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Climate change as an investment risk

There is growing recognition that rising global environmental and social risks will impact companies’ ability to operate and return value to shareholders and other stakeholders, says Amanda Young, head of Responsible Investment, Standard Life Investments

 

At the beginning of the year, all eyes were on the annual World Economic Forum (WEF) meeting in Davos and the discussions between 2,500 of the world’s political and business elite. While the global economy, conflict and political instability were key areas of focus, a number of social and environmental challenges were high on the agenda. Prominent leaders, such as Al Gore, highlighted that environmental issues, such as water, will continue to challenge the world and its companies. Indeed, in his opening presentation, the former US Vice President urged leaders to act fast to avert a climate change disaster. Although the threat is increasing, uncertainty remains around the ability to achieve international collaboration to address this issue. Economic and social problems featured prominently too, with many discussions referring to the growing problem of wealth inequality.

During this event, the WEF released its Global Risks Report. This year’s paper highlighted the fragility of societies fuelled by economic, environmental and social developments. It drew on the perspectives of almost 900 members of the WEF’s multi-stakeholder community, dividing risks into two groups, in terms of likelihood and in terms of impact (See Chart 1 and 2).

SLI Chart 1aThe 2015 report provided an overview of 28 global risks which fell into five categories: economic, environmental, societal, geopolitical and technological. Being the 10th edition, this year’s report provided an interesting insight into how the views of stakeholders have changed over the past decade.

Surge in environmental risks

Perhaps the most striking takeaway from this report was the increase in awareness around the threats posed by environmental change. Five years ago, environment risks were yet to appear in the top five risks likely to happen. Then, in the 2011 report, four of the top five risks were environmental, including storms and cyclones, flooding, biodiversity loss and climate change. This report was published nine months after BP’s Gulf of Mexico oil spill, which may have played a role in the change of perceptions. However, every report published since 2011 has included environmental risks in the top five risks, both in terms of likelihood and in terms of impact.

SLI Chart 2aAnother noticeable feature of the report was that water crises were identified as the most serious global threat in terms of impact on business and society in 2015, ranking higher than the proliferation of weapons of mass destruction, energy price shocks and infectious disease. While the underlying facts are not new, what responsible investors have witnessed over the past few years is the recognition that environmental and social challenges are increasingly likely to have an impact on business and society.

This is certainly true for socio-economic challenges which have also generated considerable interest this year across the world and include employment, access to basic services, health and education.

Returning to the Global Risks Report, it was also interesting to note the considerable difference in opinion between those respondents aged below 30 and those above. While there seems strong consensus over the type and likelihood of risk, most younger respondents viewed these risks as having a greater impact on society than the older respondents. In particular, the difference appears greatest when assessing environmental risks, such as biodiversity and ecosystem collapse, failure of climate change adaptation and extreme weather events.

Impact on shareholder value

The risks highlighted at Davos can threaten society and economic stability, and in turn create challenges for global corporations. Companies need to respond to rising global risks, and indeed many large multinationals have shifted in how they view the world’s societal challenges. There is a growing recognition about how these risks will have a bearing on their ability to operate and return value to shareholders and other stakeholders. Interestingly, one slightly reluctant guest at Davos was the director of Greenpeace, a non-government organisation (NGO). Greenpeace spends much of its time taking companies to task over the way they operate. Even these NGOs have witnessed a sea-change in attitude among some companies regarding how they treat the environment and communities that affect their operations. This has provided an opportunity for NGOs, like Greenpeace, to speak and work with companies on issues such as deforestation, hunger and human rights. Clearly, there is some way to go; not all companies demonstrate the same willingness to address environmental and social issues as part of business. However, it will be increasingly important for companies to do so, and for responsible investors to support them.

Large multinational companies operating across the world need to recognise they cannot operate in isolation. How their employees view them has a direct link to staff motivation and productivity. We live in a world of finite resources. As such, gaining and maintaining access to those resources will be essential. Irresponsible companies, focused on the short term gain and no consideration for the environment and communities in which they operate, are likely to find significant challenges to ensuring access to natural resources, minimising the impact of greater regulation, protecting their reputation and continuing to deliver returns to shareholders.

As the Millennial generation (those born between early 1980s and early 2000s) takes greater responsibility for investments, increased expectations will be placed on multinationals to address all risks within business. Companies will need to place a greater emphasis of how they manage all risks within the business environment, including those such as climate change.

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