3°C Transition Risks: It’s H2O, Not Just CO2

By Dharisha Mirando, Debra Tan 18 April, 2019

Heed warnings from CWR's Mirando & Tan to focus on both carbon + water risks as we head to a 3°C warmer world

Finally, 34 central banks and regulators recognise the vulnerability of financial systems to climate related risks in a new report out yesterday.

“It falls squarely within the mandates of central banks and supervisors” to ensure financial resilience it says. With this report, the Bank of England governor Mark Carney and France’s François Villeroy de Galhau wrote a stark open letter warning that “the catastrophic effects of climate change are already visible around the world” and “if some companies and industries fail to adjust to this new world, they will fail to exist“.

Of course climate change is a source of financial risk, how can it not be when we are heading to a 3°C world but planning to build resilience for 2°C?

But what does that mean in reality? It means we will have to deal with longer droughts, more intense & frequent floods, more damaging typhoons, as well as changing monsoon patterns and river flows affecting water scarcity. These are starting to happen today, for example, Manila had a 140 million litre daily water shortage, Cape Town implemented severe water restrictions on homes and businesses, and London’s water demand is expected to exceed its supply within the next decade.

A good start, but we need to fast track action on water…

The report acknowledges that the focus of transition risks has been carbon related. But it also recognises the physical aspects of rising water risks and says that more resources will be out toward addressing these risks in the future. This is great news, but we also have to keep in mind the water transition risk from policies implemented for a future with less/more erratic water supplies.

Just last week we released a report with Manulife Asset Management and the Asia Investor Group on Climate Change highlighting the physical and regulatory risks  from climate change for Asian pension funds, sovereign wealth funds and central banks. Are they invested in companies and industries that will “fail to adjust” and therefore “fail to exist“, as warned by the 34 central banks? More on this here.

Clearly the time to start assessing these risks now, but we’d like to see the mapping of water risk exposure happen faster. Here’s why:

Most corporates, investors & banks are solely focussed on the carbon transition risk…

… and are optimistic that we we won’t feel the “worst case scenario” physical impacts of climate change

We continue to be eternally optimistic, thinking that we can control and even reduce carbon emissions so that we won’t feel the “worst case scenario” physical impacts of climate change. Most corporates, investors and banks are solely focussed on the carbon transition risk, with governments implementing policies such as carbon caps and taxes to reduce carbon emissions. With the US aiming to pull out of the Paris Agreement by 2020 the implementation of these policies look less likely.

The impacts of climate change are already baked in to the system due to our past actions…

…we must thus start to focus on risks related to both carbon + water

Sorry to be a downer, but we need to be realistic. The impacts of climate change are already baked in to the system due to our past actions. We must thus start to focus on risks related to both carbon + water. Because while we reduce our carbon emissions to get temperature rises under control, common sense dictates that we should be prudent and adapt for the physical water and climate risks that we are already feeling. These will only likely get worse in the future, especially if the US does not behave!

Just in 2018 we saw the physical impacts from climate change, from Japan’s two-month ordeal of typhoons, floods and heatwaves and Hong Kong experiencing the strongest typhoon in the past 30 years. It’s difficult to argue that none of this was damaging to people and assets.

Coming soon! An inevitable disruption in finance…

Like it or not the financial landscape is evolving. We see the following key fundamentals shifting to meet this new climate reality:

• National regulations to protect water resources accelerate risks. China especially is implementing a variety of policies to clean up and ensure water, energy and food security for the long term, is causing disruptions to corporates and investors. We have been speaking to investors on the impacts of these physical and regulatory risks across multiple sectors. Much has changed over the last eight years so check out the Big Picture infographics for an updated at-a-glance view on water risks for: agriculture, power, metals & mining, food & beverage, textiles, and electronics . Or for a deep dive, with expert views and reports, check out “Intel by Sector”.
• Sovereign credit risk ratings could be affected by water risks. As we highlighted in our report “No Water, No Growth ” certain countries and regions are more exposed to physical water and climate risks. Unless they invest heavily in adaptation, lives, livelihoods and assets will be affected, which could downgrade sovereign risk ratings. Mercer just published a new report on climate change, and points out that the government bonds from certain countries such as Australia and New Zealand could be “more sensitive to the impact of physical damages and resource scarcity”. Some credit rating agencies have already started a dialogue with us in recognition of this. Climate change accelerates the impacts of water risks and lends urgency to figure this out sooner rather than later. The question is how do we start embedding this in to sovereign risk ratings – we have some ideas. If you’d like to get involved please contact us.
• Mainstream investment bodies and regulators are taking action. The report from the 34 central banks and regulators clearly shows that they are starting to consider these risks and want the financial sector to do so as well. So far on the whole they have not been explicit in their requirements for the physical and water transition risks but this could change sooner than we think. Let’s not forget that China already has a national policy to embed these environmental risks into credit lending.

