For as long as I can remember, adaptation and resilience have been ugly ducklings of sorts in the broader climate conversation. To many climate advocates, focusing too much on measures to prepare society for the physical costs of climate change risked distracting from efforts to cut emissions. For businesses, assessing the actual costs of climate change was too difficult to measure and the damages seemed too far out.
Not anymore. Physical risk and resilience were on the tip of the tongue last week for many of the executives who gathered in New York for Climate Week. As climate change accelerates, the cost of its effects—which can snarl supply chains and shutter operations—have become increasingly apparent to businesses. Even still, the experts who work at the intersection of climate change and finance say that both companies and markets fail to grasp the extent of these risks.
“When we’re talking to our investment team, we sort of assume physical climate risk is already mispriced,” said Jamie Franco, the head of cross-asset research and sustainable investment at TCW Group, an asset manager, on a Climate Week panel held by MSCI. “It’s already in your portfolio. You’re sort of flying blind. You have to combine some of the data you have, which is imperfect, and think about it from the asset that you’re investing in.”
For companies, there’s no easy fix. First, addressing the issue requires future-oriented data and modeling that can clearly show where the risk lies. Even more difficult is gathering the institutional will to use a company’s limited capital on resilience efforts that pay off in future cost savings rather than the more immediate returns of big financial growth-oriented investments. But pressure to do so will come soon enough. As the costs continue to stack up, companies will feel increasing pressure from investors and other stakeholders to take the resilience challenge seriously. Companies that prepare ahead of time will be rewarded; those that don’t risk being forced to change only once the crisis gets to a breaking point.
On the surface, physical climate risks shouldn’t be that hard to understand. Hurricanes, wildfires, and inland flooding already cost the U.S. economy billions in damage every year. And we know the severity and frequency of those perils will only grow with time. “The links between climate change and the economy are just numerous,” Mark Zandi, chief economist at Moody’s Analytics, told me on a Climate Week panel I moderated. “Through inflation, through interest rates, through asset prices, through migration flows.”
Many of those costs will ultimately flow to companies. So why haven’t firms taken action commensurate with the scale of the problem? There are many ways to slice and dice the problem, from climate denial to human psychology, but for the purposes of this column I’m going to look at the problem from a simple economic lens. In short, even with risk lurking just around the corner, the economic incentives have yet aligned clearly for many companies, individuals, and municipalities.
Think about it through the lens of a hypothetical industrial company. While extreme weather may affect their facilities, it’s unclear when it will happen. Meanwhile, hardening facilities is expensive—and the money could be used for more lucrative ventures. Even a forward thinking CEO who looks beyond quarterly returns may encounter skepticism from the board or shareholders. And, in most sectors, they won’t receive any benefit in their credit ratings. Finally, in the event of a major catastrophe, they may be counting on their insurance policy to save them.
From the perspective of an investor who takes a broader macro lens, it may be clear that climate events will create economic headwinds. But data measuring which companies are best prepared remains nascent and hard to translate into the metrics that drive investment decisions. And, even when you can see risk on the horizon, it’s hard to know when the market will start to price it in.
But in New York last week it was clear that a mindshift is underway—at least for the set of companies and investors who made their way to Climate Week. Companies are starting to notice the costs of chronic climate issues—think of decreased labor productivity due to extreme heat or problems sourcing goods from the usual suppliers due to climate disruption. Financial institutions are talking about their investments in efforts to understand the risk facing their clients. And a growing number of investors are beginning to ask questions about the climate risk in their portfolios. “The demand is coming from investors, from stakeholders on the board, employees,” Lori Goltermann, CEO of regions, North America at AON, a global insurance broker and risk management company, told me on a panel.
Needless to say, unpacking how the climate risk and resilience landscape is unfolding requires more than a few Climate Week panels or a single newsletter. At the center of this issue, though, one of the most nagging challenges—for any company, investor, or even homeowner—is predicting how and when climate risk will get priced. On this question, there is little agreement. I have heard some suggest that it will only happen if and when a major climate disaster hits New York City, forcing a shake up in Wall Street and a rapid repricing of assets. Others say it will happen slowly over time, death by 1,000 cuts.
But what everyone can agree on is that they don’t want to be the one left holding the bag when it happens. And that will require preparation.
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