How can you prepare for tomorrow’s climate, today?

Alex Birkin
By Alex Birkin

EY EMEIA Financial Services Consulting Leader and Managing Partner

Focused on creating the world’s leading transformation consultancy, trusted to help EY clients generate long-term value. Passionate about cars. Keen golfer. Husband and father of three.

Contributors

Isabelle Santenac

5 minute read 1 Dec. 2019
Related topics Financial Services Insurance Banking and capital markets Climate change and sustainability
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  • Climate change: The investment perspective

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The debate and investment in climate change has moved a long way since the adoption of The Paris Agreement in 2015, but, challenges and opportunities remain.

Today many organizations are acting to mitigate climate-related risks and capture opportunities arising from energy transition. Climate-related investing has also benefited from the rapid advance of sustainable investing.

Against this backdrop, the sheer complexity of climate change means that it remains one of the hardest sustainability topics for firms to respond to. Differences of political opinion are also apparent, with some jurisdictions questioning the need for action, while others urgently move ahead.

Nonetheless, we believe the last few years have been hugely positive for climate-related investment. See our 2016 report, Climate change: the investment perspective.

The growing interest in climate change

Overall, the regulatory landscape has evolved rapidly. The Financial Stability Board (FSB), the European Union (EU), central banks, national supervisors and the state of California are among those to have introduced mandatory or advisory initiatives. Public bodies seem to be increasingly proactive in shaping and even prioritizing sustainable investment, particularly around climate change. These efforts, along with a growing body of research, are driving financial institutions’ awareness of the risks and opportunities associated with climate change. Firms are also gaining an appreciation of the sectors, asset classes and financial instruments most likely to be affected.

Many investors have shown an increasing desire to factor climate change into their investments. The same view is gaining traction with, not just younger individuals, but also, many – if not all – institutional asset owners – as evidenced by growing fossil fuel divestments and commitments to green funds. One recent example is a major US public sector pension fund’s decision to commit $20bn to a sustainable investment-climate solutions investment program over the next decade.

This demand has led to a growing wave of action by financial institutions. Many leading banks, insurers and asset managers have committed to addressing climate change and are engaging with clients and investees. For example, one major European bank has begun taking steps to align its entire loan book with the emissions reductions required by the Paris Agreement.

In addition, a global insurer and pension fund were among the founders of “Net Zero Asset Owner Alliance”, and recently pledged to shift portfolios away from carbon-heavy industries.

Collectively, those of us involved in financial markets need to begin to think about climate risk the way we evaluate other more traditional financial risks. But this will take time.
Diane Larsen
Assurance Partner, Ernst & Young LLP

Taking ownership of real and long-term results

Despite this growing momentum, we’re still a long way from being able to say that climate-related thinking is truly integrated into everyday investment activities. For that to happen, we believe each segment of the investment value chain will need to enhance their clarity of beliefs and responses.

  • Asset creators. EY’s latest Global Climate Risk Disclosure Barometer shows that two-thirds of large corporates have begun to disclose climate change related data1. But too many major companies are not yet engaging seriously with the issue. Enhanced disclosure and clearer climate change strategies should be a priority. This applies to financial firms too. EY’s research suggests that asset managers have made less progress on climate-related disclosure of their own activities than banks and insurers.
  • Asset owners. Many institutional investors could do more to clarify their beliefs and investment appetites relating to climate change. Working with investment consultants, asset managers and others will help them to identify and manage potential risks and opportunities.
  • Asset managers and other financial institutions. Firms should clearly set out their view of climate-related risks, and how they plan to respond to these and other ESG factors through their core activities. Asset managers, for example, should disclose how they factor climate-related considerations into investment processes such as asset allocation and portfolio management.

Unfortunately, organizations’ efforts to achieve greater clarity continue to be challenged by the poor availability of consistent, reliable and detailed climate change data. Despite the efforts of governments and regulators, particularly the FSB’s Taskforce on Climate-related Financial Disclosure (TCFD), it remains to be seen how a global consensus on climate-related disclosure might emerge – or when this might happen.

These data headaches are further complicated by a lack of proven analytical techniques; by an absence of commonly agreed definitions and standards; and by the difficulty of end-to-end communication between end investors and their ultimate holdings.

A win-win future prospect

As we look beyond the adoption of The Paris Agreement, we are more optimistic that the financial services industry can achieve its own transition to more climate-aware operating models. For example:

  • The problems of disclosure are receiving attention from a growing range of supervisors, industry associations and professional bodies. Accounting standard-setters, such as the International Accounting Standards Board (IASB), could also exert influence in the future.
  • Regulatory change in many markets continues to gather pace. Key initiatives – such as the EU’s Action Plan on sustainable finance, which provides an ambitious roadmap for disclosure, taxonomy and governance – are still in their early days. Supervisors are also increasing their focus on potential climate change risks, as the UK Prudential Regulatory Authority’s plan to stress test insurers’ climate change resilience.
  • There are growing signs that major financial centers are actively competing to become future hubs of green finance issuance and expertise. For example, the EU’s High-Level Expert Group on Sustainable Finance will publish a package of recommendations in the summer of 2019 intended to shape future sustainable finance standards. And, Singapore recently launched a new multi-stakeholder forum aimed at creating an Asian hub for sustainable finance.
  • Investment techniques are becoming more sophisticated. The growing use of “tilting” and active stewardship show that many asset managers are developing more sophisticated and integrated approaches to climate-related factors.
  • Insurers have a unique opportunity to think and act differently using technology, real-time insight and deeper customer engagement to not only improve financial performance but also improve the lives of their customers and the planet as a whole. 
  • Despite persistent regional variations, investor interest in climate change is expanding beyond Western Europe, Canada and Australasia. Concerns over urban pollution in China could provide a significant future boost.

Above all, climate change momentum will accelerate as more financial services firms show leadership on the issue. Debate over the financial implications of climate change will continue, but the overall direction of travel looks increasingly clear.

This means that the earlier firms incorporate the issue into their everyday thinking and activities, the more likely they are to derive value from it. Instead of waiting for perfect information, firms should take a flexible approach to this fast-moving topic. We believe that every financial organization should do what it can to monitor the debate and embed climate-related considerations into ongoing decision-making.

Summary

The Paris Agreement pushed climate change firmly onto the financial services industry’s agenda. Since the landmark Agreement was adopted, firms’ levels of awareness, understanding and activity has leapt forward. Arguably though, the core challenges – and opportunities – remain largely unchanged. How will the next three years unfold?

About this article

Alex Birkin
By Alex Birkin

EY EMEIA Financial Services Consulting Leader and Managing Partner

Focused on creating the world’s leading transformation consultancy, trusted to help EY clients generate long-term value. Passionate about cars. Keen golfer. Husband and father of three.

Contributors

Isabelle Santenac

Related topics Financial Services Insurance Banking and capital markets Climate change and sustainability
Upvote