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SUPPORTEDBY:Inpartnershipwith:HEALTHWEALTHCAREERINVESTINGINATIMEOFCLIMATECHANGECONTENTS21345671.
FOREWORD012.
EXECUTIVESUMMARY053.
KEYMOTIVATIONFORINVESTORACTION194.
INTRODUCTION215.
RISKFACTORS276.
SCENARIOS337.
ASSETSENSITIVITY418.
PORTFOLIOIMPLICATIONSANDINVESTORACTIONS599.
CLOSINGREFLECTIONS7710.
ACKNOWLEDGEMENTS7911.
APPENDIX1—CLIMATEMODELS8312.
APPENDIX2—SCENARIODETAIL9113.
SELECTBIBLIOGRAPHY10114IMPORTANTNOTICES10389101112131401FOREWORDWeareexcitedtosharethisreportwithyou.
Itbuildsonourcommitmenttorevisitourgroundbreaking2011study1anditsfollow-uppaper,ThroughtheLookingGlass,2andtoacceleratetheevolutionofclimateriskmanagement.
Theinternationalcommunitywillnegotiateanewglobalclimateagreementattheendof2015inParis.
Withthisreport,Mercerandourstudypartnersaimtohelpassetownersandinvestmentmanagersincreasethesophisticationwithwhichtheyconsidertheimpactofclimate-policychangesandrelatedfactorsontheirportfolios.
Forinvestorswhoassumethatthefuturewillcontinuetomirrorthepast,thefindingsmayholdsomesurprises.
Forclimate-awareinvestors,thisstudyprovidesinformationonriskandopportunityprioritiestoincorporatewhenbuildingtheirtotalportfolios.
Forpolicymakersinthelead-uptotheParisnegotiations,thefindingsreinforcetheroleofpolicysettinginmobilisingcapitalforthelow-carboneconomy.
Asimilarapproachtothefirststudyhasbeenfollowed:acollaborationfocusedontheimpactofclimatechange,identifyingthescenarios,riskfactors,andinvestmentmodellingmethodology.
Thisallowsinvestorstobebetterinformedtoidentify,assess,andactonclimatechangewithintheinvestmentprocess.
However,amoredynamicmodellingapproachhasbeenusedthistimetoincorporatefourclimatescenariosandfourclimateriskfactorstoestimatetheimpactonreturnsforportfolios,assetclasses,andindustrysectorsbetween2015and2050.
Thissector-leveldetail,togetherwithupdatedscientificdatapointsandanimprovedabilitytoquantifypotentialphysicalimpacts,enhancesthefirststudysignificantly.
DebClarkeGlobalHeadofInvestmentResearch,MercerINVESTINGINATIMEOFCLIMATECHANGE1Mercer.
ClimateChangeScenarios—ImplicationsforStrategicAssetAllocation,2011,availableat:http://www.
mercer.
com/content/dam/mercer/attachments/global/investments/responsible-investment/Climate-change-scenarios-Implications-for-strategic-asset-allocation.
pdf,accessed8April2015.
2Mercer.
ThroughtheLookingGlass:HowInvestorsAreApplyingtheResultsoftheClimateChangeScenariosStudy,2012,availableat:http://www.
mercer.
com/content/dam/mercer/attachments/global/investments/responsible-investment/Through-the-looking-glass-January-2012-Mercer.
pdf,accessed8April2015.
213456702Manymindshavebeeninvolvedinthiscollaboration:Mercer'sInvestmentsteam;oursistercompaniesNERAEconomicConsultingandGuyCarpenter;16asset-ownerandasset-managerpartnersfromaroundtheworld;twopublicpartnersconnectingourindustrytopolicyanddevelopmentcontexts;and13advisory-groupmembers.
Wehaveunderstoodforanumberofyearsthatclimatechangepresentsaseriesofriskstoinstitutionalinvestors,whomanagetrillionsofdollarsincapitalgloballyforpensionfundmembersandindividualsavers,endowments,foundations,andinsurers.
Forthefiduciariesoverseeinginvestments,climatechangeposesportfoliorisksbutalsoopensupnewopportunities.
Thisisbecausethenecessaryreductionincarbonemissionswillrequireafundamentalchangeintheenergymixthatunderpins,tosomeextent,everyinvestmentinaportfolio.
Morethantwocenturiesofeconomicdevelopmenthasbeensupportedbyaccesstocheapfossilfuels.
Thetransitiontoalower-carboneconomyhasbegun,butweexpectthespeedoftheprocesstoincrease.
Evidenceofthepotentialimpactsthatemissions-relatedtemperatureincreaseswillhaveonresourceavailability,physicalassetdamage,andhumanhealtharedrivingtheneedforpolicyaction.
Thisstudyhasidentifiedfourscenariosdeemedmostrelevanttoinvestors,butwerecognisethatotherscenariosmayeventuateinthefuture.
Althoughthetimingandmagnitudeofpotentialclimateimpactsareuncertain,enoughisnowknowntoenableinvestmentfiduciariestoincorporatebetterclimategovernanceintheirinvestmentprocesses.
Thekeyfindingsfromthisstudycanhelpinvestorstobuildresilienceintotheirportfoliosinatimeofchange—identifyingthe"what",the"sowhat",andthe"nowwhat"forassetownersandthewiderinvestmentindustry.
PartnerscollectivelyrepresentingoverUS$1.
5trillionparticipatedineachstageofthestudy,gainingadditionalinsightsintoanappropriateresponsetothefindings,specifictotheirportfoliosandorganisations.
Thepartnergroupintendstoreconveneinthefirsthalfof2016toreviewdevelopmentsanddiscusshowtheyhaveappliedtherecommendationsintheirportfolios.
InMercer'sInvestmentsbusiness,weplacestrategicpriorityonhelpingourclientsbecomemoreeffectivelong-terminvestors.
Climatechangefitsnaturallywithinthiscontext,andwebelievethisstudywillcontributetowardsbetterpreparingglobalinvestorsforchange.
DebClarke89101112131403"Institutionalinvestorsrequireactionableinformationtoadequatelyreflectclimaterisksandopportunitiesintoassetallocation.
Whileglobalwarmingisafact,wefacegreatuncertaintyaroundpolicymeasuresandthefinancialimpactsinthenearertermarelittleunderstood.
TheMercerstudyisanimportantstepinchannellingscientificandregulatoryinsightsonclimatechangeintotheinvestmentprocessandcouldbecomeastandardtoolboxforthestrategicassetallocation.
"KarstenLffler,ManagingDirector,AllianzClimateSolutionsGmbH"Themulti-scenario,forward-lookingapproachtothisstudymakesitunique.
Investorswillbeabletoconsiderallocationoptimisation,basedonthescenariotheybelievemostprobable,tohelpmitigateriskandimproveinvestmentreturns.
"BrianRice,PortfolioManager,CalSTRS"TheChurchofEnglandNationalInvestingBodieshaveadoptedaclimatechangepolicywhichrecognisesclimatechangeasanurgentethicalissuewithimportantfinancialimplications.
Inourpolicywesaythatwewanttobeattheforefrontofinstitutionalinvestorsaddressingthechallengeoftransitiontoalowcarboneconomy.
Ourparticipationinthisstudyhasenabledustogrowourunderstandingoftheinvestmentimplicationsofclimatechangeandtoconsiderwaysinwhich,asinvestorsworkingwithothers,wecanhelppreventdangerousclimatechangeoccurring.
"EdwardMason,HeadofResponsibleInvestment,ChurchCommissionersforEngland"Cbusseesclimatechangeasasignificantissueforourinvestmentportfoliooverthelongerterm.
Webelievethatparticipationinthisstudygivesusinsightsintotherangeofimpactsthatclimatechangemayhaveonourinvestments,andenableustobetterpreparefortheclimatechange-relatedchallengesahead.
"KristianFok,ExecutiveManagerInvestmentStrategy,Cbus"Asalong-terminvestor,theEnvironmentAgencyActivePensionFundrecognisesthatclimatechangeisafinanciallymaterialrisk.
WehaveintegratedthefindingsarisingfromthepreviousMercerstudyinsettingtheFund'scurrentinvestmentstrategy,andparticipatinginthisupdateallowsustobuildonourexistingapproachtomanagingclimaterisk.
Byadoptingastrategicassetallocationthatisrobustinincorporatingboththerisksandopportunitiespresentedbyclimatechange,wewillcontinuetoactinthebestlong-terminterestofourmembers.
"DawnTurner,HeadofPensionFundManagement,EAPF"Theresultsfromthe2011climatechangestudythatweparticipatedinshowedthatclimatechangemayhavelargeimpactsonourinvestmentportfolio.
Therefore,wehaveparticipatedinthefollow-upstudytofurtherdevelopourknowledge,ourmethodsandourriskmanagementregardingclimatechange.
"MikaelAngberg,CIO,AP1"Asalong-term,intergenerationalinvestor,weneedtounderstandtheinvestmentrisksandopportunitiesassociatedwithclimatechange.
Thisstudywillhelpuscalibrateourinvestmentstrategiesaccordingly.
"AdrianOrr,CEO,NZSuper"StateSuperFinancialServicesrecognisestheimportanceofunderstandingclimatechangeriskstoourinvestmentportfoliosandweidentifiedthisstudyasanopportunitytomeetthisobjectiveandfurtherdevelopourbroaderESGapproachforourclients'benefit.
"JoCornwell,InvestmentSpecialist,StateSuperFinancialServices"Climatechangeforcesinvestorsinthe21stCenturytoreconsiderourunderstandingofeconomicandinvestmentrisk.
ThisstudyprovidestheNewYorkCommonRetirementFundwithvaluableinsightsthatwillinformoureffortstomanageclimateriskandbuildoutourportfolioinwaysthatprotectandenhanceinvestmentreturns.
"NewYorkStateComptrollerThomasP.
DiNapoli,TrusteeoftheNewYorkStateCommonRetirementFund"Thisreporthighlightsthatinvestorsshouldseetheopportunitiesinadditiontotherisksfromclimatechange.
Thetidesareturningtowardalowcarbonfutureandawayfromtheunsustainablestatusquo.
Investmentisneededtoacceleratethisunavoidabletrendandthosewhoareaheadofthistrend,thereportshows,mayinfactbettersecuretheirfinancialfuture.
Itisnowtimeforustomakesurethatourinvestmentsaresafeforthelongterm,safefinanciallyandsafeforourpreciousplanet.
"DavidNussbaum,ChiefExecutive,WWF-UKWORDSFROMOURPARTNERS213456704MERCER2015891011121314EXECUTIVESUMMARY05"WeasktheFinancialStabilityBoardtoconvenepublicandprivatesectorparticipantstoreviewhowthefinancialsectorcantakeaccountofclimate-relatedissues.
"—CommuniquéoftheG20FinanceMinistersandCentralBankGovernorsMeeting33April2015,https://g20.
org/wp-content/uploads/2015/04/April-G20-FMCBG-Communique-Final.
pdf,accessed20May2015.
2134567Climatechangeisanenvironmental,socialandeconomicrisk,expectedtohaveitsgreatestimpactinthelongterm.
Buttoaddressit,andavoiddangeroustemperatureincreases,changeisneedednow.
Investorscannotthereforeassumethateconomicgrowthwillcontinuetobeheavilyreliantonanenergysectorpoweredpredominantlybyfossilfuels.
Thispresentsassetownersandinvestmentmanagerswithbothrisksandopportunities.
Mercer's2011studyonthistopicestablishedimportantfoundationsforinvestors,anditskeyfindingsstillholdtrue.
Thestudyhighlightedtheimportanceofclimatepoliciesasariskfactorforinvestors,giventheirabilitytoincentivisemeaningfulchangesintheenergysector.
Thispolicyriskwasnotfoundtobemoreimportantthanequityorcreditriskpremiums,butwasconsideredpotentiallymoreimportantthanfactorssuchastheilliquiditypremium.
Thisstudyestimatestheimpactofclimatechangeonreturnstodemonstratewhyclimate-relatedriskfactorsshouldbestandardconsiderationsforinvestors.
Thisstudyhelpsaddressthefollowinginvestorquestions:Howbigarisk/returnimpactcouldclimatechangehaveonaportfolio,andwhenmightthathappenWhatarethekeydownsiderisksandupsideopportunities,andhowdowemanagetheseconsiderationstofitwithinthecurrentinvestmentprocessWhatplanofactioncanensureaninvestorisbestpositionedforresiliencetoclimatechange0689101112131407Howbigarisk/returnimpactcouldclimatechangehaveonaportfolio,andwhenmightthathappenOurinvestmentmodellinghasdemonstratedthefollowing:1.
Climatechange,underthescenariosmodelled,willinevitablyhaveanimpactoninvestmentreturns,soinvestorsneedtoviewitasanewreturnvariable.
2.
Industrysectorimpactswillbethemostmeaningful.
Forexample,dependingontheclimatescenariowhichplaysout,theaverageannualreturnsfromthecoalsub-sectorcouldfallbyanywherebetween18%and74%overthenext35years,witheffectsmorepronouncedoverthecomingdecade(erodingbetween26%and138%ofaverageannualreturns).
Conversely,therenewablessub-sectorcouldseeaverageannualreturnsincreasebybetween6%and54%overa35yeartimehorizon(orbetween4%and97%overa10-yearperiod).
3.
Assetclassreturnimpactscouldalsobematerial–varyingwidelybyclimatechangescenario.
Forexample,a2°Cscenariocouldseereturnbenefitsforemergingmarketequities,infrastructure,realestate,timberandagriculture.
A4°Cscenariocouldnegativelyimpactemergingmarketequities,realestate,timberandagriculture.
Growthassetsaremoresensitivetoclimaterisksthandefensiveassets.
44.
A2°Cscenariodoesnothavenegativereturnimplicationsforlong-termdiversifiedinvestorsatatotalportfoliolevelovertheperiodmodelled(to2050),andisexpectedtobetterprotectlong-termreturnsbeyondthistimeframe.
Whatarethekeydownsiderisksandupsideopportunities,andhowdowemanagetheseconsiderationswithinthecurrentinvestmentprocessKeydownsideriskscomeeitherfromstructuralchangeduringthetransitiontoalow-carboneconomy,whereinvestorsareunpreparedforchange,orfromhigherphysicaldamages.
4Growthassetsinclude:listedequity,privateequity,realassets(suchasrealestate,infrastructure,timber,andagriculture),growthfixedincome,hedgefunds,andmulti-assetfunds.
Defensiveassetsinclude:cash,sovereignbondsandindex-linkedbonds(longdated),absolutereturnbonds,andInvestment-gradecredit.
2134567Inthefirstinstance,undera2°C,orTransformationscenario,investorscouldseeanegativeimpactonreturnsfromdevelopedmarketequityandprivateequity,especiallyinthemostaffectedsectors.
Ontheflipside,thisscenariowouldbelikelytoleadtogainsininfrastructure,emergingmarketequity,andlow-carbonindustrysectors.
Undera4°C,orFragmentation(HigherDamages)scenario,chronicweatherpatterns(long-termchangesintemperatureandprecipitation)poseriskstotheperformanceofassetclassessuchasagriculture,timberland,realestate,andemergingmarketequities.
Inthecaseofrealassetinvestments,theseriskscanbemitigatedthroughgeographicriskassessmentsundertakenattheportfoliolevel.
Toembedtheseconsiderationsintheinvestmentprocess,thefirststepistodevelopclimate-relatedinvestmentbeliefsalongsideotherinvestmentbeliefs.
Thesecanthenbereflectedinapolicystatement,withrelatedinvestmentprocessesevolvedaccordingly.
Thenextstepisportfolio-orientedactivity,includingriskassessments,newinvestmentselection/weightsand,finally,enhancedinvestmentmanagementandmonitoring.
WhatplanofactioncanensureaninvestorisbestpositionedforresiliencetoclimatechangeInvestorshavetwokeyleversintheirportfoliodecisions—investmentandengagement.
Fromaninvestmentperspective,resiliencebeginswithanunderstandingthatclimatechangeriskcanhaveanimpactatthelevelofassetclasses,ofindustrysectorsandofsub-sectors.
Climate-sensitiveindustrysectorsshouldbetheprimaryfocus,astheywillbesignificantlyaffectedincertainscenarios.
