‘Climate Change Analysis in the Investment Process’ is a significant report that explores the role of the financial industry in addressing the impact of climate change. Published by CFA Institute in September 2020, the report includes case studies of firms that are integrating climate-related analysis into their investment models.
The report also provides six recommendations – summarised in this article – for what practitioners and investment professionals need, to improve their understanding about the application of climate risk to financial analysis and portfolio management.
The physical and economic impacts of our warming planet are becoming clearer year by year. Global cost estimates reach into the tens of trillions of US dollars by the end of the century, with the potential to shave off one tenth of US GDP by that time if no actions are taken to forestall climate change.
To inform our understanding about how climate change is included in or omitted from the investment process, CFA Institute surveyed its community.
We found that – at present – only about 40 per cent of respondents incorporate climate change information into the investment process, although more than 75 per cent feel that climate change is an important issue.
The gap between these percentages seems to come from a lack of data and disclosure on climate risks from issuers, which we hope that the report and other work in this area can ameliorate.
As the Earth’s atmosphere continues to warm and the side effects of climate change become more prevalent, more pressure will be placed on everyone, including financial professionals, to take this into consideration. To do this important work, financial professionals would benefit from these six developments.
A price on carbon is an essential tool
CFA Institute agrees that a price on carbon is an essential tool in combating climate change, supported by a transparent pricing mechanism that enables financial professionals to reliably incorporate carbon pricing into their analysis of investments’ exposure to climate risk. CFA Institute believes that market-based mechanisms are the most effective way to develop and support carbon pricing.
CFA Institute calls on policymakers to ensure that regulatory frameworks for carbon markets are designed to deliver transparency, liquidity, ease of access for global market participants and similar standards across jurisdictions, in order to underpin robust and reliable carbon pricing.
Carbon price expectations included in analyst reports
A realistic market price on carbon will send a price signal that analysts need in order to properly value the externalities that come with greenhouse gas emissions.
CFA Institute recommends that investment professionals account for carbon prices and their expectations thereof in climate risk analysis.The externality of climate change has a cost, and that cost will be the future impact of climate change on our markets and society. Economists, investors, and policymakers who have studied the issue agree that a realistic price on carbon will allow markets to accurately price the impact of carbon on the world economy.
Increased transparency and disclosure on climate metrics
Investors should work with issuers to settle on the metrics that matter when assessing a company’s climate change strategy.
CFA Institute acknowledges that the investment industry is coalescing around the Sustainability Accounting Standards Board (SASB) and Task Force on Climate-related Financial Disclosures (TCFD) standards for climate-related disclosures – the most relevant and succinct climate-related disclosure standards for addressing the materiality of climate-related risks.
Engagement with companies to ensure thoroughness
Investors agree that climate change is an important issue, but lack of data and consistent disclosure around climate metrics are holding back climate-related analysis.
We believe investors should engage with issuers to ensure that climate data, scenario analysis and related disclosures are sufficiently thorough to support robust climate risk analysis in the investment process.
Education within the investment profession
Investors need to continue to educate themselves about climate change in order to provide clients with the climate-related analysis they need.
Policy that complements our efforts
Investors need to continue to urge policymakers to ensure that investors have the tools they need to do the work of finance – that is, the efficient allocation of capital that helps to tackle the existential threat of climate change.
The investment profession needs to incorporate the risks of climate change into financial analysis to efficiently manage portfolio risks and opportunities. With this research, we hope to educate stakeholders and advance the debate on climate change in our industry.
‘Climate Change Analysis in the Investment Process is a 64-page report from CFA Institute. >> To download the report click here.
By Matt Orsagh, CFA, CIPM, Senior Director, Capital Markets Policy at CFA Institute.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image credits: Getty / Ilka & Franz