Translating climate risk into the language of investors

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15779530 - iceberg off the coast of greenland, atlantic ocean

A few decades ago, people were concerned about the depleting ozone layer. Then, in the late 1980s, the Montreal Protocol was ratified to phase out ozone depleting substances.

Fast forward to today.

The ozone hole is shrinking and is expected to completely close by 2060.

“That says to me that if you get policy makers, if you get business leaders and scientists together you can come to solutions to these kinds of problems,” said James Davis, chief investment officer at OPTrust.

Speaking at OPTrust’s climate change symposium on Nov. 20, 2018, Davis said that an investor’s role is to manage risk.

“We can get a handle on the risk of a recession, stock market volatility, even the systemic risk of a financial crisis that we experienced in 2008, but climate change risk is even tougher,” he said. “We know it’s real, we know it’s slow moving. Its impact is not expected to be felt for many years.”

Because for many investors, the typical investment horizon is within one to three years, investors may think climate change isn’t in their time frame, Davis said. But, with the spread of severe weather like the recent forest fires and floods, the impact is here now.

“We know, as investors in assets, that if there’s uncertainty and rising risk that eventually is going to get reflected in asset prices,” Davis said. “The market is a very effective discount mechanism.”

Despite this risk being real, Davis said that it is not being talked about more because responsible investing, or ESG professionals, are not speaking in the same language as investment professionals.

He highlights that OPTrust has a responsible investment committee with representation from every asset class. He said that when he first joined the committee the discussions were focused on compliance. “The conversations weren’t making this risk feel real,” he said. “The problem was there was no measure of the impact of climate change-related risks that an investor could relate to.”

“If we’re going to manage this risk we need to find a way to measure it,” he continued. So, OPTrust conducted a series of education sessions at the committee to better understand the economic and financial impacts of climate change on their portfolio and assets and engaged with partners. On example is that a partner presented them with a model to figure out a way to better measure climate related risks on earnings, which was focused on public markets.

“This was a wow moment,” said Davis because it allowed them to match climate change to an investor’s decision-making framework.

“The reality is that climate change has the potential to impact our ability to pay pensions,” said Davis.

He said plans need to price climate change risk into their investment decision process better than they currently do.

“Good thing is we are investors and we’re used to pricing risk. This is what we do all day long and, the fact is, if we can do this better than our competitors we might even have an edge.”

Davis said that they are still early in their journey and although there are climate risks there are also opportunities. “Risk and opportunity are often two sides of the same coin.”

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