Investorsalsohavenumerousengagementoptions.
Theycanengagewithinvestmentmanagersandthecompaniesintheirportfoliotoensureappropriateclimateriskmanagementandassociatedreporting.
Theycanalsoengagewithpolicymakerstohelpshaperegulations.
INVESTINGINATIMEOFCLIMATECHANGE08STUDYBACKGROUNDScenariosprovidehelpfulguidesforprioritisingactionswhenfacedwithuncertainty.
Therefore,ourstudyusesascenario-basedapproachtoinforminvestmentstrategy;thisbuildsonourgroundbreakingworkin2011.
Inthe2015study,anextensiveprocesshasidentifiedfourclimateriskfactorsandfourclimatescenariosmostrelevanttoinvestors.
Toestimatetheimpactofclimatechangeonexpectedreturns,wehaveincorporatedtheseintoourinvestmentmodelforsettingassetallocation.
Ouranalysisestimatesthepotentialimpactofclimatechangeonindustrysectors,assetclasses,andtotalportfolioreturns,between2015and2050.
891011121314CLIMATEMODELSClimatemodelsaretechnicallyreferredtoasintegratedassessmentmodels(IAMs).
Theseprovidequantitativeprojections,integratingbothclimatescienceandeconomicdata,whichrepresenttheinteractionsofnaturalandhumansystems.
Thesearethebesttoolsavailabletoestimateaquantitativeimpactofclimatechangeoverthelongterm(manydecadesorcenturies).
Thereare,however,significantlimitationsinquantifyingthelinkagesandfeedbackswithinandbetweenthesehighlycomplexsystems.
Therearealsochallengesinrepresentingtheseinasimplenumericway.
Typically,IAMsfocusmoreonmitigation(measurestoreducenetcarbonemissions)andlessonadaptation(actionsthataidaresponsetonewclimateconditions).
Theyhaveoftenbeenaccusedofunderestimatingphysicaldamages.
ThisstudybeganwithareviewbyNERAEconomicConsulting(NERA)oftheclimatemodelsusedtoestimatemitigationcostsandeconomicdamagesassociatedwithphysicalimpacts.
NERA'sscenarioanalysiscombinedtwomajormodels—oneformitigation,onefordamages—withadditionalliteraturereviews.
Thisprovidedglobalandregionalresultsfortheenergysectorandthetotaleconomy.
Toaddressgapsinphysical-impactestimates,GuyCarpenterdrewonitsdirectexperiencewithcatastrophe-riskmodelling,aswellasitsanalysisofclimatechangeanditsknowledgeofcurrentclimatechangeresearch.
5Analysisofadditionalperils,notquantifiedbytheclimatemodelsused,wasalsoincludedforperilsbelievedtohavethelargestpotentialimpactontheeconomyoverthenext35years—namely"CoastalFloodasinfluencedbySeaLevelRise"(CoastalFlood/coastalflooding),andWildfire.
FurtherdetailontheclimatemodelscanbefoundinAppendix1.
RISKFACTORS—TRIPClimatechangehasmanydimensions.
Wehaveisolatedfourriskfactorsthatindicatethefutureimplicationsofclimatechangeforinvestors.
ThefirstisTechnology(T),broadlydefinedastherateofprogressandinvestmentinthedevelopmentoftechnologytosupportthelow-carboneconomy.
NextisResourceAvailability(R),definedastheimpactoninvestmentsofchronicweatherpatterns(forexample,long-termchangesintemperatureorprecipitation)andrelatedphysicalchanges.
Thirdly,thereisImpact(I),definedasthephysicalimpactoninvestmentsofacuteweatherincidence/severity(thatis,extremeorcatastrophicevents).
Finally,there'sPolicy(P),broadlydefinedasallinternational,national,andsub-nationaltargets;mandates;legislation;andregulationsmeanttoreducetheriskoffurtherman-madeor"anthropogenic"climatechange.
5GuyCarpenter.
GlobalWarming:TheEvolvingRiskLandscape,2013.
213456709SCENARIOSBasedonourresearch,wedevelopedfourrelevantscenariosforinvestors,collaborativelywithinputfromall18projectpartnersandthestudyadvisorygroup.
Ourscenariosarebasedonsomeofthemostadvancedclimatemodellingandscientificliteratureavailable.
6Theyofferinvestorsarangeofwhat'spossible,providingseveralviewsofthewaythenext35yearsmightplayout.
Wehavelabelledthesescenarios:1.
Transformation.
2.
Coordination.
3.
Fragmentation(LowerDamages).
4.
Fragmentation(HigherDamages).
Transformationischaracterisedbystrongclimatechangemitigationthatputsusonapathtolimitingglobalwarmingto2°Cabovepre-Industrial-eratemperaturesthiscentury.
Thisscenariohas:Strongclimate-mitigationaction:emissionspeakby2020,thenfallby56%,relativeto2010levels,by2050.
Fossilfuelsrepresentinglessthanhalfoftheenergymixby2050.
Estimatedannualemissionsof22gigatonsofequivalentcarbondioxide(GtCO2e)by2050.
Coordinationisascenarioinwhichpoliciesandactionsarealignedandcohesive,limitingglobalwarmingto3°Cabovepre-Industrial-eratemperaturesthiscentury.
TheCoordinationscenariohas:Substantialclimate-mitigationaction:emissionspeakafter2030,thenfallby27%,relativeto2010levels,by2050.
Fossilfuelsrepresentingaround75%oftheenergymixby2050.
Estimatedannualemissionsof37GtCO2eby2050.
6NERAdevelopeddetailedmodellinginformationforthreeofthescenarios,withGuyCarpentermodifyingandsupplementingtheclimate-damageresults.
MercerdevelopedinformationfortheTransformationscenario.
Forcontext:-The2012fossilfuelshareofglobalprimaryenergydemandwas82%(IEAWEO2014).
-ArecentreportfromtheWorldBank(Nov2014),foundthat,globally,warmingofcloseto1.
5°Cabovepre-IndustrialtimesisalreadylockedintoEarth'satmosphericsystembypastandpredictedgreenhousegasemissions.
Fragmentation(LowerDamages)seeslimitedclimate-mitigationactionandlackofcoordination,resultingina4°Cormoreriseabovepre-Industrial-eratemperaturesthiscentury.
Thissees:Limitedclimateaction:emissionsgrowanother33%over2010levels,peakingafter2040.
Fossilfuelsrepresenting85%oftheenergymixby2050.
Estimatedannualemissionsof67GtCO2eby2050.
Fragmentation(HigherDamages)seesthesamelimitedclimate-mitigationactionasthepreviousscenario,butassumesthatrelativelyhighereconomicdamagesresult.
Ofthesefourscenarios,TransformationisthebestandFragmentation(HigherDamages)theworstforlimitingtheenvironmentalandsocialimplicationsofclimatechange.
Foralong-terminvestor,Fragmentation(HigherDamages)isalsotheworstclimatescenarioovertheverylongterm,withthegreatestexpectedeconomicdamagesanduncertainty(albeitwithsubstantiallylowermitigationcosts).
Duringdifferenttimeperiodsbetweennowand2050,however,differentscenarioswillbe"best"or"worst",dependingonwhetherinvestorshaveanticipatedthechangesthatoccur,andwhetherportfolioholdingsarepositionedaccordingly.
89101112131410SCENARIOPATHWAYSANDASSETSENSITIVITYInfrastructure,emergingmarketequityandrealestateareexpectedtobenefitfromclimatepolicyandtechnology.
Agricultureandtimberhavethewidest-rangingimpacts,dependentonthescenario,astheyhavenegativesensitivitytoResourceandImpactfactorsandpositivePolicysensitivity.
AgriculturealsohaspositivesensitivitytotheTechnologyfactor.
Developedmarketsovereignbondsarenotviewedassensitivetoclimateriskatanaggregatelevelwheretheyaredrivenbyothermacro-economicfactors,althoughtherearesomeexceptions.
Figure1onthefollowingpageshowstheclimateimpactonreturnsbyassetclassover35yearsto2050.
INDUSTRYSENSITIVITYANDRETURNIMPACTSTherearemeaningfulimpactsonreturnattheindustry-sectorlevel.
ThisisparticularlyevidentforthoseindustrysectorsexpectedtobemostsensitivetothePolicyfactor:energyandutilities.
Thesub-sectorswiththehighestnegativesensitivityarecoalandelectricutilities.
Renewableshavethehighestpositivesensitivity,followedbynuclear.
Industrysectorsandsub-sectorswiththegreatestpositivesensitivitytotheTechnologyfactorincluderenewables,nuclear,materials,andindustrials.
EnergyandutilitieshavethegreatestnegativesensitivitytotheResourceAvailabilityandImpactfactors,withindustrialsalsosensitivetophysicalimpacts.
Figure2onthefollowingpageshowstheclimateimpactonreturnsbyindustrysectorover35yearsto2050.
Tomodeltheclimateimpactonreturns,weadaptedourinvestmentmodelbyaddingtwoinputs.
ThefirstwasaquantifiedrepresentationofthefuturepathwaysforeachTRIPfactorundereachofthefourscenarios,andtheirrelativeimpactsovertime.
ThesecondwasthesensitivitytotheTRIPfactorfordifferentassetclassesandindustrysectors.
Weassignedsensitivitiesaccordingtoevidencethatsuggestedtherelativemagnitudeandwhethertheimpactwaspositiveornegative.
Thisenabledustoconsiderthedifferingscaleanddirectionofclimateimpactsondifferentassetclassandindustrysectorsovertime.
Therangeofclimateimpactonreturnsbyassetclassandindustrysectorarepresentedbelow,withfurtherdetailinthe"PortfolioImplicationsandInvestorActions"section.
ASSETCLASSSENSITIVITYANDRETURNIMPACTSTherearematerialimpactsattheasset-classlevel,withtheoutcomedependentontheeventuatingscenarioinmanycases.
Onlydevelopedmarketglobalequityhasaminimumnegativeimpact,regardlessofthescenario,givenitsnegativesensitivitytothePolicyfactor.
213456711Figure2:ClimateImpactonReturnsbyIndustrySector(35Years)Figure1:ClimateImpactonReturnsbyAssetClass(35Years)891011121314Medianadditionalannualreturns-6.
0%-5.
0%-4.
0%-3.
0%-2.
0%-1.
0%-0.
0%1.
0%2.
0%3.
0%4.
0%RenewablesNuclearITGasHealthConsumerdiscretionaryIndustrialsTelecomsConsumerstaplesFinancialsMaterialsUtilitiesOilCoalMedianadditionalannualreturns-0.
8%-0.
6%-0.
4%-0.
2%0.
0%0.
2%0.
4%0.
6%0.
8%1.
0%AgricultureInfrastructureTimberEmergingMarketGlobalEquityRealEstateEmergingMarketDebtSmallCapEquityPrivateEquityLowVolatilityEquityMulti-assetCreditInvestmentGradeCreditPrivateDebtDevelopedMarketSovereignBondsDevelopedMarketGlobalEquityAdditionalVariabilityMinimumImpactMinimumImpactAdditionalVariabilitySource:MercerSource:Mercer12PORTFOLIOIMPLICATIONSANDINVESTORACTIONSOurapproachtoinvestmentmodellinganalyseschangesinreturnexpectationsinthe35yearsbetween2015and2050,drivenbythefourclimatechangescenariosreviewed.
Theresultsallowustoidentifythepotentialclimateimpactonreturns,includingtheminimumandmaximumimpactinvestorscanexpectwhenclimateconsiderationsareincluded(thatis,theTRIPfactorsandfourclimatescenarios).
Inthe"PortfolioImplicationsandInvestorActions"section,wegivefurtherdetailonthefindingsfromourinvestmentmodelling.
Thesearealsocapturedbelowasthe"what",alongsidewhytheymattertoinvestors("sowhat"),andwhatcanbedoneinresponse("nowwhat").
Followingtheprocessindicatedbythesefindingswillleadtoanevolutionoftheportfolioovertime,fromtheassetallocationoftheoverallportfoliotoexposureswithinassetclasses.
Theprocesswillalsoleadtoanenhancedfocusonmonitoringandengagingwithmanagersonsectorexposuresandcompanypositions.
ThefocusforinvestorswillbeonportfolioexposurestotheassetclassesandindustrysectorsmostsensitivetotheTRIPfactorsandthosewiththegreatestpotentialforclimateimpactonreturns.
Investorsshouldalsoconsidertheuseofengagementasatoolforriskmanagement,bothwithcompaniesandfromamarket-wideperspective.
Assetownerswillrequireagovernanceapproachthatenablesthemtobuildcapacitytomonitorandactonshorter-term(1–3years)climateriskindicators,aswellaslonger-term(10-yearplus)considerations.
Thiswillincludeengagingwithinvestmentmanagerswhosefocuswillbeonbuildingcapacitytoaddressshorter-termclimateconsiderations.
Consistentwithourthinkingonthebestwaytoincorporateenvironmental,social,andgovernance(ESG)considerationsintotheinvestmentprocess,werecommendanintegratedapproachthatestablishesinvestmentbeliefsandpolicy,enhancesprocessesandthenreviewstheportfolio.
72134567137Mercer.
AnInvestmentFrameworkforSustainableGrowth,2014,availableathttp://www.
mercer.
com/services/investments/investment-opportunities/responsible-investment.
html,accessed11May2015PUTTINGTHEFINDINGSINCONTEXT:SOWHATTables1(a)to(e)belowoutlinehowourkeyfindings("what")mattermosttoinvestors("sowhat"),andshowwhatcanbedoneinresponse("nowwhat").
Insummary,wefindthatallinvestorshaveactiontotakeinresponsetoclimatechange.
89101112131414Table1(a):Climateriskisinevitable—investorscanimproveoutcomesbybeingpreparedSomeimpactsoninvestmentreturnsareinevitable.
Findingssuggestthatclimatechangeriskswillimpactinvestmentreturns—regardlessofwhichscenariounfolds.
Inalow-returnenvironment,thesenumbersareparticularlymeaningful.
Someactionwillleadtobetterinvestmentoutcomesthannoaction.
Tooptimiseinvestmentoutcomes,investorsshouldconsiderclimaterisksattheassetclass,industry-sector,andindustrysub-sectorlevel.
Thiswillrequirechangesinhowtheyworkwithserviceproviders.
Uncertaintyaboutthefutureshouldnotbeabarriertoaction.
Improveinvestorgovernanceofclimaterisk.
Attentiontolong-termissuesoftenrequiresneworrevisedgovernancearrangements—inparticular,toensurethatdueattentionisgiventothemevenifthe"sowhat"isn'tnextquarter.
Developingrelatedinvestmentbeliefsandpoliciesisanimportantstep.
Investorsshouldalsorevisitandreviewclimateimpactsandsensitivitiesaspartoftheirregularmonitoringprocesses.
Seethe"Beliefs,Policy,andProcess"sectionsoftheActionstables(Tables4and5).
WHATSOWHATNOWWHATTable1(b):Sensitiveindustrysectorsdeservefocusthatmaybeoutsidethetypicalremitofinvestmentcommittees.
Investmentcommitteeswillbestretchedtoaddressthis.
Consideringcompanywinnersandloserswithinindustrysectorsstretchesthetypicalremitofinvestmentcommitteesandwillrequiredirectengagementwithinvestmentmanagers(betheyinternalorexternal),potentiallyrequiringmandatedguidanceandlonger-termincentives.
Thismayrequireinvestorstoinvestindifferentvehiclesorwithdifferentmanagersortodevelopalternativebenchmarks.
Considerhedgingandweightingchanges.
Policy-relatedrisksaremostsignificantintheneartermandcanbemitigated.
Forpassivemandates,investorscanconsiderlow-carbonandmoresustainableversionsofbroadmarketindices,whichareevolvingrapidlytoprovideinvestorswiththemeanstohedgeclimateexposure.
Withinactivemandates,managershaveopportunitiestomanageportfolioexposuretoclimatechangerisks.
Assetownerscantrackindustry-sectorexposure,anddiscussapproachestoclimateriskassessmentaspartofthemanagersearchandmonitoringprocess.
Numerousthematicstrategiesarealsoavailable,whichcancomplementacoreequityallocation.
