Matt Orsagh, CFA, CIPM
Senior Director, Capital Markets Policy, Americas, CFA Institute
Climate change is arguably the biggest problem ever
faced by humanity. The good news is that we know what
the solutions are. The bad news is that the solutions will
require most people on earth to change how they live.
The physics behind climate change are simple. There
has always been some carbon dioxide (CO2) in our atmosphere.
Throughout most of human history, that level
has been in the range of 200 to 300 parts per million
(ppm). That number sounds incredibly low, but because
greenhouse gases trap heat and keep it from escaping
back into space, relatively small increases can have
a profound impact. Think of greenhouse gases in the
atmosphere as a blanket warming the earth. The higher
the concentration of greenhouse gases, the thicker that
blanket becomes. In 2021, the atmosphere’s average
ppm is about 415, and it is rising at a rate of about 1
ppm to 2 ppm per year.
Physical Risks Are Largely Baked In, But Transition Risks Are Up to Us
Greenhouse gases (GHGs) trap heat in the atmosphere.
The more GHGs we put into the atmosphere, the more
heat they trap. This cycle raises the atmosphere’s temperature,
contributing to several follow-on problems.
A hotter planet means more drought, more famine, more
extreme weather events, more property damage, and
more dislocation of humanity than any of us have seen.
We cannot know on what calendar date these disasters
will arrive, but we can be confident that they will. The
business community needs to incorporate these new
realities into our analysis to help efficiently allocate
capital in a world where the effects of climate change
are increasing. Climate change will affect every company
and every investor on earth.
Businesses need access to material data on climate
change to make the most informed investment decisions
possible. We need a robust market price on carbon
emissions; we need timely, comparable, and audited
data on material climate-related metrics; and we need
to know how the companies we invest in are responding
to climate change.
Estimates of the costs of climate change vary widely,
but all contain bad news. If no action is taken to limit
climate change, losses could be between $4 trillion and
$20 trillion), according to a 2019 estimate by Sarah Breeden,
then the Bank of England’s executive director
of international banks supervision.1 The cost of adapting
to climate change in developing countries could
rise to between $280 billion to $500 billion per year by
2050, according to a recent United Nations Environment
Programme report. Climate change could slash up to
one-tenth of U.S. gross domestic product annually by
2100, according to the Fourth National Climate Assessment,
published in 2018 by the U.S. Global Climate
Change Research Program. That figure is more than
double the losses of the Great Recession of 2008–2009.
Physical Risks/Transition Risks and Opportunities
A hotter world will increase heat stresses and coastal
flooding due to more storm surges and rising sea levels
from ice melting in the Arctic and Antarctic. This is
already increasing the cost of insuring coastal areas
as insurance companies change their rates every year,
with dire implications for some coastal properties and
homes with long-term financing.
Hotter oceans give hurricanes more power, and hotter
air holds more moisture, creating stronger and more
damaging hurricanes and thunderstorms.
The earth’s oceans are actually larger carbon sinks—
things that absorb more carbon than they release— than
the trees and plant life that we usually think of as the
main check against carbon dioxide in the atmosphere.
This, however, leads to a warming ocean with higher
acidity levels, which is a problem because about 40%
of the world’s population lives within 100 kilometers
of the coast, and 4.3 billion people rely on fish for 15%
of their animal protein.2 Investors need to understandfesti
the impact of climate change on our oceans to grasp its
impact on businesses that depend on the sea and what
comes from it for their livelihoods.
Terrestrial food sources will also be challenged, as—if
there is no change in current growing regions—weighted
average yields are predicted to decrease by 30%–46%
before the end of the century.3
These physical risks are well known because we see them
in the headlines. But just as important are the transition
risks that a reaction to climate change will bring. In the
coming years and decades, whole industries will be
transformed. Oil and gas, utilities, and transportation
are the sectors that will be most affected, but no industry
will be untouched by climate change.
As businesses, regulators, and policymakers react to
climate change by moving to a low-carbon economy in
the coming decades, that transition will have profound
effects on businesses. It is important that businesses
understand the changes coming, their relative timing,
and the likely impact on their businesses, so they can
plan for it. Businesses that fail to do so will be left at
a severe disadvantage compared with companies that
manage the transition well.
What Can Businesses Do?
Climate change isn’t “coming.” It is already here. “Hundred-
year floods” are coming every 10 years, making
flood maps based on historical weather patterns all
but obsolete. Extreme heat is making droughts more
extreme and longer-lasting, already stressing water
resources in the western U.S. and increasing the number
and severity of forest fires. But business and finance can
only do so much. The real big lifting on climate change
will take changes in behavior, which requires changes
in incentives. Governments can set these incentives, so
business and finance should work with policymakers
to iron out what to do.
3 Recommendations for Action
1. Set a price on carbon—Adopting a price on carbon
is essential for combating climate change, which must
be supported by a transparent pricing mechanism that
enables businesses to reliably incorporate carbon pricing
into their analysis of investments’ exposure to climate
risk. CO2 and other greenhouse gases in the atmosphere
are negative externalities—effects that aren’t priced
into the cost of goods and services—that are not yet
widely priced.
About 20% of global emissions are priced by some sort
of carbon market. Europe, China, New Zealand, and
others, including the east and west coasts of the U.S.
operate under some kind of carbon pricing mechanism.
But the reach of carbon markets needs to expand to
eventually provide consumers and businesses with the
incentive to move away from carbon. CO2 and other
greenhouse gases are a negative externality that needs
to be priced to adequately address the negative effects
of climate change.
It is important that policymakers ensure that regulatory
frameworks for carbon markets are designed to deliver
transparency, liquidity, ease of access for global market
participants, and similar standards across jurisdictions,
to underpin robust and reliable carbon pricing.
2. Include carbon price expectations in business
strategy—A realistic market price on carbon will send
a price signal that businesses and consumers need to
properly value the externalities that come with greenhouse
gas emissions. The externality of climate change
has a cost, and that cost will be the future impact of
climate change on our markets and society. Economists,
investors, and policymakers who have studied the issue
agree that a realistic price on carbon will allow markets
to do the heaviest lifting in combating climate change.
3. Increase transparency and disclosure on climate
metrics—Businesses should work with investors, policymakers,
and stakeholders to settle on the metrics that
matter when assessing a company’s climate-change
strategy. Investors, policymakers, and stakeholders
often lack the data needed to make informed decisions
on climate investment and policy. Businesses should
work with these groups to determine what information
(scope 1,2, and 3 emissions, for example) is needed to
make the best policy and investment decisions around
the issue of climate change.
Conclusion: Risks and Opportunities
The bad news is that climate change is one of the largest
economic and societal challenges that mankind has ever
faced. The good news is that we know the solutions to the
problem. However, this will require changes to how we
live, including the way we eat, farm, travel, do business,
and invest. Addressing and adapting to climate change
will be a cultural change for all of us, from the individual
to the largest corporation. But those changes contain
as much opportunity as they do risk. Those who can
adapt best to the changing landscape and seize those
opportunities will find the most benefit.
References
1 2015 report from the Economist Intelligence Unit.
2 Global Environment Facility, “Fisheries.”
3 Wolfram Schlenker and Michael J. Roberts, “Nonlinear Temperature
Effects Indicate Severe Damages to U.S. Crop Yields under Climate
Change,” Proceedings of the National Academy of Sciences (15 September
2009).