Thursday, July 18, 2024

How climate change has impacted Financial Markets

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Climate change is having a significant impact on financial markets around the world. As the effects of climate change become more pronounced, investors are increasingly factoring in the risks and opportunities associated with climate change when making investment decisions. From the physical risks associated with extreme weather events to the transition risks associated with shifting towards a low-carbon economy, climate change is shaping financial markets in a variety of ways.

Financial markets refer broadly to any marketplace where the trading of securities occurs. They include the stock market, bond market, forex market, and derivatives markets. They are vital for the smooth operations of economies by allocating resources and creating liquidity for businesses and entrepreneurs.

Types of financial markets and how climate change impacted each:

Bond markets: Bond markets refer to the financial markets where the issuance, buying, and selling of debt securities like bonds occur. is the place to trade debt securities issued by governments or corporations to raise capital. It is a platform for companies and governments to raise capital by issuing debt instruments like bonds. 

The need to raise resources for climate finance has led to the innovation and development of green bonds.

A green bond This is a type of bond instrument where proceeds are applied to finance or re-finance new or existing green projects. Examples of these projects include Renewable energy, energy efficiency clean transportation, sustainable water management, climate-smart agriculture, forestry, and pollution control prevention. They help diversify the investor base of bond issuers, attracting new investors with climate mandates.

Insurance Markets: This includes the buying and selling of insurance and includes the entities involved in the process as well as customers. Insurance companies sell contracts that provide risk management to policyholders.

Climate change has created threats/risks and opportunities in the insurance markets. Examples of insurance climate opportunities includes:

Ensuring the net-zero transition: In high-emitting sectors, technology will play a crucial role in decarbonization efforts alongside changes in business models. These climate technologies are huge investments that will attract higher insurance premiums. Growth in decarbonization technologies and renewables represents a significant growth opportunity for insurers.

Insurers are presented with an opportunity of providing favorable policies on projected investment flows in renewable power assets and established green technologies. Insurers could play an important role in catalyzing new markets which are yet to be ventured. For example, insurers could accelerate the development of voluntary carbon markets by providing protection to both buyers and sellers.

Demand for insurance will grow in line with the level of investments in these technologies.

New opportunities will emerge for insurance to support derisking along the value chain, from manufacturing to deployment to production.

Creating new risk transfer solutions for rising physical risks: Insurers need to anticipate a high demand for parametric insurance covers as extreme weather increases in both frequency and severity. Many climate-related assets (eg solar and wind) are built in climate-exposed areas. In addition to coverage for natural catastrophes, parametric policies can be used for income loss on renewable assets 

Providing adaptation and resilience Services: Insurers and industry players may offer advisory services to manage and reduce clients’ exposure to climate risks and enable more effective responses to climate-related issues. Example of such services includes risk assessments, preconstruction risk advisory, and post-loss incentives to rebuild with improved resilience. The insurance industry could play a significant role in reducing risks and losses that are climate-engineered.

Risks In insurance

The insurance market is exposed to climate-related liabilities on two fronts: in both its investments and on the liability side through property-casualty and underwriting.

Liability Risks: Climate change could also expose insured entities to litigation and resulting damages from failing to comply with relevant climate change-related legislation or even failure to act. As a result, insurance undertakings may also be exposed to the resulting adverse liability losses

Transition Risks: The financial losses resulting from the transition from a carbon-based economy as insurers and insured adapts to climate change. An example includes redundancy costs and financial losses resulting from scaling down operations related to fossil fuel usage. Transition risks also capture the cost of complying with climate change-related legislation such as climate change financial risk disclosures.

One of the key ways in which climate change is affecting financial markets is through the physical risks associated with extreme weather events. As we have seen in recent years, hurricanes, floods, and wildfires can cause significant damage to homes, businesses, and infrastructure. This can lead to significant financial losses for investors, particularly those with exposure to real estate, insurance, and infrastructure assets. As a result, investors are increasingly looking to factor in the potential impact of extreme weather events when making investment decisions.

In response to these trends, there has been a growing interest in environmental, social, and governance (ESG) investing. ESG investing involves taking into account a range of non-financial factors when making investment decisions, including a company’s environmental impact reporting, and corporate governance practices. This approach to investing recognises that companies that are committed to sustainable practices are more likely to be successful in the long term, and can help to mitigate the risks associated with climate change.

Dr. Edward Mungai
Dr. Edward Mungaihttp://www.edwardmungai.com/
The writer, Dr. Edward Mungai, is a global sustainability expert. He is the Lead Consultant and Partner at Impact Africa Consulting Ltd (IACL), a leading sustainability and strategy advisory in Africa. He is also the Chief Editor at Africa Sustainability Matters. He can be contacted via mailto:edward@edwardmungai.com

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