Forinvestorswithastronglong-termeconomicoutlook,achangeinbenchmarkmaybewarranted.
Beyondequities,investorsshouldconsiderindustrysectorexposureinprivatemarketandcorporatebondinvestments.
Seethe"Portfolio"sectionsoftheActionstables,particularlytheequitiessection(Tables4and5).
WHATSOWHATNOWWHAT213456715Theimpactondifferentsectorsvarieswidelybutcanbesignificant.
Energysub-sectors,utilities,andmaterialswillhavethemostmeaningfulimpacts.
Theminimumimpactforthecoalsub-sectorislikelytobeareductioninexpectedreturnsfrom6.
6%p.
a.
to5.
4%p.
a.
averagedoverthenext35years,andwithadditionalvariabilityaveragereturnsmayfallaslowas1.
7%p.
a.
Renewableshavethegreatestpotentialforadditionalreturns:dependingonthescenario,averageexpectedreturnsmayincreasefrom6.
6%p.
a.
toashighas10.
1%p.
a.
Oilandutilitiescouldalsobesignificantlynegativelyimpactedoverthenext35years,withexpectedaveragereturnspotentiallyfallingfrom6.
6%p.
a.
to2.
5%p.
a.
and6.
2%p.
a.
to3.
7%p.
a.
respectively.
Theimpactsareparticularlyapparentinannualreturns,whicharemoresignificantintheshorterterm(i.
e.
thatis,overthecoming10years).
89101112131416Table1(c):CertainassetclassesdeserveparticularattentionEmergingmarkets,infrastructure,andrealestatearepositivelyalignedwithalow-carbonscenario.
Therearealsomaterialimpactsattheassetclasslevel,withtheoutcomedependentontheparticularscenarioinmanycases.
Onlydevelopedmarketglobalequityequityisexpectedtoexperienceareductioninreturnsacrossallscenarios.
InfrastructureandemergingmarketequitiesshowpositiveadditionalreturnsundertheTransformationandCoordinationscenariosover35years,withfurthergainsexpectedinrealestate(duetoitspositivesensitivitytotheTechnologyfactor).
Agricultureandtimberaretheassetclasseswiththewidest-rangingpotentialimpacts(positiveornegative,dependingonthescenario),giventheirnegativesensitivitytoResourceandImpactfactorsandpositivePolicysensitivity(withagriculturealsopositivetotheTechnologyfactor).
Developedmarketsovereignbondsarenotviewedassensitivetoclimateriskatanaggregatelevel(theyaredrivenbyothermacro-economicfactors),withexceptions,suchasJapanandNewZealand.
Medium-termallocationsshouldconsiderclimate-orientedopportunities.
Investorsshouldconsiderincreasingexposuretoemergingmarketequitiesandsustainablerealassetsiftheyenvisionstrongorverystrongactiononclimatechange.
Physicalrisksmustbemanagedinproperty,infrastructure,andnaturalresources,particularlyifweseelittleactiontakentoreduceemissions.
Focusonrisksandopportunitiesacrossandwithinassetclasses.
Investorsshouldconsiderclimaterisk—includingadiscussionofwhichscenario(s)theybelieveismostprobable—whenundertakingstrategicasset-allocationexercisestoprioritisekeyactions.
Havingclearinvestmentbeliefsaboutclimatechangewillsupportthisprocess.
Seethe"Portfolio"sectionsoftheActionstables(Tables4and5)WHATSOWHATNOWWHATTable1(d):Foratotalportfolio,medium-term(multi-year)and50+yeareconomicmotivationsarealignedtowardsalowest-emissionsscenario.
Investmentimpactsofdifferentscenariosarenotsignificantlydifferentatthetotalportfoliolevel.
Acrossatotalportfolio,resultsarelesssignificantbecauseofthecombinationofpositiveandnegativeeffectsoverthenext35years.
ComparingtheTransformationscenariowiththeotherthreescenariossuggeststhattheeconomictransitionimpliedbyTransformationisnotpunitivefromaninvestmentperspective.
A2°Cscenariodoesnothavenegativereturnimplicationsforlong-termdiversifiedinvestorsatatotalportfoliolevelovertheperiodmodelled(to2050).
Extendingmodelledtrendsbeyond2050—theendpointforthisanalysis—wewouldexpecttheFragmentationscenariostohaveincreasinglylargenegativeimpactsonreturnsatthetotalportfoliolevel.
ATransformationscenarioisexpectedtobetterprotectlong-termreturnsbeyondthistimeframe.
A"2°C"scenario(i.
e.
Transformation)doesn'tjeopardisefinancialreturns.
Thisfindingiscountertoarelativelycommonviewthatarapidtransitiontowardsalow-carboneconomywouldcomeatasignificantfinancialcosttoinvestors.
Thisoutcomecouldremoveabarriertomoreinvestorstakingactiontohelpachievea2°Coutcome.
Potentialmotivationforheightenedinvestorfocusona2°Coutcome.
Thefactthatthelowestemissionsdonotresultinadragoninvestmentreturnscomparedwiththeotherscenariosmeansthatfiduciariescanalignshortandlong-termbehaviouraroundinvestingandengagingforthisoutcome.
Assetownersshoulddiscussanddeterminetheirposition.
Seetheargumentinsupportofinvestorsadopting"futuremaker"behaviour,asoutlinedintheClosingReflectionssection"Investorsas'FutureMakers'or'FutureTakers'".
WHATSOWHATNOWWHAT213456717Table1(e):Climateriskismorecomplexandlonger-termthanmostinvestmentrisks.
Climateriskiscomplexandhasmultipledimensions.
ThisismadeclearthroughtheTRIP(Technology,ResourceAvailability,Impact,andPolicy)climateriskfactorsmodelledinthisstudy.
Managingclimateriskisoutsidetheaverageinvestorfocusarea.
Traditionalrisks(suchasmarket,inflation,orinterestrate)aretypicallymeasuredonanannual-plus(1to3year)basisusingfamiliarmeasuressuchasvolatilityorvalueatrisk.
Climaterisksgenerallydemandlonger-term(>3years)measurement,withriskmetricssuchassea-levelrise,carbon-pricedevelopments,andlow-carboninvestmentflowsoutsidetheaverageinvestor'srangeofknowledgeorexperience.
Climateriskdeservesmoreattentiononthelong-terminvestmentagenda.
Long-terminvestorsarerethinkingthewaytheysetprioritiesanddefineandmeasurerisk.
Climatechangefitsnaturallyintothe"long-terminvestors'agenda",yetmoremustbedonetobridgethesetimeframes.
SeetheActionstables(Tables4and5)toestablishashort-termactionplantoensureimmediatestepsaretaken.
WHATSOWHATNOWWHATCLOSINGREFLECTIONSAllinvestorswillbeinfluencedbywhicheverglobalpoliticalandphysicalclimatescenarioemergesoverthecomingdecades.
Inthissense,theyareall"futuretakers"inthecontextofclimatechange,althoughinvestorswillfacethisissuewithdifferentlevelsofresilience—withthoseinvestorsthatareunpreparedfortheminimumreturnimpactexpectedtoaccompanyanyofthefuturescenarioseffectivelynegatingtheirbestpossibleoutcome.
Ontheotherendofthespectrumistheemergenceofagroupofinvestorsthatwecouldterm"futuremakers".
Theseinvestorsfeelcompelledbythemagnitudeofthelonger-termriskofclimatechangetoseektoinfluencewhichscenariocomestopass.
Akeyquestionforfiduciariesis,"Whichcategorybestdescribesyourapproach"89101112131418KEYMOTIVATIONFORINVESTORACTIONThisreport'sfindingsgeneratefourkeymotivationsforinvestoractiononclimaterisk,spanningshortandlong-termconcerns.
Thesemotivationsare:1.
Medium-termriskmanagement(years).
2.
Mediumandlong-termopportunities(years).
3.
Short-termrisk(months).
4.
Long-termeconomiccostofinactionandconcernsofbeneficialowners(decades).
MEDIUM-TERMRISKMANAGEMENT(YEARS)Long-terminvestorsgenerallytakeamulti-yearperspectivewhensettingassetstrategy.
Thisisavitalcomponentofinvestmentoversight.
Capturingclimatechangeinriskassessmentsandonthe"riskregister"willbeimportantforunderstandingandmanagingtheassetclassandindustry-sectorrisksandimpactsonreturnidentifiedinthisstudy.
Yetourresearchsuggeststhatfewmainstreaminvestorsincorporateadetailedviewonthepoliciesthatcouldunderpinthischangeininvestmentanalysis.
Investorsneedtoconsidertheirequityassetclassand2134567"Climatechangeforcesinvestorsinthe21stCenturytoreconsiderourunderstandingofeconomicandinvestmentrisk.
ThisstudyprovidestheNewYorkCommonRetirementFundwithvaluableinsightsthatwillinformoureffortstomanageclimateriskandbuildoutourportfolioinwaysthatprotectandenhanceinvestmentreturns.
"—NewYorkStateComptrollerThomasP.
DiNapoli,TrusteeoftheNewYorkStateCommonRetirementFundindustry-sectorrisksbyaskingquestionssuchas:DosectorweightsacrosstheportfolioreflectanticipatedstructuralchangeAndisthereenoughfocusonthisinourportfolio-constructionprocessCaninvestmentmanagersarticulateaclearperspectiveontherelevance(orotherwise)ofclimateriskstoaninvestmentmandateIsengagementemployedasariskmanagementtool,particularlyforpassivemandatesRealassets,whichincluderealestate,infrastructure,timber,andagricultureinvestments,areidentifiedintheresearchasincreasinglyexposedtotheriskofphysicaldamagecausedbyclimatechange.
Theseassetsaretypicallyheldforover10years,yetfewlargeinvestorswithsignificantreal-assetexposureareassessingormanagingtheserisksattheportfoliolevel.
Akeyquestionis:Canweundertakeatotal-portfolioriskassessment(includingallrealassetholdings)toidentifyexposuretopotentialphysicaldamageriskunderdifferentclimatescenarios19MEDIUMANDLONG-TERMOPPORTUNITIES(YEARS)Forecastingthefutureisinherentlydifficult—noonecanpredictwhichscenariowillunfold,orhowtheindustryweightingsofstock-marketindiceswillevolve.
Undertheclimatescenariosexploredinthisstudy,therearepotential"firstmover"advantagesinsomeassetclassesandlower-carbonindustrysectors,suchasrenewableenergy,greenbuildingmaterials,andsustainabletransport.
Tocapturemedium-termopportunities,investorsneedtoask:WhichassetclassesarepositionedtobenefitfromfutureopportunitiesWhatactiveandpassiveequityproductsexisttotilttowardsthesesourcesofgrowthHowcanattractiveindustrysectorsbeaccessedthrougheachassetclass,andparticularlyinprivatemarketsSHORT-TERMRISK(MONTHS)Althoughourstudyhasnotfocusedonanticipatingsignificantshort-termvolatilitydrivenbyunanticipatedclimaterisks,onescenariodoesanticipateswiftpolicyactiononclimateinthenearterm.
Thisisexpectedtobeanincreasingcostoncarbon,designedtoreduceemissionsandlimittemperatureincreases.
Thisincreasingcostoncarboncoulderodeexpectedgainsinsomesectorsandproduceannuallosses.
Inconsideringthisorotherscenarioswhichmayunfold,investorsneedtoask:Whatifclimatechangerelatedpoliciesareintroducedatalevelorwithinatimeframeunanticipatedbythemarket,eithergloballyorinregionalblocksMightthisleadtoabroadmarketcorrection,orcouldcertainassetsbeleft"stranded"Couldfossil-fuelsubsidiesberemovedWouldthisputmajorinvestmentsatriskHowquicklycouldtheportfolioberepositionedifrequired,andwhatoptionsexisttodaytohedgeagainstfutureuncertaintyLONG-TERMCOSTOFINACTIONANDCONCERNSOFBENEFICIARIES(DECADES)Thisstudyusesa35-yeartimeframetoexplorethepotentialimpactsofclimaterisk,butthemostsignificantphysicalimpactsresultingfromclimatechangewillbefeltafter2050.
Thisisanexampleofalong-termdownsideriskthatmarketsstruggletoaddress.
However,otherswithstrategicfocusarenotignoringthisrisk:USandUKreportssuggestthatclimatechangeislikelytocreatestrategicmilitaryrisksasthephysicalimpactsamplifyfragilesocialandeconomicconditions(forexample,byreducingaccesstovitalresourcessuchaswaterorfood).
Thereisstrongevidencethat,ifwefollowourcurrenttrajectory,therewillbeahighriskofirreversibleandsevereimpactsacrosstheglobe.
Lookingto2100andbeyondsharpensthefocusonwhethertomitigatenow,ortoadaptlateratpotentiallysignificantlygreatercost.
RefertoAppendix2formoreonthe2100timeframe.
Althoughadoptingalong-termperspectiveischallenginginpractice,itisnotimpossible.
Investorsneedtoask:Asalong-terminvestor,howlongismytimehorizonDowefeelsufficientlyknowledgeableaboutthistopicWhatareourinvestmentbeliefsDowehavethegovernanceframeworktofocusonstrategicallyimportantlong-termissuesWhataretheviewsofbeneficiariesandclientsAsassetowners,shouldwebemorevisibleincallingforstrongclimateactionbypolicymakersMAKETOMORROW,TODAYInvestorsfaceanumberofbarrierstoactiononclimatechange.
Itisachallengetotakealong-termviewinthecontextofanincreasinglyshort-termmarketenvironment;boardsandinvestmentcommitteesfacearangeofcompetingpriorities,andtheaverageinvestorhaslittlefamiliaritywithclimate-relatedrisks.
Yettheinvestorimplicationsofclimateriskwarrantachangeinbehaviour.
Thisstudyprovidesinvestorswithevidenceofthelikelyimpactontheirportfoliosofarangeofrelevantclimatechangescenarios,alongwithpracticalsuggestionsformitigatingandmanagingtheirexposure.
Indoingso,itcontributestotherapidlyevolvingknowledgeandtoolsthatareavailabletotheinvestmentindustrytounderstandandmanageclimaterisk.
Itisnowuptoinvestorstoevolve—takingaprudentviewofriskdemandsit.
20891011121314INTRODUCTIONCLIMATECHANGEISANINVESTMENTRISKFailureofeconomiestoadapttoclimatechangeisamongthetopfiverisksglobally,accordingtothisyear'sreportfromtheWorldEconomicForum(theForum),9whichrankstherisksofhighestconcerntotheForum's900globalstakeholders.
Adaptationfailurehasnowbeenrankedasoneofthetopfiverisksforlikelihoodorimpactoverthepastfiveyears.
Economic,environmental,geopolitical,social,andtechnologicalrisksaregroupedintheForumreport.
Eachriskisnotisolatedbutinterconnected,exposinginvestorstoamplificationofriskimpacts.
Comparingtheshort-termview(18months)withtheviewover10years,severeweathereventsaretheonlynear-termenvironmentalriskidentified.
Overthenextdecade,however,environmentalandassociatedsocietalrisksrepresentmorethanhalfofallglobalrisks,asoutlinedinFigure3onthefollowingpage.
"Pastwarningsofpotentialenvironmentalcatastropheshavebeguntobeborneout;yetinsufficientprogresshasbeenmade—asreflectedinthehighconcernsaboutfailureofclimatechangeadaptationandloomingwatercrises…"—WorldEconomicForum8TheForumreportisreinforcedbyotherriskreports,suchasGuyCarpenter'sGlobalWarming:TheEvolvingRiskLandscape(2013),10whichfocusedonhazardssuchascoastalfloodingandwildfires,andtheRiskyBusinessproject11,throughitsUSnational(2014)andUSregionalreportsontheeconomicrisksinclimatechange.
Intermsofinvestmentrisk,analyticalworkisincreasinglybeingundertakentoquantifythepotentialdamagesfromclimatechangetoinvestors.
Arecentpaper12hasestimatedthat,inaplausibleworst-caseclimatechangescenario(a4°C-increaseoutcome),thevalueatriskofanequityportfolioin2030maybebetween5%and20%versusano-warmingscenario.
8WorldEconomicForum.
GlobalRisks2015,availableathttp://reports.
weforum.
org/global-risks-2015/executive-summary/,accessed11May2015.
