Framing Climate Change Risk in Portfolio Management

Policies to regulate greenhouse gas emissions caused by human activity are being developed and implemented in major markets around the world. Because these new policies bring with them costs as well as opportunities, prudent investors will factor climate change risk into investment decisions.

This report provides investors with a multidimensional framework for assessing climate risk in their portfolios. This tool stresses the competitive dynamics resulting from climate policies as the most important investment issue.

Different types of climate policies can have different effects on industries and on companies in the same industry. This report shows how the structure of these policies will shape companies’ competitive responses. Both policy design and competitive response will define the impact on company finances. Despite uncertainties, especially in the United States, investors can use existing financial techniques to discount the potential consequences of climate policies on the value of their investments.

Key Points

• Climate change presents industries and companies with both risks and opportunities. The framework explained in this report is intended to help investors identify and evaluate the impact of climate risk on their portfolios.
• Advances in scientific understanding of the causes of climate change are driving international, national, regional, and state policies to regulate greenhouse gases (GHGs). As more and more countries adopt policies to limit greenhouse gas emissions, pressures are building on the United States to do the same.
• For investors, GHG regulatory risk and its competitive implications are the most immediate and tangible aspects of climate risk.
• To accurately analyze the implications of climate policies, investors should consider how companies’ respond competitively to these policies and ultimately how this affects cash flows.
• Prudent investors will pay close attention to climate risk in the auto, electricity, and oil and gas industries. In evaluating their portfolios, investors can use existing financial techniques to reflect the risk of future climate policies. This consideration is particularly important in the United States, where lack of a federal climate policy leaves great uncertainty about the future regulatory environment.