How Will Climate Change Continue to Impact on the Financial Landscape?

For the vast majority of us, the concept of climate change is one that comprises of both ideological and theoretical elements. Those who are active in the commercial world must also consider this as a core business issue, however, and one that will continue to impact heavily on the financial and economic landscape.

At the heart of this shift is the Paris Agreement, and more specifically its stipulation that global warming must be kept below 2 degrees Celsius.

This will drive substantial reductions in global greenhouse gas emissions over the course of the next three decades, with economies, investors and businesses required to reduce their carbon integrity during this time. So how will this impact on the financial landscape, and particularly the interests of investors across the globe.

How Will Climate Change and the Switch to a Low-carbon Economy Force Investors to Adapt?
In simple terms, the transition to a low-carbon economy will mark a decisive shift away from fossil-fuel energy and its related physical capital. There is no doubt that such a transition must be managed efficiently, but even then the risk to investment portfolios is considerable and particularly hard to ignore.

This risk can be measured in two key stages, with the first being the macroeconomic impact of sudden changes in energy use. We have already seen the price of crude oil decline by around 50% in recent times, for example, thanks largely to fact that supply has continued to outstrip the falling levels of demand. As we see the managed transition from this type of fossil fuel to more sustainable energy forms, the value of oil will fall further as it loses its viability as a lucrative asset class.

From a macroeconomic perspective, however, the falling cost of oil will reduce the cost of living for the foreseeable future, potentially boosting investor sentiment and empowering traders to seek out more sustainable assets. So while virtual trading platforms such as LCG host various indices, emerging alternatives like the MSCI Low Carbon Indexes help investors to identify the risks associated with a transition to a low-carbon economy while appraising carbon exposure and performance of sustainable asset classes.

Clearly, the declining price of oil and similar fossil fuels will divert investors attention elsewhere, while potentially lowering the cost of living and boosting economic sentiment. The sudden depreciation or revaluation of carbon-intensive assets can significantly undermine investor portfolios, however, primarily as individuals do not have the opportunity to adapt or diversify their efforts in time. With this in mind, it makes sense for investors to manage their own transition to a carbon-friendly portfolio, including shares in companies that are developing sustainable technology.

This also raises the issue of market exposure, which instantly increases the level of risk facing individuals trades and overarching portfolios. This means that prices can move sharply and at a rate that is disproportionate to the prevailing economic climate, even in instances when the transition to sustainable energy is relatively smooth. Some initial estimates have suggested that affected energy and fossil fuel shares could lose up to 40% of their underlying value in the best case scenario, so there is a pressing need for investors to begin diversifying their portfolios now and before price volatility takes hold.

The Last Word: Embracing Change in a Proactive and Progressive Manner
In recent times, we have seen numerous studies that have sought to assess the exposure of the financial markets to climate policy shifts. Regardless of these investigations, however, the most important thing is that investors take a proactive approach to embracing sustainability and diversifying their portfolios. More specifically, it is crucial that investors begin to transition away from high carbon-intensity assets and begin to deal in new and disruptive technologies that are helping to minimise emissions across the globe.