9Ibid.
10GuyCarpenter.
GlobalWarming:TheEvolvingRiskLandscape,September2013,availableathttp://www.
mmc.
com/content/dam/mmc-web/Files/GRC_EmergingRisk_TheEvolvingLandscape.
pdf,accessed30April2015.
11RiskyBusiness.
TheEconomicRisksofClimateChangeintheUnitedStates,June2014,availableathttp://riskybusiness.
org/uploads/files/RiskyBusiness_Report_WEB_09_08_14.
pdf,accessed30April2015.
12CovingtonH,ThamotheramR.
ACaseforForcefulStewardshipParts1&2,2015.
213456721EconomicalInter-stateconflictwithregionalconsequencesNEXT18MONTHS10-YEARHORIZONRANK1122334455667788991010RANKWatercrisisStatecollapseorcrisisFailureofclimatechangeadaptionFailureofnationalgovernanceFoodcrisisLarge-scaleterroristattacksExtremeweathereventsLarge-scalecyberattacksHighstructuralun-orunderemploymentProfoundsocialinstabilityLarge-scalecyberattacksRapidandmassivespreadofinfectiousdiseasesStatecollapseorcrisisExtremeweathereventsMajorbiodiversitylossandecosystemcollapseFiscalCrisesinkeyeconomiesFailureofnationalgovernanceHighstructuralun-orunderemploymentProfoundsocialinstabilityEnvironmentalGeopoliticalSocietalTechnologicalFigure3:RisksofHighestConcernbyTimePeriodSource:WorldEconomicForum-GlobalRisksReport2015.
22891011121314THETIMEFRAMECHALLENGEFORINVESTORSTheproblemofinvestor"shorttermism"iswelldocumented.
13Theproblemcanbedefinedasalackofadequateattentiontoissuesthathavethepotentialtocreateanddestroyvalueoverthelongterm.
Theoutcomesincludethemisallocationofcapital,excessive(managerandportfolio)turnover,andtheerosionofreturns.
14Anotherissueisinrecognisingthat"risk"isnotjustaboutshort-termvolatility,butaboutthepotentialforpermanentlossorimpairmentofcapital.
The"longterm"canbevariouslydefinedasabusinesscycle,thelengthofatypicalmandate,orthetimeframeofapensionfund'sliabilities.
Developingalonger-termmindsetischallengingandrequiresagovernanceframeworkandaculturethatappreciatestheneedtothinklongterm.
Suchacultureshouldallowfor,andideallyencourage,decision-makerstolookto13CFAInstitute.
VisionaryBoardLeadership—StewardshipfortheLongTerm,2012;Mercer.
BuildingaLong-termShareholderBase:AssessingthePotentialofLoyalty-drivenSecurities,2013;GovernmentoftheUK.
TheKayreviewofUKequitymarketsandlong-termdecision-making,2011.
14AmbachtsheerJ,et.
al.
"BehavingLikeAnOwner:PluggingInvestmentChainLeakages,"RotmanInternationalJournalofPensionManagement,Volume6:2(2013),pp.
18–27;CFAInstitute.
BreakingtheShort-termCycle,2006.
thehorizonandconsiderissuesthatmaybeuncertainandcurrentlyhavelowprobabilitiesattachedtothem.
IntheUK,itistypicalforfiduciariestomaintaina"riskregister",addressingconcernsaroundinterestratechanges,trusteeturnover,ormarketvolatility.
Historically,climateriskhasnotbeenincludedontheregister,butweexpectthiswillchange.
Climatechangepresentslong-termchallengestoallofus,investorsincluded.
Figure4comparesthetimeframeofatypicalinvestorwiththetimeframeofthisstudy,andthehorizonofclimatechangeimpacts.
TheredboxhighlightshowanongoingassessmentoftheTRIPfactorscanenableinvestorsto"bridgethegap"byincorporatinganassessmentofclimateriskconsiderationsintoongoinginvestmentprocesses.
2134567THEINVESTORZONEQuarterlyreviews:3monthsAnnualreviews:1yearStrategicreviews:3-10yearsModellingperiodforthisstudy:10-35yearsMostsignificantclimateimpacts:100+yearsTHECLIMATEZONENEWACTION!
MonitorclimateriskfactorsFigure4:TheTimelineChallengeSource:Mercer23STUDYOBJECTIVESClimatechangeandatransitiontoamoreresilient,low-carboneconomyareuponus.
Thispresentsuncertaintyforfinancialsystems,portfolios,andspecificinvestments,duetothecomplexcomponentsandtimeframesinvolved.
Theseareallnewrisksforinvestorstomanage.
Mercerandourprojectpartnershaveadoptedascenario-basedapproachtoincorporatefourclimatescenariosandfourclimateriskfactorswithinstrategicinvestmentmodellingtoexaminethepotentialmagnitudeoftherisksandopportunitiesacrossindustrysectors,assetclasses,andatotalportfolio,between2015and2050.
Uncertaintysurroundingtheglobalapproachtomanagingclimatechangecanalsobeassumedtoresultinperiodsofvolatility—whenmarketshavenotanticipatednews,information,orphysicalimpacts.
Short-term"shock"eventswillimpactinvestors'returnsandcanalsobeexpectedtoaccelerateandamplifyapotentiallow-carbontransition—althoughtheseareverydifficulttopredict.
Thebalancethatneedstobeachievedisbetweendrivingeconomicoutcomesandsimultaneouslylimitingcarbonemissions.
Inordertobuildportfolioresilience,investorscannotassumethefuturewillmirrorthepast,particularlywheneconomicgrowthisheavilyreliantonanenergysectorpoweredfirstandforemostbyfossilfuels.
Thefuturemaylookverydifferent,whichmeansafundamentalimpactoneconomiesandinvestors.
Questionsposedbysuchchangeare:Howsignificantarisk/returnimpactcouldclimatechangehaveonaportfolioandwhenmightthathappenWhicharethekeydownsiderisksandupsideopportunities,andhowcantheseconsiderationsbemanagedtofitwithincurrentinvestmentprocessWhatplanofactioncanensureaninvestorisbestpositionedforresiliencetoclimatechangeThreedivisionsofMarsh&McLennanCompanieshavecollaboratedwiththeprojectpartnerstofindtheanswerstothesequestions,bymodellingandconsideringtheeconomicsofenergyandenvironmentalpoliciesinthecontextofclimate-specific:Riskfactors—isolatedkeymarketdriversthatcanbeembeddedintoportfolioconstructionalongsidemoretraditionalriskfactors,suchasequity-riskpremiums,liquidity,creditrisks,etc.
Thefourclimatechangeriskfactorsreferencedinthisstudyare:Technology(T),ResourceAvailability(R),Impactofphysicaldamages(I)andPolicy(P)—theTRIPfactors.
Scenarios—groundedinclimatemodellingandrelatedliteraturethataremostpertinenttoinvestors,withdistinctiveeconomicandphysicalimpactsthatcanbeconsideredinthestrategicprocessalongsidemoretraditionalscenarios,suchashighinflation,deflation,etc.
Thefourclimatechangescenariosreferencedinthisstudyare:Transformation,Coordination,Fragmentation(LowerDamages),andFragmentation(HigherDamages).
24891011121314INVESTMENTMODELLINGThisstudyhasadaptedaninvestmentmodelusedforsettingassetallocation,toexplicitlyincorporateclimatechangeconsiderationsandisolatetheestimatedimpactonreturns.
Thisrequiredquantifyingtwonewinputs,thescenariopathwaysandassetsensitivity,totheTRIPfactors,andcalculatinganinteractionbetweenthetwo.
Volatilityadjustmentshavealsobeenmade.
TheinteractionoftheTRIPfactorswillpotentiallyincreasevolatility,therebyreducingcompoundedreturns.
Initialsectorandassetclassvolatilityassumptions,basedonhistoricalaverages,wereadjustedforeachscenariobasedonthevarianceoftheTRIPfactorvaluesat2050.
Thismethodaccountsforthedegreetowhichinvestmentreturnsmightbe"pulled"indifferentdirectionsbyclimatechange,withgreaterpotentialvolatility.
Theadjustmentresultedinincreasestohistoricalvolatilitymeasuresbyasmuchas20%forthecoalsector,downto0%forthehealthsector.
Theresultsestimatetheimpactonreturnexpectationsbetween2015and2050whenclimateconsiderationsareincluded.
Uncertaintysurroundingtheglobalapproachtomanagingclimatechangecanalsobeassumed.
Theinvestmentmodellingoutputsformaframeworkforinvestorstoprioritiserisksandopportunitiesduringstrategysetting,portfolioconstruction,andmanagerselectionandmonitoring.
Figure5providesaconceptualmapofthestudy'sapproach.
2134567Figure5:CalculatingtheClimateImpactonReturnSCENARIOPATHWAYSASSETSENSITIVITYINVESTMENTIMPACTSX=HowwilleachTRIPfactorchangeovertimeforeachscenarioAquantitativepathwayisdevelopedforeachriskfactorandscenario.
HowsensitiveiseachsectorandeachassetclasstoeachTRIPfactorRiskfactorsensitivityassigned,aseitherpositiveornegative,andarelativemagnitudeHowaredifferentsectorsandassetclassesimpactedoverdifferenttimeperiodsWhatassetallocationimplicationsshouldinvestorsbemostawareofSource:Mercer25Modellingtheinvestmentimplicationshelpsinvestorsidentifytherisksandopportunitiesposedbyclimatechangeintheirportfolio,andthenactaccordingly(seepage59).
NumberstorepresenttheassetsensitivityandthescenariopathwaysarepluggedintoMercer'sinvestmentmodellingtooltoestimatetheclimateimpactonreturn(seepage59).
Figure6:GettingtothePoint:FromClimateModellingtoPortfolioImplementationCLIMATEMODELS/MODELLINGRISKFACTORSANDSCENARIOSPORTFOLIOIMPLICATIONSASSETSENSITIVITYPORTFOLIOIMPLEMENTATIONFourclimateriskfactorsandfourclimatescenariosprovideaframeworkforconsideringclimatechangerisksandpotentialpathwaysovertime(seepages27and33).
Sensitivitytothefourclimateriskfactorsisassignedtodifferentindustrysectorsandassetclasses(seepage41).
IntegratedAssessmentModelsestimatingthecostofmitigation,adaptation,andphysicaldamagestoidentifyclimatechangescenariosmostrelevanttoinvestors(seeAppendix1).
ThisstudyhasdrawnontheFUND,DICEandWITCHmodels.
AdditionalLiteratureCO2EMISSIONSECONOMICDAMAGESLowestemissionspeakingby2020Loweremissionspeakingafter2030Highestemissionspeakingafter2040Source:Mercer26MERCER2015891011121314RISKFACTORSInourseminal2011report,ClimateChangeScenarios—ImplicationsforStrategicAssetAllocation,wereportedthatclimatechangeincreasesinvestmentrisk,withhigherriskresultingfrominefficientpolicy.
Partoftheprocessofisolatingrisksforinvestorsistoidentifythefactorsthatsignpostdriversofchange.
Inthe2011report,weconsideredhowTechnologyinvestment,Impactcosts,andPolicy(TIP)measures—eachaseparateriskfactorinourinvestmentmodelling—mightdriveinvestorsintoaworldofopportunityandsustainablegrowth,orintoonefacinghigherexpensesandever-increasinguncertainty.
TodeterminethequantumofcostsfallingundertheImpactriskfactor,aclimatemodelthatutilisesatop-downapproachtodamageestimation(withoutanysegmentation)wasused.
Feedbackonthe2011reportincludedaninterestinaddingamoredetailedanalysisontheestimationofimpacts.
Toaddressthisconcern,anewapproachwasdevised,adoptingalternativeclimatemodels.
Thisapproachprovidesgreatergranularitywithrespecttoimpactestimation,allowingformoredetailedtreatmentofdamagepossibilitiesacrossindustrysectorsandassetclasses.
Italsoleadstotheacknowledgmentthatnotallimpactsfromclimatechangeresultincostsovertheshort-term—economicgainsarealsopossible.
Moreover,uponanalysisofmoredetaileddamageresults,adichotomyarisesbetweentwobroadimpactcategories—thosethatmanifestasaresultofshiftsinacuteorextremeweatherphenomenonandthosethatmanifestasaresultofshiftsinchronicorlong-termweatherpatterns.
Damagesintheformercategorylargelyarisefromdestructionofphysicalproperty/thebuiltenvironmentorlossoflifefromclimatologicalevents,whereasdamages(gains)inthelattercategorylargelyarisefromshiftstoestablishedeconomicsystemsinresponsetoclimate-drivenchangesinresourceavailability.
Thus,toaddressthisdichotomyappropriatelyinourinvestmentmodelling,theImpactriskfactorincludedintheTIPframeworkwassplitintotwoseparateriskfactors—ResourceAvailabilityandphysicalImpact—resultinginTRIP.
Ourfocuswillnowbeonmakingsureinvestorsdonot"TRIP"overtherisksassociatedwithclimatechangeandinsteadfindwaystomitigateandprofitfromthem.
Weconsiderthesefourclimatechangeriskfactorsas"lenses"throughwhichwecansharpenourfocusonthefutureinvestmentimplicationsofclimatechangeforinvestors.
2134567Broadlydefinedastherateofprogressandinvestmentinthedevelopmentoftechnologytosupportthelow-carboneconomy.
Definedasthephysicalimpactoninvestmentsofacuteweatherincidence/severity(i.
e.
extremeorcatastrophicevents).
Definedastheimpactoninvestmentsofchronicweatherpatterns(e.
g.
long-termchangesintemperatureorprecipitation).
Broadlydefinedasallinternational,national,andsub-nationaltargets;mandates;legislation;andregulationsmeanttoreducetheriskoffurtherman-madeor"anthropogenic"climatechange.
TECHNOLOGY(T)IMPACT(I)RESOURCEAVAILABILITY(R)POLICY(P)27"Weconsiderthesefourclimatechangeriskfactorsas"lenses"throughwhichwecansharpenourfocusonthefutureinvestmentimplicationsofclimatechangeforinvestors.
"MERCER201528891011121314"Technology"isbroadlydefinedastherateofprogressandinvestmentinthedevelopmentoftechnologytosupportthelow-carboneconomy.
It'sallabouttechnologicaladvancementandtheopportunityforincreasedefficiencythroughtechnologicalchange.
Speed,scale,andsuccessoflow-carbontechnologies,coupledwiththeextentoftransformation/disruptionofexistingsectors,ordevelopmentofnewsectors,arethekeymetricsofthisfactor.
Technologyprimarilyreferstomitigationeffortstotransformenergyproduction,transmission,andusetoreduceboththeworld'scarbonintensityandenergyintensity.
Italsoreferstoothertechnologicaldevelopmentsformitigation(inagriculture,landuse,etc.
)andadaptation(disasterriskmanagement,resilientinfrastructure,agriculture,etc.
).
TheTechnologyfactorcanbeinterpretedasameasureofthefutureprivate-sector,low-carboninvestmentflowsunderdifferentclimatescenarios,forwhichahighertechnologyvalueindicatesahigherlevelofinvestment.
TECHNOLOGY(T)Itisimportantforinvestorstohaveasenseofthelow-carboninvestmentflowsacrosstheclimatescenariosasanindicatorofthepotentialdepthofthepoolofinvestmentopportunitiesandassociatedeconomictransformation.
Thekeymetricsarethespeedandscaleofinvestmentflows,whichcanbeinfluencedby:Policy(forexample,carbonpricing,low-carbonmandates,minimumefficiencystandards).
Availabilityofcost-effective,low-carbonalternatives(forexample,absentsubsidiesand/orcarbonpricing).
Private-sectordemand(forexample,businesseswithtargetsofbecoming100%renewable).
Investortargetsrelatedtodecarbonisationofportfolios(forexample,divestment,cleantechcommitments).
213456729"ResourceAvailability"isdefinedastheinvestmentimpactofchronicweatherpatterns(forexample,long-termchangesintemperatureorprecipitation)andrelatedphysicalchanges.
Thisisanewaspectandisbeingaddedtothepreviousstudy'sTIPframeworktoidentifyhowchangestothephysicalenvironmentmightimpactinvestmentsreliantontheuseofresources(forexample,air,naturalmaterialsand,ofcourse,agriculture)thatareatriskofbecomingscarceror,insomecasesoratcertaintimes,moreabundant.
