weather trends across specific locations.

Green Investing, or Eco Investing, has become the focus of attention in stock markets across the world. Investors have access to “green mutual funds” like the TIAA-CREF Social Choice Equity Fund (TICRX) and  Portfolio 21 Global Equity Fund Class R (PORTX). Green bonds are being offered by governments to fund environmentally friendly endeavours. Sustainable investment strategies yielded close to USD 45 Billion in investments during 2016, a number which will only rise in future.

What was once neglected and considered insignificant by the moguls on Wall Street and financial hubs across the world has now become a core area of interest. More companies are now trying to reduce their carbon footprint by either undertaking green activities or having targeted funds for research and development into cleaner and greener operations. Climate change has become a pressing issue which poses a real threat to the soundness of the global macroeconomic environment and has certainly made its importance felt by key players.