KUALA LUMPUR (April 18): Trillions of dollars in financial assets will be at risk if the global climate gets warmer. According to a new study on the value at risk from climate change — or climate VaR — by the Grantham Research Institute on Climate Change and the Environment and Vivid Economics, about US$2.5 trillion ($3.4 trillion), or 1.8%, of the world’s financial assets, will be at risk if the global mean surface temperature rises 2.5°C (4.5°F) above its pre-industrial level by the year 2100. 

Climate change is of great concern to governments around the world, as temperatures continue to rise. In December last year, the UN Climate Summit in Paris established that temperatures should not be allowed to rise more than 2°C as that was the danger limit. 

The summit saw 200 countries sign the “Paris Agreement” in a collective effort to cut emissions beginning 2020. A key point in the agreement was keeping global temperatures below the 2°C threshold, with efforts made to limit the increase at 1.5°C. 

The study says staying within the 2°C (3.6°F) limit will significantly reduce the climate VaR. An average of US$1.7 trillion in global financial assets will be at risk if the world fails to stay within the threshold, with a 1% chance of US$13.2 trillion being at risk.

“Our results may surprise investors, but they will not surprise many economists working on climate change because economic models have over the past few years been generating increasingly pessimistic estimates of the impact of global warming on future economic growth. But we also found that cutting greenhouse gases to limit global warming to no more than 2°C substantially reduces the climate VaR, particularly the tail risk of big losses,” says Professor Simon Dietz, one of the authors of the study.

Limiting global warming to 2°C will see governments incur more costs. But the researchers say that even after factoring in the price of reducing greenhouse gas emissions, the average value of global financial assets will be 0.2% higher, or valued at US$315 billion. This figure would be higher if efforts were not made to reduce the impact of climate change.

“When we take into account the financial impact of efforts to cut emissions, we still find that the expected value of financial assets is higher in a world that limits warming to 2°C. This means risk-neutral investors would choose to cut emissions and risk-averse investors would be even more keen to do so,” says Dietz.

He adds that the risk of climate change to investment returns in the long run should be an important issue for all long-term investors such as pension funds and financial regulators.

While this is the most comprehensive estimate so far of the climate VaR, Dietz says there are still uncertainties and difficulties in performing the economic modelling of climate change. The researchers note that the impact of climate change on financial assets has rarely been researched.

“Yet, if the economic impact of climate change is as large as some studies suggest then, because financial assets are ultimately backed by economic activities, it follows that the impact of climate change on financial assets could also be significant,” says the study.

The researchers name two ways the value of assets can be impacted. The first is through direct contact, where depreciation can happen through its connection with extreme weather events. “Second, it can change (usually reduce) the outputs achievable with given inputs, which amounts to a change in the return on capital assets, in the productivity of knowledge, and/or in labour productivity and, hence, wages.”