Agricultureandenergyareresourcesectorsrequiringspecialtreatmentgiventheirdirectlinkagetolargeassetclasssub-sectorsforinvestment.
Waterisalsoakeyresource,givenitsimportancetomanysectorsofindustry.
Tosummarise,thisfactorcanbeinterpretedastheinvestmentimpactofclimatechangeonnaturalandmaterialresourcedistribution/availabilitycausedlargelybyshiftsinlong-term(thatis,oneyearorlonger)weatherpatterns.
RESOURCEAVAILABILITY(R)Chronicweatherpatternscanhavepositiveornegativeimpactsthatmayevolveovertime,suchas:Higheraverageannualtemperaturesresultinginincreasesordecreasesincropyields.
Loweraverageannualprecipitation(orshiftsintiming/durationofrainyseasons)resultinginreducedcropyields,livestockdeath,andwatershortages,whichcanhavenegativeeffectsontheenergyandminingindustries.
30891011121314"Impact"referstothephysicalimpactofclimatechangeandisdefinedastheimpactoninvestmentsofacuteweatherrisk(thatis,extremeorcatastrophicevents).
Thisfactorcanbeinterpretedastheinvestmentimpactofclimatechangeonthephysicalenvironmentcausedlargelybyshiftsinextremeweatherincidence/severity.
Someprominentexamplesofphysicalimpactswouldbe:Increasedpropertydamageandbusinessinterruptionasaresultofmorevolatileextremeflooding(coastal/inland).
Coastalfloodingandpotentialshiftsinthedistributionofhurricaneactivitytowardslessfrequentandmoresevereevents(withlessscientificconfidenceinthelatter).
Wildfire,whichcausesallsortsofcomplexdamagestovariousindustries,thoughmostdirectlyaffectsforestry,residentialrealestateinthewildland/urbaninterface,andruralpublicentities.
Tosummarise,thisfactorcanbeinterpretedastheinvestmentimpactofclimatechangeonthephysicalenvironmentcausedlargelybyshiftsinshort-termextremeweatherpatterns.
IMPACT(I)213456731"Policy"isbroadlydefinedasalltheinternational,national,andsub-nationaltargets;mandates;legislation;andregulationsmeanttoreducetheriskoffurtherman-madeor"anthropogenic"climatechange.
Itreferstodevelopmentsinclimatepolicytoreducecarbonemissionsbyincreasingthecostofcarbon;and/orincentiviselow-carbonalternatives.
Thisfactorcanbeinterpretedasthelevelofcoordinatedambitionofgovernmentstoadoptandadheretopoliciesandregulationstoreducegreenhousegas(GHG)emissions.
Climate-relatedpolicyconsistsofvariouselementsand,inthiscontext,includes:Reductiontargets:specifically,thegoaltoreduceGHGemissionsbyagivenamountandbyasetdate.
Fiscalpolicy:carbonpricingandsubsidies.
Energysupply:restrictionsoncoal,renewableenergymandates,fuelswitch,carboncapturestorage(CCS),etc.
Energyefficiency:buildingcodes,appliancestandards,fuel-efficiencystandards,etc.
Landuse:reducingemissionsfromdeforestationandforestdegradation(REDD)programs.
Methanereduction:reductionofshort-livedclimatepollutants(primarilyagricultureandenergy).
Thedegreetowhichclimate-relatedpolicyactiontakesplaceanditsanticipationbyinvestorswillbethecrucialfactorstoconsiderwhenevaluatingtheinvestmentimpactsofclimatepolicy.
AkeyfeatureofanyclimatepoliciesthataremeanttoreduceemissionsshouldbeassigningacosttoCO2emissions,andincreasingthecostsufficientlyovertimetoshiftbehaviourstowardsazero-carboneconomy.
POLICY(P)Climatepolicywillgenerallyincludeacombinationof:Explicitcarbon-pricingmechanisms(forexample,carbontax,emissionstradingsystems).
Measuresthatputanimplicitpriceoncarbon(forexample,energytaxes,industry-specificregulations).
Targetedsupportforresearchanddevelopment(forexample,subsidiesrelatingtocleantech).
Revisionstopoliciesthatruncountertoemissionsreductionsgoals(forexample,fossilfuelsubsidies).
Suchpoliciescanbeclassifiedintotwocategories,whethertheyfocusonthesupplyordemandside.
Thatsaid,policiesthatfocusononesideofthemarketwillindirectlyaffecttheother(forexample,taxesononecommodityimplicitlysubsidiseothers15):Supply-sidepoliciesencouragingsubstitutionofhigher-emissiontechnologies(forexample,coal-generatedelectricityandfossilfuels)withlow-emissiontechnologiesandproducts(forexample,renewableenergyandbiofuels).
Demand-sidepoliciesdiscouragingconsumptionofproductsthatgenerateemissions,eitherthroughpriceincreasesofthoseproductsand/ornon-price-induceddecreasesindemandforemissions-intensiveproducts(forexample,vialabelsshowingembeddedCO2emissionsofvariousproducts).
15OECD.
EffectiveCarbonPrices,2013,availableathttp://www.
oecd-ilibrary.
org/environment/effective-carbon-prices_9789264196964-en,accessed9April2015.
32SCENARIOS213456733"Whathappensinthenext40yearsiscriticalforallhumanityforcenturiestocome.
Whathappensinthenext10yearssetstherangeofwhat'spossible.
"—AlexSteffen,futurist16MERCER201516Volans.
"GetReadyForTheBreakthroughDecade,"availableathttp://volans.
com/2014/05/get-ready-for-the-breakthrough-decade,accessed191214,accessed10April2015.
34891011121314AsnotedbytheIntergovernmentalPanelonClimateChange(IPCC),the"warmingoftheclimatesystem"is"unequivocal".
17Theextensiveuncertaintiesthatstillexistincludejusthowmuchourcurrentpracticeswillcontributetothisunequivocalwarmingbywayofemissions,whatlevelofwarmingwillbesustainable,andwhatdamagesinvestorsneedtopreparefor,whateverthelevelofwarming.
Whathappensbytheendof2015willhaveasignificantinfluenceonwhathappensoverthecomingdecadeandultimatelywhichscenarioplaysoutinthelongerterm.
18Table2setsoutfourfuturescenariosrelevantforinvestors.
ThesescenariosweredevelopedcollaborativelybyNERAandMercer,withinputfromall18projectpartnersandtheproject'sadvisorygroup,andarebasedonsomeofthemostadvancedclimatemodellingandscientificliteratureavailable.
Theyofferinvestors"arangeofwhat'spossible",providingseveralviewpointsofthewaythenext35yearsmightplayout.
Table2:SummaryoftheScenariosMoreambitiousclimatechangemitigationactionthatputsusonapathtolimitingglobalwarmingto2°Cabovepre-Industrialeratemperaturesthiscentury.
Policiesandactionsarealignedandcohesive,keepingwarmingto3°Cabovepre-Industrialeratemperaturesthiscentury.
Limitedclimateactionandlackofcoordinationresultinwarmingrisingto4°Corabovefrompre-Industrialeratemperaturesthiscentury.
Asabove,coupledwithassumedhigherdamages.
Strongclimatechangemitigationaction:Emissionspeakby2020thenreduceby56%relativeto2010levelsby2050.
Fossilfuelsrepresentlessthanhalfoftheenergymixat2050.
Estimatedannualemissionsat2050of22gigatons(Gt)ofequivalentcarbondioxide(GtCO2e).
Substantialclimatechangemitigationaction:Emissionspeakafter2030thenreduceby27%relativeto2010levelsby2050.
Fossilfuelsrepresentaround75%oftheenergymixat2050.
Estimatedannualemissionsat2050of37GtCO2e.
Limitedclimateaction:Emissionspeakafter2040,increasingby33%over2010levelsby2050.
Fossilfuelsrepresent85%oftheenergymixat2050.
Estimatedannualemissionsat2050of67GtCO2e.
AsperFragmentation(LowerDamages),butassumesthatrelativelyhighereconomicdamagesresult.
1.
TRANSFORMATIONSCENARIODESCRIPTION2.
COORDINATION3.
FRAGMENTATION(LOWERDAMAGES)3.
FRAGMENTATION(HIGHERDAMAGES)213456717IPCC.
ClimateChange2007:SynthesisReport,availableathttps://www.
ipcc.
ch/publications_and_data/ar4/syr/en/spms1.
html,accessed11May2015.
18Consensusofthestudypartnergroup.
35Source:MercerOurscenariosarebuiltontwokeycomponents:1.
Theemissionspathway(whichdependsontheambitionsofclimateaction).
2.
TheeconomicdamagesbasedonhowsensitivetheclimateandtheeconomyaretofuturelevelsofCO2concentrations(modelledusingIAMs—see"ExecutiveSummary"—includingWITCH,DICE,FUND,andotherinputs).
EconomicimpactofphysicalandpolicychangesLevelofemissionsLowestemissionsLoweremissionsMODELSHigheremissionsFUNDFUNDFUNDFUND(DICE)1.
TRANSFORMATION2.
COORDINATION3.
FRAGMENTATIONLowerDamages4.
FRAGMENTATIONHigherDamagesTHEFOURSCENARIOSTWOKEYCOMPONENTSFigure7:DevelopingtheMercerScenariosECONOMICDAMAGESEMISSIONSPATHWAY36MERCER2015891011121314"Eachscenariohighlightsthepotentialfutureeffectsofclimatechangemitigationandadaptation,aswellasphysicalimpactsacrossregions,countries,assetclasses,andindustrysectors.
"213456737INVESTINGINATIMEOFCLIMATECHANGE19BielloD,"EverythingYouNeedtoKnowabouttheU.
S.
–ChinaClimateChangeAgreement,"ScientificAmerican,2014,availableathttp://www.
scientificamerican.
com/article/everything-you-need-to-know-about-the-u-s-china-climate-change-agreement/,accessed2April2015.
ButwhatdosuchscenariosmeanforinvestorsEachscenariohighlightsthepotentialfutureeffectsofclimatechangemitigationandadaptation,aswellasphysicalimpactsacrossregions,countries,assetclasses,andindustrysectors.
Applyingclimate-relatedscenarioswithininvestmentmodelsisnewtoinvestors,thusprovidingadditionalinsightsinordertopositionportfolio-allocationdecisionsthatrespondtotheirinformedexpectationsaroundclimatechangeriskandopportunities.
Themorelikelyscenariomaybecomeclearerbytheendoftheyear,determinedbytheoutcomeoftheDecember2015UnitedNationsClimateSummitinParis.
Thisyearisperhapsourlastchancetoaligninternationalpolicyobjectivesbehindstrongaction.
Wehopethefindingsofthisstudywillplayaninfluentialroleinshapingthecommitments,disclosure,andchangesneededtosupportatransitiontoaresilient,low-carboneconomybylimitingwarmingtowithin2°C.
Thecommitmentsrequiredaresignificant,andviewscurrentlyvaryastothelikelihoodofwhetherthiscanbeachieved.
However,negotiationsandeconomicanalysiscontinuetofocusonthe2°Climit,soitmakessenseforinvestorstotrytounderstandtherisksandopportunitiesunderthistypeofscenario.
Inanimportantrecentdevelopment,theleadersoftheUSandChinaannounceda"historicdeal"thathassetthetwonations"onapathtoachievingdeepemissionsreductionsbyadvancedeconomiesthatthescientificcommunitysaysisnecessarytopreventthemostcatastrophiceffectsofclimatechange.
"19ThedealsawtheUSandChina—twonationsthattogetheraccountforoverone-thirdofglobalGHGemissions—agreetomovepeakGHGemissionstargetsearlierthancurrentlyexpectedandincreasetheuseofnon-fossil-fuelledenergyby2030.
ThecommitmentbyChina'sPresidentXiJinpingtopeakhisnation'sCO2emissionsbyaround2030whileincreasingnon-fossil-fuelledenergytoaround20%bythattimeisalmostperfectlyalignedwithourstudy'sCoordinationscenario.
TheUSgoaltoreducenetGHGemissionsto26%—28%belowtheir2005levels—by2025isactuallymoreambitiousthanourCoordinationscenario.
ThesignpostsonthefollowingpageshelptosummarisethekeyindicatorsforinvestorsinrelationtoeachoftheTRIPfactorsforeachscenario.
38891011121314Rateofinvestmentintechnologiessupportingthelow-carboneconomy:CumulativeinvestmentofUS$65trillioninenergysupplyandefficiency(ex-fossilfuels)isrequiredover2015–2050(approximately64%oftotalenergyinvestments).
**Fortheperiod2015–2035,thisisassumedtobesplitbetweenenergyefficiency(48%)andenergysupply,suchasnuclear,renewables,biofuels(40%),andothertechnologies(CCS).
20Potentialchangestoenergymix:21In2050,fossilfuelsrepresentapproximately43%oftotalenergy.
Energyefficiency,renewables,andCCSmakethelargestcontributionstoglobalemissionsreductionsintheTransformationscenario.
Respectively,theyaccountforsharesof38%,30%,and14%cumulativeemissionsreductionsto2050.
Potentialshiftsinlong-termweatherpatternsandimpactonresourceavailability:Limitedimpactby2050.
EconomicdamagesexpectedtobeminimisedbygainsinAgriculture,partiallyoffsetbylossesrelatedtoBiodiversityandWateravailability.
FRAGMENTATION(LOWERDAMAGES)Estimatedtotalneteconomicbenefit22fromresourceavailabilityasapercentageofglobalGDPof:--0.
63%at2030.
--0.
50%at2050.
Drivenbygainsinagriculture,partiallyoffsetbylossesrelatedtobiodiversityandwater.
FRAGMENTATION(HIGHERDAMAGES)EstimatedtotalneteconomiclossfromresourceavailabilityasapercentageofglobalGDPof:--0.
27%at2030.
--0.
80%at2050.
Drivenbylossesduetoenergy,water,andbiodiversity.
Rateofinvestmentintechnologiesintosupportingthelow-carboneconomy:TotalenergyinvestmentsincreasefromUS$1.
41trillionin2020toUS$2.
31trillionin2050.
*Cumulativeinvestmentinenergysupplyandefficiency(ex-fossilfuels)requiredfrom2015–2050ofUS$47trillion(approximately46%oftotalenergyinvestments).
**Potentialchangestoenergymix:Some(butlimited)useofCCSby2030.
In2050,fossilfuelsrepresent:--75%ofprimaryenergy.
--74%ofsecondaryenergy.
--44%ofelectricity.
Rateofinvestmentintechnologiesintosupportingthelow-carboneconomy:TotalenergyinvestmentsincreasefromUS$1.
59trillionin2020toUS$3.
13trillionin2050.
*InternationalEnergyAgency(IEA)estimatesnotgiven.
Investmentrequirement(ex-fossilfuels)presumedtobelessthanforCoordination.
**Limitedinvestmentintolow-carbonenergy.
Potentialchangestoenergymix:In2050,fossilfuelsrepresent:--86%ofprimaryenergy.
--85%ofsecondaryenergy.
--68%ofelectricity.
TRANSFORMATIONCOORDINATIONFRAGMENTATION(lower/higherdamages)TRSCENARIOSIGNPOSTS20IEA.
WorldEnergyInvestmentOutlook,2014,availableathttp://www.
iea.
org/publications/freepublications/publication/WEIO2014.
pdf,accessed11May2015.
21IEA.
EnergyTechnologyPerspectives,2014,(2°CScenarioat2050).
22Estimatesofeconomicdamage(gain)producedbytheFUNDmodelandassupplementedbyGuyCarpenterdonotnecessarilytranslatedirectlytoindustrysectororassetclassinvestmentlosses(gains).
Incertaininstances–mostnotablyrelatedtoAgriculturaldamages(gains)–weusedsupplementalresearchtoinformourinvestmentmodelingassumptions.
2134567*In2013;USD**InternationalEnergyAgency,Mercer39GlobalpolicyresponseMosteffectivefromaclimatechangemitigationperspective,butanunexpectedcarbonpriceintroductionislikelytocatchfinancialmarketsoffguard.
