Climate Concerns Investors

Welcome back. In 2021, Swiss Re Institute, one of the world's leading insurance providers, conducted a climate-change stress test. The test examined how climate change would affect the economies of 48 countries, 90% of the world economy, by 2050.

The results: Carbon emissions could reduce global GDP from 4% if the Paris Agreement targets were met (temperature increase below 2°C ) to 18% if no mitigating actions are taken (3.2°C temperature increase). With no actions, the U.S. risked losing close to 10% of its GDP, Europe almost 11% and China nearly 24%.

In line with the potential economic impact, a recently published study sought to capture institutional investors’ concerns about climate risk disclosures by companies they have invested in. The researchers expected that, for investment decisions and pricing, the investors would want the companies to report detailed information on their climate risk exposure.

Institutional investors are companies or organizations that pool money to buy securities and other financial assets on behalf of individual investors or shareholders, buy in large quantities and are specialists with access to exclusive resources & research (from marketbusinessnews.com/financial-glossary/institutional-investor/ and www.sofi.com/learn/content/institutional-vs-retail-investors/).

Demand for Climate Risk Disclosures
The study’s international team of researchers were affiliated with the University of Texas at Austin, the National University of Singapore, the University of Geneva and Swiss Finance Institute, and the Frankfurt School of Finance & Management.

They approached the study through a survey of 439 institutional investors that would likely exhibit a stronger demand for climate risk reporting: those from countries with stewardship codes that develop principles for investors with regard to their portfolio firms, those from countries that reflect disclosure demand due to environmental norms, and universal investors that face externality risks and thus demand more information and could benefit from climate risk disclosure.

The survey asked the investors how important they consider companies’ reporting on climate risks to be compared to reporting on financial information.

- 79% considered climate risk disclosure to be at least as important as financial disclosure, while almost one-third considered it more important.
- 67% thought existing company disclosures were not precise enough.
- 73% believe that standardized and mandatory climate risk reporting was necessary.

The importance that institutional investors place on climate risk reporting by companies in their portfolios compared to reporting on financial information (Fig. 1 from academic.oup.com/rfs/article/36/7/2617/6978207?login=false).

To support the survey findings and further explore the relationship between firms’ climate risk disclosures and institutional ownership, the researchers examined carbon-related disclosure data from CDP (formerly known as the Carbon Disclosure Project). CDP is an international nonprofit organization that conducts an annual survey of companies’ climate-related data on behalf of institutional investors and other stakeholders.

The CDP data revealed that companies disclosed risks more fully if they had higher percentages of ownership from climate-conscious institutional investors.

Wrap Up
As climate change is increasingly considered to impact the financial system, sound disclosure of climate risks can be essential to protect financial stability. Toward that end, institutional investors are considered to be the most powerful financial mechanism to reduce climate risk exposures.

The study provides evidence that international institutional investors value and demand climate risk disclosures. Analysis of investors’ portfolio holdings shows a positive association between institutional ownership and improved climate risk disclosure, with limited exceptions because of costs to the companies.

Thanks for stopping by.

P.S.
Swiss Re Institute’s stress test analysis: www.swissre.com/media/press-release/nr-20210422-economics-of-climate-change-risks.html
Study of climate risk disclosure in The Review of Financial Studies journal: academic.oup.com/rfs/article/36/7/2617/6978207?login=false
Articles on study on EurekAlert! website and Texas McCombs Big Ideas newsletter:
www.eurekalert.org/news-releases/996861
medium.com/texas-mccombs/investors-want-climate-risk-disclosures-b05e78b63dfd
CDP website and Wikipedia review:
www.cdp.net/en
en.wikipedia.org/wiki/Carbon_Disclosure_Project