In the month since the International Panel on Climate Change (IPCC) 6th Assessment Report (Working Group 1) landed in inboxes, financial markets don’t seem to have taken any notice of its worrying conclusions. If, as the science warns, the real-life consequences are likely to be more devastating and intractable than the Covid-19 crisis (which saw a sharp initial sell-off), why do
At Tribe, we see a significant economic risk from rising temperatures and consequent rising sea levels and extreme weather patterns, yet we don’t envisage a sharp climate risk related market correction in the near term. We believe the change in markets, based on potential climate risks, is likely to be gradual, as policy measures are more widely adopted by governments and more widely acknowledged by market participants. Ahead of COP26, we believe now is the time for wealth and asset managers to position themselves for tighter regulatory and policy changes as a result of more widescale commitments and reforms pledged by countries around the world.
In the first report from Working Group 1, the IPCC brought forward the probability of global temperatures exceeding a 1.5 degree increase from the 2040s to
a 50% probability of this happening in the next 10 years 1International Panel on Climate Change (IPCC) 6th Assessment Report (Working Group 1)
For climate scientists, this represents an extremely serious acceleration of risk. Yet for financial, and especially stock analysts, the long timeframe coupled with the uncertain probability, hasn’t been enough to turn more negative on valuations, as estimates for companies’ earnings in the short term (which drives most valuation approaches) are not being materially affected – yet. In short, given that there has been no reduction in consensus earnings forecasts, there is no tangible reason for a re-pricing. Based on this, it’s difficult to think of any single event which could cause a market wide re-pricing as a result of increased perception of climate risk.
This is in stark contrast to February 2020, when the market reacted quickly to the economic consequence of the severity of the Covid-19 pandemic and the subsequent lockdowns in many markets around the world. In the four weeks following on from Italy’s lockdown in Lombardy on 20th February 2020, the MSCI Global Equity Index fell by a third. 2 Covid is a human health crisis, that required countries to lockdown in an attempt to control it. The economic impacts of those lockdowns were instant. Welfare systems were overwhelmed in a short period of time. People lost their lives, many businesses closed and global trade was disrupted.
We believe the primary driver will come from an improved Policy and Regulation framework to nudge the market into better behaviour. Changes in accounting practice will be important in driving more accurate disclosure, which could lead to changes in valuation approaches. We’ve recently seen the scale of the problem, with widespread lapses in climate reporting uncovered.
The work of the Impact Weighted Accounts Initiative at Harvard, developments with the International Financial Reporting Standards Foundation
Better Business Act (BBA)
The establishment of a global carbon tax, coupled with an increase in the reach and scale of emissions trading schemes (ETSs) will also help repurpose the system and ensure that companies begin to internalise the cost of their negative climate
Science Based Target (SBT)
These steps together can help unlock fundamental changes into how companies are assessed for value and should also catalyse a longer-term valuation approach from both management teams and asset and wealth managers.
This aligns to our investment approach, where our portfolios are positioned to channel capital into those businesses supporting a socially responsible and economically sustainable future. Our “
We see these changes coming and believe they will compel markets to begin to price in climate risk more accurately. Wealth and asset managers should respond now by building portfolios which exhibit greater earnings resilience as global regulations and investor awareness continue to grow.