Two other points to consider …

The burden will fall on the private sector to step up & not only invest in adaptation to protect existing assets…

 

…but also to think long term about spreading risks

• Where regulations lag, assets are more exposed as the government is not planning for the future physical impacts of water scarcity and floods, droughts, storm surges etc. For example, six Indian cities could suffer from acute water scarcity and pollution in the next 10 years if the situation is not managed. The burden will fall on the private sector to step up and not only invest in adaptation to protect existing assets but also to think long term about spreading risks by investing in different cities and locations given our current resource constraints.
• Adaptation is not easy and can be a hard-sell. Our new report highlights the need for greater adaptation because there is an investment lag. Even with so much at stake, adaptation investment can still be a hard sell as there may not be a clear revenue stream. Instead, the investment is about risk management for the long term protection of assets, business operations and people. Banks and investors withholding/withdrawing capital from vulnerable regions or companies until adaptation is in place could fast-track adaptation efforts.

Tycoons can lead the way in Asia …

The short termism in capital markets does not help adaptation investments. We spoke at a variety of conferences last week, including FT Investing for Good, RI Asia 2019 in Japan and the Risk Forum HK 2019. Many of the questions were about what we need to do to change this mismatch between short termism in capital markets and the long term foresight and risk management needed to plan for climate change.

A sizeable class of players in Asia are tycoons…

…wishful thinking but a handful of tycoons could really move the needle

We need Asian asset owners and banks to push for long termism; after all they are meant to be long term investors and they are sizeable. Another sizeable class of players in Asia are tycoons. Each control conglomerates with a stable of multiple listed companies and typically do not sell; when the market is down tycoons have been known to even buyback shares. Perhaps it is wishful thinking but action from a handful of tycoons could really move the needle!

Banks and pension funds need to make the correct investment decisions today…

… delaying will put our savings at risk and breach fiduciary duties

Banks and pension funds need to be prudent and make the correct investment decisions today, because the impacts of climate change are happening now, not in 2100. Delaying will put our savings at risk and breach fiduciary duties.

If you’re confused about what to do next, read the recommendations in our report or send us an email, we’d be happy to chat.

Like we said in “5 Trends” the spotlight for the year will be on protecting piggy banks. Interestingly, only five of the 34 of the central banks and regulators are based in Asia: they are Bank Negara Malaysia (Central Bank of Malaysia), Bank of Thailand, Japan FSA, Monetary Authority of Singapore and People’s Bank of China. The Hong Kong Monetary Authority is conspicuously absent – is Hong Kong relinquishing its role as a regional finance hub?

It’s up to us to ensure that we are prepared for 3°C so go bug whoever is managing your savings (especially if you’re in Hong Kong!). If we don’t act to protect ourselves who will?

Further Reading

• Are Asia’s Savings Exposed To Water & Climate Risks? – Asian asset owners have portfolios skewed towards domestic markets that will bear the brunt of climate change. Find out about these risks and what to do as our Dharisha Mirando shares key takeaways from the new report China Water Risk co-authored with Manulife Asset Management & the Asia Investor Group on Climate Change
• India’s Water Policies: Just Feel Good Documents? – Chetan Pandit, former #2 of India’s Central Water Commission, joins Professor Asit Biswas from the National University of Singapore in a “no holds barred” review on what’s gone wrong with India’s water management in the past 31 years
• Confronting Storms & Climate Risk In HK – Typhoons Hato and Mangkhut have wreaked havoc in the Greater Bay Area but Dr. Faith Chan from the University of Nottingham Ningbo believes these climate risks can be confronted, with Hong Kong leading the way
• More From Less: Building Water Resilience – Water and climate are really two sides of the same coin so what are the holistic solutions that can build resilience? Bluetech’s Paul O’Callaghan sat down with Ecolab & Aquatech experts to explore these and more
• Modern Water Dispensers: Shifting Consumers Off Plastic – With Hong Kong throwing away 5.5 million plastic bottles every day, Urban Spring’s Jennie Wong explains how their network of water refill stations could be the way forward

• Banking On Granularity To Reduce Climate Blindspots – Climate & water risks are locational but most financial institutions are flying blind, not having mapped their assets. Until they do, they & our savings are exposed. CWR’s Dharisha Mirando expands
• Financial Water Risk: A Unique Investment Opportunity – The first water risk index has been launched by TSC. Founder, Thomas Schumann, explains how the waterBeta model benefits investors and why we should mainstream water risk into portfolios
• Portfolio Water Footprinting: Investors’ Visual Path To Water Risk & Exposure – Pressure to mitigate & value water risk is rising. Ceres’ Investor Water Toolkit is one tool investors can use. Their Hugh Brown Jr. expands and shares their latest developments on visualising risk
• Have Investors Incorporated Climate Risks Into Portfolios? – Hear from WWF HK’s Jean-Marc Champagne & Sam Hilton on their new report that introduces climate change & financial risks to institutional investors, focusing APAC & the energy sector