Climate change: FSA warns of risk, predicts opportunities

The Financial Services Authority (FSA) has stated in its Financial Risk Outlook 2007 report that climate change poses “considerable risks and challenges to the financial sector”.

The report predicts that climate change will put companies’ operations and physical assets at risk through increasingly frequent and extreme weather events such as hurricanes, typhoons and flooding in coastal areas – of particular concern to financial centres like London, New York, Hong Kong and Tokyo which all have costal locations. The increased use of offshore centres for outsourced financial services will further expose the financial system to the effects of rising sea levels.

The FSA observes that such changing operating conditions for businesses will drive the emergence of new financial products which will allow hedging against climate change impacts or improve the reputation of businesses, which will be seen to be “green”. However the products will also involve significant risk.

“The climate and weather forecasting models that are used to value weather-dependent financial instruments are highly reliant on the accuracy of data and models. A key feature of weather and climate change is that it is highly unpredictable,” says the report.

The FSA warns “it is important that firms understand the risks involved with these products and manage their portfolios appropriately. Firms that are not seen to be acting either in the best interests of consumers as the external environment changes or ensuring that they minimise their climate impact could face severe reputational risks.”

A recent report by UBS (Climate Change: Beyond Whether) stated “Investors who seek to incorporate climate change risks and opportunities into their portfolios have a number of available options that span a wide range of asset classes...there are opportunities, in our view, to directly benefit from climate change mitigation by investing in companies exposed to renewable and low-carbon energy production and energy efficiency.”

The UBS report goes on to say “investors can target theme funds focusing specifically on climate change mitigation, as well as a range of equity baskets, certificates, and indices on specific investment areas, such as white biotech, photovoltaics, and biofuels. Investors may also access unlisted renewable or energy efficiency companies by investing in the growing number of venture capital firms and private equity funds focused on environmental technology.”