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Extreme weather poses significant portfolio risks

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Climate change could wipe out the value of 50 per cent of the value of some institutional investors’ infrastructure portfolios before 2050, yet these risks are neither fully understood nor properly priced in, according to the EDHEC Infrastructure and Private Assets Institute.

Frederic Blanc-Brude, EDHEC Infrastructure & Director, Scientific Infra & Private Assets Private Assets Institute, says that current approaches to understanding the physical risks of extreme weather events on assets including toll roads, airports, power plants and pipelines, are short-sighted and fail to factor in the likely severity of future floods and storms.

This, Blanc-Brude says, is a particular issue since – following significant encouragement by governments worldwide – current allocations to infrastructure exceed USD4 trillion.

He says: “Many regulators and national authorities are encouraging pension funds to increase their investment in this attractive asset class. It should nonetheless be recognised that regarding climate risk, and notably physical climate risk, the data on the exposure and the financial materiality of this risk being realised for private assets is fairly limited.”

Typically, according to Blanc-Brude, investors assess risk based on an overlay of hazard data based on todays’ weather days which is applied to the near vicinity of their assets, which is used to calculate a risk score, that is reported under the Task Force on Climate-related Financial Disclosures. 

“This approach offers no sense of the real physical risk to the asset. There is no granularity, there is no future climate risk scenario and there is no valuation of the risk just a score.”

EDHEC offers in depth analysis of severe weather risk for unlisted infrastructure investment based on what Franc calls “a very granular database of asset-level physical risk estimates and financial data” based on a universe representing approximately USD4.1 trillion of enterprise value and USD2.2 trillion of market capitalisation at current market prices in 25 key markets.

Looking at both exposure to key weather events today and the increasing risk from climate change in the future, EDHEC projects the impact of the asset’s future cash flows and discount rate

The infraMetrics data finds that “the impact of runaway climate change on the value of infrastructure investments before 2050 is significant”.

Blanc-Brude says: “We also find that if no serious measures are taken, financial losses from physical risk – which are never zero – would be twice as high than in a low carbon scenario, for all investors.”

Blanc-Brude says investors should not underestimate the importance of physical risks on their infrastructure portfolio over the next 30 years, adding: “These risks can be managed but first they need to be documented.”

The latest report from EDHEC follows an open letter sent to the European Insurance and Occupational Pensions Authority (EIOPA) this August calling on the regulator to alert investors to the risk of climate change on their portfolios.

Blanc-Brude wrote: “Without action from all stakeholders, including regulators and governments, climate change will have a very significant impact on the value of investments. EIOPA’s favoured position as an advisory body to the European Commission, the European Parliament and the Council of the European Union will allow you to draw attention to the impact that a lack of climate action can have on the stability of the pensions and insurance system and on financial stability more generally at a time when institutional investors are playing an increasingly important role in the financing of infrastructure.”

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