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Forward-looking financial metrics can hasten climate action

One small step for climate finance, one giant leap for a net zero economy

By Carl Hess | November 2, 2021

By using forward looking financial metrics, investors can accelerate climate action in line with existing fiduciary duties, capture mispricing opportunities and enable policymakers to raise their climate ambitions.
Climate Risk and Resilience|Climate and Resilience Hub

In the insurance business, we are used to painful wake-up calls. I personally witnessed the devastation caused by Hurricane Ida in my home city of New York, which caused more than 100 deaths across the country. It is estimated to join the top costliest hurricanes measured by insured losses along with Katrina and Sandy.

When flood waters come close to Wall Street, in one of the richest cities in the richest country in the world, we know we have a perfect storm to demonstrate the need for action on climate change and secure a more resilient future for all. As incoming CEO of Willis Towers Watson, one of our top priorities is to help our clients manage their climate risks and support their transition to a net zero economy.

With heads of state and their negotiators meeting in Glasgow for the Conference of Parties (COP26), the UN’s flagship climate summit, a summer of deadly floods and fires will be front of mind. And while they can already see what’s at stake with their own eyes wherever they are in the world, these same policymakers already know what’s required to avoid catastrophic climate change. The 1.5°C target to limit global warming above pre-industrial levels was settled at Paris in 2015, and yet current commitments to cut emissions put us on track for 2.7°C warming, according to a recent report from the UNFCCC.

Just as Paris is remembered for finally bringing consensus to the 1.5°C warming target, Glasgow must be remembered as the COP where practical solutions to close the emissions gap were accelerated.

Accurate pricing of climate risk is the first step to ensure an orderly transition. Wall Street and the global financial system that has funded a fossil-fuel economy must now be at the heart of the transition to a net zero and resilient economy.

But accurate pricing requires transparent information. We are only at the frontier of understanding the financial impact that the huge social and economic transformation required to meet the 1.5°C Paris target and adapt to climate change will have on investors, industries, companies and countries.

Any investor today has to think about the financial implications of every major risk they're running in their investment portfolio. In our view, climate transition risk, i.e., climate-related changes to policy, market and consumer behaviors, is one of the largest risks for any investor.

Climate-related indices have proliferated in recent years. It’s a welcome trend, but they are unlikely to tell you much about the financial impact of policy or market changes beyond a price on carbon or carbon exposure, and they often rely on historical emissions data. Nor do they tell you much about structural shifts in consumer behavior.

We think that carbon exposure only accounts for a small proportion of climate-related financial risk, and using carbon as a proxy for risk may in fact distort the real picture for investors. Metrics that are both financial and forward looking provide a higher resolution view of risk and opportunity in the transition. Taking a bottom-up, asset-by-asset approach to company valuations provides a more meaningful view of what may happen to a company, industry or country during a transition consistent with the goals of Paris.

This approach reduces the capital allocation to companies with the largest transition risk, which reduces financial risk to investors. It facilitates the repricing of climate risks, allowing capital markets to align with government policy. It also increases capital allocation to the companies that stand to gain from the climate transition and hence offers potential for improved returns. Finally, it brings transparency at the company level, which helps identify what companies can do to mitigate climate transition risk and be a part of the solution.

Climate transition represents a huge addressable market but we recognize the urgent need to innovate practical tools that can enable organizations to transition to a climate-resilient economy and benefit society at large.

Understanding climate risk through a robust, forward-looking financial metric is the essential next step in that evolution that will ensure capital flows where it is needed in the climate decade ahead.


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