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The Atlantic hurricane season, which begins in June and lasts throughout November, is upon us. Coastal homeowners have reason to be concerned. So do shareholders.
Until recently, reinsurers and banks assumed most of the market risk of climate change. Now things are changing. Individual companies are explicitly responsible for the risks of global warming. A court in The Hague has ordered Royal Dutch Shell to reduce its emissions. The International Energy Agency says energy groups must stop new oil and gas projects in order to achieve zero net emissions by 2050.
In fact, market sanctions for companies that make bad decisions about climate risk are broader than we might think. A Pentland Analytics report, “Risk, Reputation and Accountability”, watched several episodes of extreme disasters, including the 2017 hurricane season, which was the most expensive in U.S. history.
Deborah Pretty, the author, examined U.S.-listed companies with annual revenues in excess of $ 5 billion that revealed the financial damage from Hurricanes Harvey, Irma and Maria. Modeling its stock price reaction throughout the year, it found an average discount of 5% over the S&P 500 index, the equivalent of $ 18 billion in impaired shareholder value.
Pretty also delved into companies that had more than 10 percent of their global values of insured properties in an affected area, to see what precautions, such as flood or wind protection, they had taken. Among the companies that reported financial damage, less than half of the recommended measures had been completed. On the other hand, among those who did not report material economic damage, almost two-thirds of the recommendations were completed.
Bottom line? Market perceptions of the adverse outcomes of such natural disasters have “changed from bad luck to mismanagement,” says Pretty. Stock prices now reflect whether suite C is taking the risk of climate change seriously. In fact, Pretty’s research shows that the best-performing companies are those that consider resilience more important than balance sheet trading. In other words, they take every possible action to mitigate this risk, even if the models show that the risk is mild.
This may baffle economists, but, as one engineer interviewed in the study said, “Look, if you have four holes in your boat and plug three, you’ll still sink!” It is part of the argument for resilience over economic “efficiency”, which influences not only climate-related disaster preparedness, but also supply chains (companies are starting to make them shorter) and cyber risk. Pretty notes that between 2010 and 2020, ill-prepared companies that suffered cyber attacks had a yield of less than 20% of the market the year after the attack.
If regulators have their way, these risks will be more explicit, especially when it comes to climate. G7 leaders last week announced its commitment to mandatory climate-related financial disclosures, based on those recommended by the G20 working group on climate-related financial disclosures. This provides a roadmap on how to integrate climate risk metrics into government and corporate strategy.
Europe has made more progress than the United States in forcing companies to do so reveal this risk. In Washington, the best-placed body to create and enforce this regulation would be the Securities and Exchange Commission. But under President Donald Trump, the SEC loosened regulation in general and made no mention of the weather. The U.S. government continues to subsidize coastal flood insurance, even as cities like Miami explore building multimillion-dollar walls to curb the rising tide.
If the Biden administration has its way, that will change. The SEC, now led by ambitious regulator Gary Gensler, has just gathered public comments on ESG reporting rules. Diu Gensler it wants to bring “consistency and comparability” to what companies report. This could mean industry-specific standards for emissions reporting, as well as information on how many properties a company has on the waterfront or prevention measures they have taken around floodplains.
Some activists are betting on extremely granular disclosures about water insecurity, thermal stress and the extent to which companies could be affected by disease, political unrest and migration. A February Center for American Progress report, co-author of Andy Green (now senior advisor to the U.S. Department of Agriculture for Fair and Competitive Markets), outlines the potential range of future information requirements.
If companies are forced to quantify their ESG footprint in a way that facilitates the comparison of the efforts of individual sectors and companies, it is difficult to exaggerate what the impact of the market may be. Exposure, for example, of a clothing manufacturer to agricultural production (and the consequent potential for crop damage due to drought, heat, or pestilence) could dramatically affect shareholder value. A carbon price could change the calculation of some exporters, making activities such as remote shipping of heavy machinery much more expensive. Asset managers who have too much investment in high-carbon sectors could find themselves in breach of their fiduciary duties.
When hurricane season begins, we may be in a maritime shift in markets and climate.
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