Expectedcostofcarbon23Globalcarbonpricingintroducedrelativelyswiftly,thenflatteningouttoaround$180($US2013/tCO2)by2050.
GlobalGHGemissionsat2050:2422GtCO2e/yr.
56%decreaseversus2010levels.
(emissionspeakby2020).
GlobalpolicyresponseExistingpolicypledgeswithrespecttocarbonemissionsareimplementedwithmitigationeffortsextendedto2030.
ExpectedcostofcarbonGlobalcarbonpricingintroducedmoreslowly,pickinguppaceafter2030andreaching$210($US2013/tCO2)in2050.
GlobalGHGemissionsat2050:37GtCO2e/yr.
27%decreasevs2010levels(emissionspeakbt2030).
GlobalpolicyresponseDivergentwithlimitedeffortsbeyondexistingpledges.
Althoughareductioninemissionsof10%(versus2010levels)isachievedby2050bydevelopedmarkets,thisisoutweighedbyincreasesinemissionsinemergingmarketswithtotalemissionsincreasingby33%increasefrom2010levels.
ExpectedcostofcarbonLackofglobalcarbonpricedevelopmentrecognisedbythemarket.
Wherepricingmechanismsexist,carbonpricinglimitedtoaround$40by2050.
Thelevelofphysicaldamagescausedbycatastrophicevents,suchasfloodsandhurricanes:Limitedimpactby2050.
Drivenbylossesfrom(extra)TropicalStormsandCoastalFlood.
EstimateddamagesbasedonFUNDmodeloutput,supplementedbyMercerwithsupportfromGuyCarpenterforCoastalFloodandWildfire.
FRAGMENTATION(LOWERDAMAGES)EstimatedtotalnetlossfromphysicalimpactsasapercentageofglobalGDPof:--0.
25%at2030.
--0.
41%at2050.
Drivenbylossesfrom(extra)TropicalStormsandCoastalFloodFRAGMENTATION(HIGHERDAMAGES)EstimatedtotalnetlossfromphysicalimpactsasapercentageofglobalGDPof:--0.
40%at2030.
--0.
73%at2050.
PrimarilyrepresentslossesfromWildfireandCoastalFlood,andextremetemperatures.
TRANSFORMATIONCOORDINATIONIP23SeeAppendix2–Scenariodetailformoredetailonexpectedcostofcarbon.
24TotalGHGemissionsherereferstothesumoftheCO2equivalentofthesixGHGscoveredbytheKyotoProtocol(carbondioside,methane,nitrousoxide,hydrofluorocarbons,perfluorinatedcompounds,andsulphurhexaflouride).
2010Levelswereapproximately50GtCO2e/yr.
FRAGMENTATION(lower/higherdamages)*In2013;USD**InternationalEnergyAgency,Mercer40891011121314ASSETSENSITIVITYHOWSENSITIVEAREDIFFERENTASSETCLASSESTOCLIMATECHANGEInvestmentportfoliosaretypicallywell-diversifiedacrossabroadrangeofdifferentassetclassesandgeographies,someofwhichwillbemoresensitivetoclimatechangethanothers.
Indeed,assetclassesandregionswillalsodifferintermsofwhetherweexpectclimatechangeimpactstobebeneficialordetractfrominvestmentreturns.
Inordertohelpinvestorsconsiderthepotentialportfolioimpacts,thisstudyhasassessedthesensitivityofdifferentassetclassesandindustrysectorstoourfourclimatechangeriskfactors:Technology,ResourceAvailability,Impact(ofphysicaldamages),andPolicy.
Thisassessmentiscapturedwithinsensitivityheatmaps.
Theheatmapsareconstructedbasedoncurrent-dayevidencewithsomeforward-lookingqualitativejudgement.
Althoughtheinvestmentmodellingundertakenassumesthatthesensitivitieswillbestaticovertheperiodmodelled(to2050),weknowthatinpracticethiswillnotbethecase.
Wewillrevisitandupdatetheheatmapsonaregularbasistoensuredevelopmentsarecapturedasadditionalevidencebecomesavailable.
Whileassetownersdonottypicallyconsiderindustry-leveldetailwhenmakingstrategicinvestmentdecisions,thesensitivityofdifferentindustriesenablesareasoffocustobeidentifiedfromaclimatechangeperspective.
Itisnecessaryto"drill-down"totheindustrysectorlevelduetothedisparityofsensitivityacrossdifferentindustries.
ThiswillrequireunderstandingtotalportfolioindustryexposuresandthenengagingwithinvestmentmanagersontheTRIPfactorsensitivities,expectingmanagerstounderstandthepotentialimplicationsfortheindustriesandcompaniesinwhichtheyinvest.
Wehavefocusedourattentiononthoseindustrieswebelievetobeofmostinterestforthisstudy;thosethatareexpectedtobethemostsensitive(eitherpositivelyornegatively)toclimatechange.
Wehaveassignedsensitivityonarelativebasisusingascaleof-1whereweexpectthemostnegativeimpactoninvestmentreturns,to+1whereweexpectthemostpositiveimpactoninvestmentreturns.
213456741Figure8:SensitivitytotheClimateChangeRiskFactors—AssetClassLevelDevelopedMarketGlobalEquityEmergingMarketGlobalEquityLowVolatilityEquitySmallCapEquityDevelopedMarketSovereignBondsInvestmentGradeCreditMulti-assetCreditEmergingMarketDebtHighYieldDebtPrivateDebtGlobalRealEstatePrivateEquityInfrastructureTimberAgricultureHedgeFunds-0.
25>-0.
25>-0.
25-0.
25>-0.
25>-0.
25-0.
25>-0.
25>-0.
250.
000.
000.
000.
00-0.
25>-0.
25>-0.
250.
000.
00>-0.
250.
000.
00>-0.
25-0.
25-0.
25-0.
25>-0.
250.
000.
000.
000.
00-0.
25-0.
25>-0.
250.
25>-0.
25-0.
50-0.
25-0.
50-0.
25-0.
25-0.
75-0.
250.
00-0.
250.
00>-0.
250.
00-0.
25-0.
500.
00-0.
250.
00TRIPEQUITYSECTORENERGYUTILITIESNegativePositive25BasedonMSCIGlobalIndustryClassificationSystem.
43STRUCTURALCHANGEWHYPASTPERFORMANCEISNOTAGUIDETOFUTUREPERFORMANCEAllinvestorswillbefamiliarwiththestandardcaveataroundtheperformanceofinvestments:pastperformanceisnoguidetofutureperformance.
However,investmentmodellingremainsbasedonlong-termhistoricalreturnsdata,albeitwithinformedoversight,andoverthetypicaltimeframeusedforsettinginvestmentstrategy(10years).
Althoughinvestmentmodellingprovidesausefulguide,existingmodellingisnotabletocaptureverylong-termstructuralchanges—preciselythetypeofchangewewouldexpectastheworldmanagestherisksposedbyclimatechange.
WehaveadaptedourinvestmentmodelbyaddingtheTRIPfactorsandourfourdefinedclimatechangescenarios.
Aparticularlydifficulttaskforinvestorsisinidentifyingandmanagingstructuralchanges.
Thegreaterthelevelofchange,themoredisparitybetweenthewinnersandlosers,andtoday's"giants"oftenbecometomorrow's"dinosaurs",asthosethatfailtoadaptareleftbehind.
Suchchangescancreatenewindustriesattheexpenseofexistingindustries.
Onerelativelyrecentexampleistheshifttomobile-basedtechnology.
Emergingmarketconsumersarebypassingtheuseoffixed-linetechnologyandgoingstraighttomobile-basedtechnology.
Itremainsverydifficulttocapturelong-termforward-lookingchangeswithinquantitativemodellingprocesses,andalthoughweknowthatinpracticelong-term,sustainableglobaleconomicgrowthisnotgoingtofollowthesamepathashistoricaleconomicgrowth,wehavenotsoughttoreflecttheseuncertainfuturestructuralchangeswithinourinvestmentmodelling.
Therefore:Industryclassificationisbasedontoday'sdefinition:wehavenotmadeanallowancefornewindustriesand/oranyre-classificationthatwouldbeexpectedasmarketsreflecttheadaptationtoalow-carboneconomy.
Wehavenotattemptedtoforecastchangesintheregionalcompositionofglobalequityindices.
However,overtheperiodmodelledto2050,wewouldexpectcertainnationscurrentlyclassifiedasemergingmarketstobere-classifiedtodevelopedmarkets.
Thereisa"negativebias"totheheatmaps(thatis,morepinkthangreen),asaresultofouranalysisbeingbasedonastartingpointoftoday.
Werecognisethattherewillbeopportunitiescreated,andthatacrossdifferentindustriesandregionstherewillbewinnersandlosers,assomecompanieswilladaptbusinessmodelsaccordinglyandotherswillnot.
Withinindustrysectors(andsub-sectors)therewillcontinuetobedifferentsupplyanddemanddrivers.
Thisalsoappliestoindustrieswhereoverallsensitivitymaybeneutral.
However,wehavenotattemptedtoadjustourmodellingtopredictthespecificsofthesefuturedevelopments.
Althoughwehavenotlookedatsecurity-levelanalysisaspartofthisstudy,itiscrucialthatinvestorsunderstandwhererisksandopportunitiesmightlieandforassetownerstoensurethattheirinvestmentmanagersarefullyconsideringtheseriskswhenbuildingportfolios.
Thisisparticularlyrelevantwhenconsideringinvestinginassetclasses,industrysectors,andsub-sectorswiththehighestsensitivitytoclimatechange.
44MERCER20152134567EQUITIESEquitiestypicallycompriseasignificantproportionofmostinstitutionalinvestmentportfolios.
Atanassetclasslevel,climatechangeimplicationsarebetterunderstoodforequitiesgiventherelativelyhighlevelofintegrationofESGissuesrelativetootherassetclasses.
Wealsonotethattherearethematicsustainableinvestmentstrategieswhereexposuretoasectorsuchasindustrialsmaybehighbutclimatechangesensitivityislowergiventhenatureoftheunderlyingcompanies.
Wehaveusedourglobalsectoranalysisasastartingpointforconsideringregionalandglobalequityportfoliosbyaggregatingthesectorexposurebyregionandhavemadesomeadjustmentsbasedonconsiderationsatacountrylevel.
Werecognisethatdifferencesinlocalclimatechangepolicy,aswellasotherlocalmarketdrivers,willcausesomeregionaldivergence.
TechnologyTechnologyImpactImpactResourceAvailabilityResourceAvailabilityPolicyPolicyDEVELOPEDMARKETGLOBALEQUITYGLOBALEMERGINGMARKETEQUITIES45Inparticular,wewouldexpect:UK,Australian,andCanadianequitiestobemoresensitivegiventhehigherexposureoftheseregionalequitymarketstocarbon-intensivesectors.
UKandEuropeanequitiestobelessvulnerabletoclimatechangepolicyshocksgivenexistingpolicyandcommitmentsinplace.
Weexpectthesemarketstobebetterpreparedforadditionalclimate-relatedpolicygiventherelativetransparencyregardingthedirectionoffuturepolicy.
Australianequitiestobemoresensitivetoaclimatechangepolicyshockgiventhegreaterlevelofpolicyuncertaintyinthismarket.
WeexpecttheUStocontinuetodriveglobalequitymarketsinthenearterm.
Therefore,wewouldexpectanysignificantpolicydevelopmentsintheUStoimpactglobalequitiestoagreaterextentthandevelopmentsinotherregions.
Althoughtherewillbecountry-leveldifferencesacrossemergingmarkets,overallwewouldexpectemergingmarketequitiestobenefitfromadditionalclimatechangemitigationpolicyandtechnologydevelopments(subjecttothesupportandothertermsofaninternationalclimateagreement).
Emergingmarketequitiesaremoresensitivetotheclimatechangeriskfactorsassociatedwithphysicaldamagesofclimatechange(physicalimpactsandresourcescarcity)thandevelopedmarkets,andalsoaremorelikelytofacecostsaroundadaptationtoclimatechange.
Thus,emergingmarketsarelikelytoreceivegreaterrelativegainsfrommoreambitiousmitigationpoliciesthandevelopedmarkets.
Forsmall-capequityandlow-volatilityequity,riskfactorexposuresarederivedfromthesector-levelanalysis.
Wewouldnotethatwithinthesmall-capspace,thereisconsiderableopportunitytoinvestincompaniesdirectlyrelatedtotheshifttowardsalow-carboneconomy.
Low-volatilityequitieshaveslightlylowernegativesensitivitytotheclimatechangeriskfactorsthanstandardglobalequities.
Theindustrysectorofmostinteresttoinvestorsisenergy,inthatitisexpectedtobemostaffectedbyastructuralchangetoalow-carboneconomy.
Changesintheenergymix—fromfossilfuelstolow-carbonenergysources—areoneofthekeysignpoststoinvestorsashighlightedinourdiscussiononthefourclimatechangescenarios.
Theenergyindustryisexpectedtobethemostsensitivetoclimatechangeimpactsandalsothemostdifferentiated,inthatsensitivitytoourclimatechangeriskfactorsrangesfrom-1forcoalto+1forrenewableenergy.
Thedetailedheatmapfortheenergyindustryisshownbelow.
Althoughtheworldcannotchangeitsrelianceonfossil-fuel-basedenergyovernight,wehaveassignedthefollowingsensitivities:ThecoalsectorisverynegativelysensitivetoPolicyduetothemuchhigherlevelofassociatedCO2emissionsfromburningcoalcomparedwithgas,whereasrenewableenergyhashighpositivesensitivity.
Wenotethatwithinthecoalsector,themarketdriversforthermalcoal(usedtogenerateelectricity)andmetallurgicalcoal(usedforsteelproduction)areverydifferentandthuswewouldexpectdifferentiationinsensitivitybetweencompaniesoperatinginthesetwoareas.
WehaveassignedapositivesensitivitytoPolicyandTechnologyforthegassectorasgasisexpectedtobethe"transitionfuel"intheshifttoalow-carboneconomy.
46891011121314Thegreatesttechnologicaladvancesandsubsequentefficiencygainsareexpectedtooccurintherenewableandnuclearindustries,withfossilfuelsbecomingincreasinglychallengedbyexplorationlimits.
Althoughtherearepositiveopportunitiesexpectedforinvestors,reflectingdemandchanges,thenegativeriskfactorsensitivityreflectsthecurrentweightingswithintheenergysector.
Allenergyproductionhasexposuretoresourceshortages,especiallywater,whichhasabroadimpactacrossfossilfuels,nuclear,andrenewables(hydro).
Oilisthemostwater-intensiveofthefossilfuels,andmoresothannuclear.
Gashasexposuretowater-scarcityrisk,althoughislesswater-intensivethanoilandcoal.
Coalhasexposuretowaterscarcityrisk,moresothangas,butlesswater-intensivethanoilandnuclear.
Wind/solarhavelittleexposuretoresourceavailabilityrisk.
Hydro(accountingforaround50%ofoverallrenewableenergycapacityglobally)isveryexposedtowaterrisk,withregionalvariance.
Bioenergyhasexposuretowaterscarcity.
Nuclearhasexposuretowaterscarcityrisk.
Oilaccountsfor95%oftransportenergyuse.
Newtechnologiesandfuels(e.
g.
natural-gasvehicles,hybrids,andelectricvehicles)areexpectedtotakemarketshare,withtechnologicaladvancementspotentiallyadvancingtheswitchingpace.
Increasingtechnicalandlogisticalcomplexityfornewreservoirexplorationanddevelopmentwillmakethismorecostly—bornebythecompanyand/orpassedontocustomers.
Shalegashasalreadychangedtheshapeandleveloftheoilandgascostcurve,withsomeregionalvariation.
Althoughenvironmentalconcernsremainwiththegrowthoffracking,gasisseenasakey"transitionfuel"inamovetoalow-carboneconomy.
Coalisoftenadominatesourceforbasepowersupply.
Withoutrapidandwidespreadadoptionofhigh-efficiencycoal-firedgenerationtechnologiesand,inthelongerterm,ofCCS,coalwillbeincompatiblewithclimategoals.
Parityforrenewablesisalreadyarealityinsomemarketsandisexpectedtobecomemorewidespreadinashorttimeframe.
Theratethatthepriceofsolarpanelshasreducedhasexceededexpectations.
