Adding Environmental Risk to the Financial Equation

Despite projections, many financial analysts ignore the risks and opportunities associated with environmental trends. ENVEST seeks to change this.

Climate change and other environmental trends can have a major impact on companies and industrial sectors. Recently, the SEC advised publicly held companies to inform investors of any potential risks of climate change. This guidance comes at a time when nearly half of global money managers are ignoring climate change risk completely when they make their investment decisions, according to a recent survey. Why?

Investment and Environmental Risk

Environmental data, even when available, does not fit neatly into the financial models that investors commonly use. Environmental trends are complex and have a long time horizon, making them difficult to accurately quantify and predict. As one analyst put it, “If it’s going to be a problem in 2025, tell me about it in 2024.”

Even with these challenges, financial analysts are starting to realize that they will have to change their approach to environmental issues if they want to keep on top of risks facing companies. A better grasp of risk will translate into better (and more sustainable) investment decision-making. That’s why WRI's ENVEST has been producing research for over 10 years that explores innovative ways of overcoming the inherent challenges in analyzing environmental trends for a financial audience.

ENVEST Work in the Food and Beverage and Asian Power Sectors

ENVEST’s upcoming report on the food and beverage sector in Asia uses scientific climate change predictions about projected crop yield to analyze potential risks. For example, a climate change induced crop price increase of 1% would have a sevenfold impact on the profitability of a sugar company.

In its upcoming report on the Asian Power sector, ENVEST uses geographical information systems (GIS) maps that show the intensity of water scarcity in certain geographic areas overlaid with locations of current and planned power generating facilities. The mapping shows that over half of existing and planned capacity for major power companies, representing 74GW, is located in areas that are already considered water scarce or stressed.

Both reports also identify the risk factors that would make companies in these two sectors vulnerable to environmental trends, and support investors in engaging with companies about how they are positioned to manage these risks by providing guiding questions.

From Financial Risk to Opportunity

ENVEST is constantly exploring new ways to move research forward in this field, both by looking at expanding the traditional focus from equity to debt markets and from risk to opportunity, and by looking at evolving analytical approaches. Past ENVEST work has used techniques such as peer-to-peer exposure ranking within a sector (2004's Changing Drivers on the automotive sector) and mapping of company assets in environmentally sensitive areas (2002's Changing Oil on the oil and gas sector).

Though there is a way to go before environmental trends analysis becomes a mainstream practice in the financial community, we believe that markets that fully account for environmental risks will ultimately shift capital to companies and projects with sound environmental strategies. ENVEST is working to contribute research and ideas to continue the evolution of this vitally important space.