Thepredictabilityandlow-risknatureofsolaralsomakeitwellsuitedtodebtfinancing.
Windtechnologyisevolving,butmoreslowlythansolar.
Windhastheadvantageinthatitischeaper.
Futurereactortechnologiesandassociatedfuelcycleswillseekcontinuedimprovementsoverthecurrentgenerationintheareasofsafety,economics,fueluse,wasteproduction,andnon-proliferationofweaponsmaterials.
ENERGYOilGasCoalNuclearRenewablesTRENERGYSENSITIVITYTOCLIMATERISKFACTORS213456747Physicaldamageswillnegativelyaffectallformsofenergy.
However,fossilfuelsareathigherriskgiventhatsupplyisoftencentralisedandnearcoastalareas.
Policiesareexpectedtosupportlow-carbonenergyandposearisktofossilfuels.
Oilinfrastructureisoftenincoastalareas(aswellasoffshore)resultinginstorm-surgeandotherextremeweatherriskscausingoperationaldisruptions.
Oilisaffectedbyenergyefficiency,carbonintensity,subsidies,and/orcarbon-pricingpolicies.
Thepolicyimpactisexpectedtobelesssevereforsometimethanforcoalbecause:--Oilislesscarbonintensive.
--Alternateoptionsfortransportfuelarenotyetavailableatscale.
Unconventionaloilisalsoatriskofadiminished"sociallicensetooperate"duetosocialactivismonclimateconcerns.
Riskofoperationaldisruptionsduetoextremeweatherevents.
Gasistheleastcarbon-intensiveofthefossilfuels,andthusaffectedtheleastbycarbon-pricingpolicies.
Overthecomingdecades,gasisexpectedtobenefitfromtightercarbon-pricingpolicies,butultimatelywillseereduceddemandtowardsalow-carboneconomy.
Coalinfrastructureisoftenincoastalareas(refineriesandexportterminals)resultinginstormsurgeandotherextremeweatherriskscausingoperationaldisruptions.
RegulationofCO2emissionstogetherwithpollutionfromothertoxicemissionsfrompowerplantsleavescoal(particularly,thermalcoal)veryexposedtotheimpactsofclimatepolicies.
Coalisalsoatriskofadiminished"sociallicensetooperate"duetosocialactivism.
Riskofoperationaldisruptionsduetoextremeweatherevents.
Renewable-energy-relatedpolicies(e.
g.
renewabletargets,subsidies,etc.
)havehadasignificantimpactongrowthofrenewablestodate,andareexpectedtocontinueinthefuture.
Riskofoperationaldisruptionsduetoextremeweatherevents.
Governmentpolicyunderpinstheoutlookfornuclearpowergivenlargeupfrontinvestmentcosts,longconstructiontimesfornewreactors,andintensepublicconcernsurroundingawiderangeofissues(safety,managingwaste,nuclearweapons,etc.
).
Nuclearcouldcontinuetoplayanimportantroleinenergysystemswherethereisfast-growingelectricitydemand,goalstoimproveenergysecurity,andanavoidanceofGHGemissionsandotherairpollutants.
ExistingnuclearisnotexpectedtobenefitfromthispositivesensitivitytoPolicy.
OilGasCoalIPENERGYNuclearRenewables48891011121314BONDSBondsaretypicallyheldwithininstitutionalinvestmentportfoliosforanumberofreasons,includingliability"matching"andgrowthseeking.
Mercertypicallycategorisesinvestmentinbondsintothreeareas:Developedmarketsovereignbondsandequivalents(forexample,municipalbonds,supranationalbondssuchasthoseissuedbytheWorldBank,etc.
).
Investment-gradecredit(corporatebonds).
"Growthfixedincome",whichincludesanumberofdifferentunderlyingopportunities,includinghigh-yielddebt,emergingmarketdebt(sovereignandcorporate),asset-backedsecurities,leveragedloans,convertibles,distresseddebt,etc.
DEVELOPEDMARKETSOVEREIGNBONDS—US,UK,ANDEUROPEDevelopedmarketsovereignbondsthathavebeenclassifiedas"leastvulnerable"byStandard&Poor's26—oneoftheleadingglobalratingagencies—includetheUS,theUK,Canada,andthemajorityofdevelopedmarketEuropeansovereignbonds,includingGermanyandFrance.
InMercer'sview,thereisnotacaseforassigningsensitivitytotheclimatechangeriskfactorstothesovereignbondsofthesedevelopedmarkets,asthedriversofthesewillcontinuetobedominatedbyothermacro-economicfactors.
Inaddition,theabilityofthesenationstoadapttopotentialadverseeffectsofclimatechangeishigh.
WithintheUS,wenotethatstateandlocalmunicipalissuanceislikelytobemoresensitive;however,theconsiderationofthisisbeyondthescopeofouranalysis.
Wenotethefollowingspecificmarkets,whichhavesomedifferencesfromtheoverallfindings.
NEWZEALANDNewZealandisthemostvulnerableofthedevelopedmarketsovereignbonds,duetoahigherproportionofthepopulationlivinginlow-lyingareas,aswellasthehigherdependenceofnationalGDPontheagriculturesectorcomparedtootherdevelopedmarkets.
NewZealand'sexpectedabilitytocopewiththeadverseeffectsofclimatechangehelpstoimprovetheoverallrankingofNewZealand.
26ClimateChangeIsAGlobalMega-TrendForSovereignRisk,Standard&Poor's,May20142134567TechnologyTechnologyImpactImpactResourceAvailabilityResourceAvailabilityPolicyPolicy49JAPANJapanisalsosusceptibletorisingsealevels,witharelativelyhighproportionofitspopulationlivinginlow-lyingareas.
AUSTRALIAWehaveassignedanegativesensitivitytothePolicyriskfactorforAustraliansovereigndebtgiventheheavyrelianceofAustralianeconomicgrowthonresources(notablyminingandagriculture).
WebelievethattheAustralianeconomyismoresusceptibletoapolicyshockthanotherdevelopedmarketsgiventheuncertaintysurroundingitsnationalclimatechangepolicy,whichcurrentlylagsotherdevelopedmarkets,combinedwiththelevelofdependencyoftheAustralianeconomyoncarbon-intensivesectors.
TechnologyTechnologyImpactImpactResourceAvailabilityResourceAvailabilityPolicyPolicy50891011121314INVESTMENT-GRADECREDITWeanticipateglobalcreditmarketstohaveasimilar,albeitless-sensitiveprofiletothatofglobalequities,asweexpectthesamesectordriversthatimpactcompaniesontheequitysidewillalsoimpactthedebtside.
Thesensitivitiesassignedintheheatmapabovearederivedfromtheinteractionofthecreditmodel(whichconsidersvolatilityofcreditspreads)andthesensitivitywehaveassignedtotheequitysectors.
Companiesthatissuedebtinordertofundchangestobecomebetterpreparedfortheshifttoalow-carboneconomymayfacecostpressuresintheshortterm,butoverthelongertermwewouldexpectthebenefitsofbeingpreparedtooutweightheinitialfinancingcosts.
Aswithequities,wewouldexpectwinnersandloserstoemerge,withthosecompaniesfailingtoadaptbeingmoresusceptibletopotentialdowngradeordefault.
Wewouldexpecttheextenttowhichcreditratingsintegrateenvironmentalriskstoincrease,particularlyforthosesectorsthataremorecarbon-intensive.
GROWTHFIXEDINCOMEWebelievethegreatestsensitivitytoclimatechangefromaninvestmentperspectiveiswithingrowthfixedincome,particularlyemergingmarketdebtandhigh-yielddebt.
EMERGINGMARKETDEBTEmergingmarketsovereignbondsaremorevulnerabletothepotentialimpactsofclimatechange.
Thisisaresultofthelowerabilityofemergingmarketcountriestoaccommodatetheoftenhighercostsofclimatechangeadaptation.
Inaddition,emergingmarketeconomiesaretypicallymorereliantonagriculture.
Asnotedintheemergingmarketequitydiscussion,emergingmarketregionsmaybenefitfromgovernmentpoliciesonclimatechangeduetoanincreaseinfinancialsupportfromdevelopednationstoclimate-vulnerableregions.
Institutionalinvestorstypicallydonothaveexposuretothosenationsmostatrisk,andsothesensitivitiesassignedonourheatmapremainmodest.
2134567TechnologyTechnologympactImpactResourceAvailabilityResourceAvailabilityPolicyPolicy51GREENBONDSFixedincomegenerallyremainsamoredifficultassetclassforESGconsiderationstobeintegratedrelativetoequities(bothlistedandprivate)andrealassets,includingrealestateandinfrastructure.
However,oneopportunityarisingisthegrowthofthegreenbondmarket.
Theterm"greenbonds"isappliedtobondsforwhichtheproceedsraisedareusedtosupportprojectsoractivitiesthathaveapositiveenvironmentalimpact,suchasthosefocusedonenergyefficiencyorrenewableenergy.
Althoughstillanascentinvestmentarea,thegreenbondmarketisgrowingrapidlyand,intime,couldofferattractiveopportunitiestoinvestors.
Althoughthescaleofissuanceremainssmallinthecontextofglobalfixedincome,in2014,greenbondissuancereachedUS$35billion,growingfromUS$5billionbackin2011whenMercerundertookourfirststudyontheHIGHYIELDDEBTSimilarlytoinvestmentgradecredit,thesensitivitytotheclimatechangeriskfactorsislinkedtotheindustry-sectoranalysis.
Weexpecthighyielddebttobemoresensitivetotheclimatechangeriskfactors,asweassumeahighercorrelationwiththeequityanalysisthanforinvestmentgradecredit.
Withinthehighyielddebtuniverse,theenergysectorrepresents15%oftheindex.
Weexpectmulti-assetcreditstrategiestohavelimitedsensitivitytotheclimatechangeriskfactorsthroughexposuretohighyielddebt.
Althoughprivatedebthaslinkagetotheexposureofthebroaderfixedincomespacetotheclimatechangeriskfactors,wedonotbelievethatthereisaclearcasetoassignsensitivitiestothisassetclass.
TechnologyImpactResourceAvailabilityPolicy27Formoreinformation,seehttp://www.
icmagroup.
org/Regulatory-Policy-and-Market-Practice/green-bonds/,accessed21May2015.
impactsofclimatechange.
Historically,theissuersofgreenbondsweretypicallysupra-nationalssuchastheWorldBankGroupandregionaldevelopmentbanks;however,thenumberofcorporatesissuinggreenbondshasincreased.
Asthemarketgrows,itisalsoovercomingsomeofthebarriersthathavehistoricallymadeitdifficultforinstitutionalinvestorstoallocatecapitaltothisarea.
SeveralinvestablegreenbondindiceshavebeenlaunchedoverthelastcoupleofyearsandtheGreenBondPrinciples27wereestablished.
ThePrinciplesarevoluntaryprocessguidelinesthatrecommendtransparencyanddisclosure,andpromoteintegrityinthedevelopmentofthemarket.
Wehaveseenanincreasingfocusonthisspaceandwillcontinuetoresearchthisgrowingareaofthefixedincomemarket.
52MERCER2015891011121314REALESTATEClimatechangehasthepotentialtohaveanimpactonrealestateinvestmentreturnsthroughchangesinoperatingcosts(forexample,waterandenergycosts,tax,maintenance,depreciation,insurance)andoccupancyrates(efficiencyandlocationdiscounts/premiums).
Inaddition,capitalgrowthmaybeaffectedthroughchangesindepreciationandexpectedrentalgrowth(again,efficiencyandlocationdiscounts/premiums).
Technologyisalreadywelldevelopedwithintherealestatesector,andmanytechnologiesthatfocusonenergyhavealreadybeenproven.
WehaveassignedpositivesensitivitytoTechnology,asthesustainabilityofdevelopmentandenvironmentalratingsofbuildingscanimpactpotentialtenantinterestaswellasreducerunningcosts.
Inaddition,thepotentialimpactonbuildcostsisexpectedtobeoutweighedbylonger-termbenefits.
Foremergingmarketproperty,wehaveassignedamorepositivesensitivity,aswewouldexpectahigherproportionofbuildingstobebuiltfromscratchwithlatesttechnologies.
ThefollowingconsiderationsledustoassignanegativesensitivitytoImpactofphysicaldamages:Adisproportionatelylargesegmentofthecommercialrealestatesectorbyvalueislow-lyingandincoastalpopulationcentres.
Under-insuranceagainstcatastrophicevents,whichareincreasinginfrequencyandseverity.
Riskofinsurance-marketdisruptionasaresultofcatastrophicperils(catastrophe[re]insurancepricesarecurrentlyverylow;increasesinpremiumsorcapacityshortagescouldresultfromclimatecatastrophesandinsurancecostsareahighportionofpropertyoperatingcosts).
2134567TechnologyTechnologyImpactImpactResourceAvailabilityResourceAvailabilityPolicyPolicyGLOBALREALESTATEEMERGINGMARKETREALESTATE53EXISTINGASSETSVERSUSNEWASSETSWehavesoughttocapture,atahighlevel,thesensitivityofdifferentassetclassesandindustriestoclimatechange.
Oneimportantaspectforinvestorstoconsider,particularlyforassetclassessuchasrealestateandinfrastructure,istheextenttowhichtheimplicationsofclimatechangewilldifferforexistingassetsandnewassets.
Suchconsiderationistoogranulartobecapturedbyourmodellingandisoutsidethescopeofouranalysis,butitiscrucialthatinvestorsarecognisantofthisissue.
Takingrealestateasanexample,indeveloped-marketregionssuchasEurope,thefocusisonretrofittingexistingpropertiestocomplywithincreasinglystringentregulationaroundtheenergyefficiencyofbuildings.
Althoughsuchactivitywillincurshort-termcosts,inthelongertermthisshouldbeoffsetbysavings,aswellasmaintainingtheattractivenesstotenants.
Retrofittingcanleadtosignificantsavingsinenergyuse,butthelargestandmostcost-effectivesavingsoccurwhenbuildingsaredesignedfromscratchwithenergyefficiencyinmind.
Therefore,emerging-marketregions,wheretherearehighlevelsofconstructioninsuchnew-buildproperties,areexpectedtoofferthegreatestpotentialforlow-costclimatechangemitigation.
PRIVATEEQUITYAtahighlevel,privateequityconsistsofseveralgroups(includingventurecapital,growthequity,mezzaninedebt,buyouts),witheachhavingspecificcharacteristicsandrisk/returndrivers.
Thesestrategiesspanthelifecycleofcompanies,rangingfromventurecapitalorinvestmentsinearlystage/start-upcompanies,throughtodevelopmentcapitalandexpansionfinancingforgrowthcompanies,andtofundingtypicallycontrol-orientedbuyoutsinmorestable,maturebusinessesandinvestmentsinfinancially,operationallytroubledordistressedentities.
Typically,thesestrategiesencompassprimarilyequity-orientedinvestments,butcanincludedebtinvestmentsaswell(forexample,distresseddebtinvesting).
Giventhediversityofprivateequitystrategies,atanoverallassetclasslevel,weexpectthesensitivitytotheclimatechangeriskfactorstoberelativelylow,andthisislinkedtoourequity-sectoranalysis.
Similarlytoequities,althoughtherewillbecertainsectors,suchascleantech(includingrenewableandenergyefficienttechnologies),thatwewouldexpecttobehighlysensitive(positively)toPolicyandTechnology,thisisoffsetbyothersectors,wherethesensitivityisnegative.
CleantechandotherenvironmentallydrivenstrategiesareexpectedtohavemorepositivesensitivitytotheTechnologyandPolicyfactors.
TechnologyImpactResourceAvailabilityPolicy54MERCER2015891011121314INFRASTRUCTUREInfrastructureisanattractiveassetclassforinstitutionalinvestorsgiventhepotentialforpredictableearningsstreamsandcashflows,aswellasadegreeofinflationlinkageinreturns.
Thepotentialimpactofclimatechangeoninfrastructure,atanassetclasslevel,needstobeconsideredinthewidercontextofthedriversforadditionalinvestmentininfrastructureglobally,including:Replacementofageingassets.
Provisionofadditionalcapacitytoreflectsocio-economicgrowth(agrowingglobalpopulationandrisinglivingstandardsindevelopingeconomies).
Replacementofassetsorconstructionofnewassetsaspartofadaptingtoclimatechange.
Increasingefficienciestosupporteconomicgrowth.
Thekeydrivers(fromaclimatechangeperspective)behindlong-terminfrastructureinvestmenttrendsaretheadaptationtoclimatechangethroughthereplacementofassetsortheconstructionofnewassets.
Intermsofhowthesewilltranslateintorisk/returncharacteristics,themostimportantfactorswillbechangesattheglobalandregionallevelregardingclimatepolicyandtechnologyadvancements.
Wenotethatalthoughinfrastructurewouldbesensitivetoanyimpactsoninflationthatmayarise,suchimpactsarehighlyuncertain.
Thereisalsoadistinctionbetweenexistinginvestmentsandnewinvestments,whereexistingassetsmightbemorevulnerabletotheclimateriskfactorsiftheyhavenotbeenadequatelypricedintotheassetvalue.
Future(new)investmentsfacethechallengeofputtingamarketvalueontheseriskstoensuretheinvestorisadequatelycompensated.
Wenotethatsensitivitytotheclimatechangeriskfactorswillvarybyunderlyingsector.
Morestringentclimatepolicy(andinvestmentintechnology)islikelytoreducethevalueofsomeinfrastructureassetsthatarelessadvancedorunabletoadapt(andinthemostextremecases,someinfrastructureassets,suchascoalpowerstations,couldbe"stranded"),whereasothers,particularlythoseinthepure-playcleanenergyspace,willbenefitstrongly.
TheNewClimateEconomyreportsuggestedthat"maintainingorstrengtheningeconomicgrowthto2030willrequireasignificantincreaseininvestment,includinganestimatedcumulativeUS$89trillionofinvestmentininfrastructure.
Ashifttolow-carboninfrastructurewillhaveanadditionalimpact,changingboththetimingandmixofinfrastructureinvestment.
"28Overall,wewouldexpectmorestringentclimatepolicytobeanet(albeitslight)positiveforinfrastructure,aspolicychangeswoulddriveanextendedperiodofsignificanteconomictransformationandinvestmentininfrastructureglobally.
WehavethereforeassignedpositivesensitivitytothePolicyandTechnologyriskfactors.
28TheNewClimateEconomy.
BetterGrowth,BetterClimate,availableathttp://newclimateeconomy.
report/misc/downloads/,accessed11May2015.
NCEalsoconcludedthatalow-carbontransitionacrosstheentireeconomycouldbeachievedwithonly5%moreupfrontinvestmentfrom2015-2030.
2134567TechnologyImpactResourceAvailabilityPolicy55TIMBERRelativelyfewinstitutionalinvestorshaveexposuretotimberlandgiventhenuancesofinvestinginthisarea.
However,oneofthedistinguishingfeaturesoftimberland(anditskeysourceofreturn)isitsbiologicalgrowth,whichunderpinstherationalefortimberlandinvestmentanddrivesmanyofthediversificationbenefitsthatcancomefrominvestingintimberland.
Thelow-carboncredentialsofthisassetclasscangiveitaclearrolewithinportfoliosforinvestorslookingtohedgeagainsttheimpactofclimatechange.
Althoughbiologicalgrowthdrivestheharvestvalueofanareaoftimberland,theultimatereturnfromatimberlandinvestmentisalsoheavilyinfluencedbythepurchaseprice.
Theexpectedreturndriverstypicallycomprisethreemaincomponents:thestrategicriskpremium,changesintimberprices,andactivemanagement.
TheUSremainsthelargestandmostdevelopedmarketforinstitutionalinvestmentintimberland,althoughtheopportunitysethasexpandedoverthepastfewyearstootherglobalregions,includingLatinAmerica(Brazil,Uruguay,andChile),Australia,NewZealand,andEurope.
Wewouldexpecttimberlandinvestmentstobenefitfromfavourableclimatepolicyshifts,aswewouldexpectthistoincreasethepenaltiesfordeforestationandincreasethepriceoftimberproductprices,landvalues,andthepremiumattachedtocarbon-trading-relatedactivities.
Therefore,wewouldexpectexistingtimberlandassetstoappreciateinvalue,whereasnewassetswillbecomemoreexpensivetoinvestin.
Withenhancedpolicy,wewouldalsoexpectashifttowardsmoresustainableforestryproducts,asdemandedbycustomers.
Wewouldanticipatecomplianceandmonitoringcoststoincrease,withadditionalpolicyoffsettingsomeofthebeneficialpricerises.
MorestringentclimatepolicywouldbeexpectedtocreateincentivestoreducedeforestationandprotectnativeforestsviainitiativessuchastheUN'sReducingEmissionsfromDeforestationandForestDegradationProgramme(REDDandREDD+),andwewouldexpectthedemandforsustainablyharvestedforestresourcestoincrease.
Shiftsinlong-termtemperatureswillimpacttypicaltimberlandgrowingpatternsandlocations,causingsignificantdisruptiontothesector.
Climatechangemayalsoleadtoincreasedincidencesoftimberlandpestilenceanddisease,whichhavealreadystartedtomanifest(mostnotablyinCanada).
Althoughtimberlandislargelyinsulatedfromcoastal-relatedcatastrophes,droughtcouldhavesignificantimpacts,ascouldwildfire.
TechnologyImpactResourceAvailabilityPolicy56891011121314AGRICULTURERelativelyfewinstitutionalinvestorshaveexposuretoagriculturegivencurrentchallengesforinvestmentmanagersinthisarea,whichincludethelackofestablishedandproventrackrecords,difficultiesinsourcingspecificagriculturalexperience,andalackofinstitutional-qualityoperationalstructures.
Thecurrentuniverseofagriculturefundsisrelativelysmallanddisparate;however,weareseeingincreasinginterestfrominvestorsinthisspace.
Broadlyspeaking,agricultureisacollectionofheterogeneousactivities,asaretheinvestmentopportunitiesseekingexposuretoit.
Theassetclassofagricultureorfarmlandbroadlycoversinvestmentinthefollowingcommodities:Rowcrops—forexample.
wheatandothergrains(typicallyrotatedeveryyear).
Permanentcrops—forexample,fruitsandnuts.
Livestock—forexample,cattleandsheep.
Thelong-termreturnsforagricultureinvestmentsaretypicallygeneratedfromthesaleofagriculture-basedcommodities(cropsandlivestock)andappreciationoflandandfoodprices.
Investmentexposuretothesevariousendcommoditiescanbeachievedinanumberofways,withvaryingrisk/returnprofiles,andtherisksofinvestinginagricultureare,toacertainextent,regionallydependent.
Geographically,theUS,LatinAmerica(inparticularBrazil),Australia,andNewZealandarethecoreareasoffocuswhenconsideringagriculturalinvestments.
ProminentcountriesintheEuropeanUnion(EU)arelessattractiveasinvestmentopportunitiesbecauseoftheirrelianceonsubsidiestodeterminepricing(andinpartsoftheUK,landpricesmoredirectlyreflectpotentialdevelopmentvaluesratherthanexpectedagriculturalreturns).
TheUSalsoemployssubsidies,butwebelievethereareopportunitiestonavigatetheseand,onthewhole,managerswillnotlooktoincorporatesubsidiesintoreturnestimates.
Opportunistically,areassuchasCentralandEasternEuropemayprovidepotentialsatelliteexposure,capturingtheopportunitiesforcreatingeconomiesofscaleinfragmentedmarketsandthepotentialbenefitsofcloserEUrelationships.
Theimpactsofclimatechangeonagriculturewouldbecountryspecific,butatanoverallassetclasslevel,wewouldexpectagricultureinvestmentstobenefitfrommorestringentclimatepolicy,whichwewouldexpecttopromotesustainablecropmethods,reducingtheriskofdisruptedproduction.
However,thereisariskthatprotectionistpoliciesinresponsetofoodshortagescouldcreateunrestandadditionalgeopoliticalriskpremiumforagricultureinvestments.
Overall,wehaveassignedpositivesensitivitytothePolicyriskfactor.
Inthecasethatmorestringentpolicyisimplemented,we2134567TechnologyImpactResourceAvailabilityPolicy57HEDGEFUNDSAlthoughoftencategorisedassuch,hedgefundsarenotstrictlyanassetclass.
Rather,hedgefundsareacollectionofheterogeneousinvestmentstrategies.
Thesestrategiestendtohavedisparaterisk/returnprofilesandindividualhedgefundmanagersimplementingthesameinvestmentstrategyoftentargetandgeneratecontrastingriskprofiles.
Giventhedisparatenatureofhedgefunds,wehavenotassignedsensitivitytotheclimatechangeriskfactors.
Wenotethatsomestrategies,suchasinsurance-linkedstrategiesthatseektocapturecatastropheriskpremia,arelikelytobesensitive;howeverthiswouldrequiremoredetailedanalysisatastrategylevel,whichisoutsidethescopeofthisreport.
wouldexpectsubstantialcapitalwouldbemadeavailabletoassistemergingmarketcountrieswithrespecttoadaptationinfarmingmethods.
Wewouldexpectagricultureinvestmentstobenefitfromtechnologicaldevelopmentwithrespecttomoreproductiveandresilientcropvarieties,andwewouldanticipatethatmoreheat-anddrought-tolerantcropswouldbeintroducedinordertoimprovetheclimateresilienceandreliabilityofproduction.
Toreflectthis,wehavealsoassignedapositivesensitivitytotheTechnologyriskfactor.
Agricultureistheassetclassthatismostsensitive(negatively)toResourceAvailability.
Agricultureproductionisheavilysusceptibletolong-termshiftsinregionalweatherpatternsandwaterstress.
Inaddition,thecapacityoffarmerstoadaptisdifficulttopredictandstrainsonthevaluechainarelikelytoariseasaresultofclimateshifts.
Similarlytotimberland,agricultureislargelyinsulatedfromcoastal-relatedcatastrophes,butdroughtcouldhavesignificantimpacts.
TechnologyImpactResourceAvailabilityPolicy58891011121314PORTFOLIOIMPLICATIONSANDINVESTORACTIONS213456759"Asalong-term,intergenerationalinvestor,weneedtounderstandtheinvestmentrisksandopportunitiesassociatedwithclimatechange.
Thisstudywillhelpuscalibrateourinvestmentstrategiesaccordingly.
"—AdrianOrr,CEO,NewZealandSuperFundOurapproachtoinvestmentmodellinganalyseschangesinreturnexpectationsinthe35yearsbetween2015and2050,drivenbythefourclimatechangescenariosreviewed.
Themodellingresultsallowustoidentifythepotentialclimateimpactonreturns,includingtheminimumandmaximumimpactinvestorscanexpectwhenclimateconsiderationsareincluded(thatis,theTRIPfactorsandfourclimatescenarios).
Ourinvestmentmodellinghasdemonstratedthefollowing:1.
Climatechange,underthescenariosmodelled,willinevitablyhaveanimpactoninvestmentreturns,soinvestorsneedtoviewitasanewreturnvariable.
2.
Industrysectorimpactswillbethemostmeaningful.
Forexample,dependingontheclimatescenariowhichplaysout,theaverageannualreturnsfromthecoalsub-sectorcouldfallbyanywherebetween18%and74%overthenext35years,witheffectsmorepronouncedoverthecomingdecade(erodingbetween26%and138%ofaverageannualreturns).
Conversely,therenewablessub-sectorcouldseeaverageannualreturnsincreasebybetween6%and54%overa35yeartimehorizon(orbetween4%and97%overa10-yearperiod).
3.
Assetclassreturnimpactscouldalsobematerial–varyingwidelybyclimatechangescenario.
Forexample,a2°Cscenariocouldseereturnbenefitsforemergingmarketequities,infrastructure,realestate,timberandagriculture.
A4°Cscenariocouldnegativelyimpactemergingmarketequities,realestate,timberandagriculture.
Growthassetsaremoresensitivetoclimaterisksthandefensiveassets.
44.
A2°Cscenariodoesnothavenegativereturnimplicationsforlong-termdiversifiedinvestorsatatotalportfoliolevel,overtheperiodmodelled(to2050),andisexpectedtobetterprotectlong-termreturnsbeyondthistimeframe.
Wherereturnimpactsarepositive,investorscanpositiontheirportfoliostoaccessthoseopportunities.
Wherereturnimpactsarenegative,investorscanpositiontheirportfoliostominimiseriskexposures.
60891011121314Inassessingtheresults,webeginwithaconsiderationofindustrysectorsinsteadofassetclasses,asthisiswheretheclimateriskimpactsaremostpronounced.
Thisresultisinitselfaninterestingtake-away,giventhatthemajorityofinvestorsbuildportfoliosaroundassetclasses(i.
e.
goingforward,anincreasedfocusonsectorexposureseemswarranted).
Figure10belowshowsthepotentialclimateimpactonmedianannualreturnsforindustrysectorsoverthenext35years.
Therangeshowstheminimumimpactandtheadditionalvariability,toreachamaximumpotentialimpactforeachindustrysectorwhenclimateconsiderationsareincluded.
Theseimpactsshouldbeconsideredincontextasapercentageofunderlyingexpectedreturns,whichrangefrom6-7%perannum.
Theenergysectorisbrokenintoitssub-sectors,asoneofthemostimpactedindustries.
Coal'saverageexpectedannualreturnscouldbereducedfrom6.
6%p.
a.
tobetween1.
7%p.
a.
and5.
4%p.
a.
overthenext35years,dependingonthescenario.
Oilandutilitiescouldalsobesignificantlynegativelyimpactedoverthenext35years,withexpectedaveragereturnspotentiallyfallingfrom6.
6%p.
a.
to2.
5%p.
a.
and6.
2%p.
a.
to3.
7%p.
a.
respectively.
Thiswouldnegativelyimpactunpreparedinvestors.
Renewableshavethegreatestpotentialforadditionalreturns:dependingonthescenario,averageexpectedreturnsmayincreasefrom6.
6%p.
a.
toashighas10.
1%p.
a.
Figure10:ClimateImpactonReturns—byIndustrySector2134567Medianadditionalannualreturns-6.
0%-5.
0%-4.
0%-3.
0%-2.
0%-1.
0%-0.
0%1.
0%2.
0%3.
0%4.
0%RenewablesNuclearITGasHealthConsumerdiscretionaryIndustrialsTelecomsConsumerstaplesFinancialsMaterialsUtilitiesOilCoalAdditionalVariabilityMinimumImpactSource:Mercer6110-YEARIMPACTS—CONSIDERING'STRANDEDASSETS'Theconceptofstrandedassetsrelatestoinvestmentsthatlosesignificanteconomicvaluewellaheadoftheiranticipatedusefullifeasaresultofchangesinlegislation,regulation,marketforces,disruptiveinnovation,societalnorms,orenvironmentalshocks.
29Inthecontextofthisstudy,tounderstandthepotentialforstrandedassetsitisimportantforustoconsiderpotentialreturnimpactsunderashortertimeframe–wethereforelookatreturnimpactsoverthecomingtenyears(i.
e.
versusaverageimpactsto2050).
Ourresultslargelysupporttherecentdiscussionsonstrandedassets,whichhavefocusedontheconstraintsthatwouldbeplacedonfossilfuelcompaniesfromclimateactionsimilartothatexpectedunderourTransformationscenario.
WeexpectthatundertheTransformationscenario,coalandoilsectorreturnscouldbeerodedoverthenext10years(infact,weexpectpotentialaveragereturnsof-2.
0%p.
a.
and-0.
7%p.
a.
respectively).
Ouranalysisexpandsontheissueoffossilfuelstranding,bymodellinghowarangeofpossibleclimatechangescenarioswillimpactinvestorreturnsacrossallsectorsandassetclasses.
UndertheTransformationscenariowealsodiscoverthatutilities'returnscouldfallfrom5.
1%p.
a.
to1.
2%p.
a.
overthenext10years.
Incontrast,therenewablessub-sectorcanbeexpectedtoseepotentialreturnsincreasefrom5.
3%p.
a.
to10.
4%p.
a.
andthenuclearenergysub-sectorfrom5.
3%p.
a.
to7.
7%p.
a.
overthesametimeperiod.
Becauseourstudyaccountsforfourclimateriskfactors,wearealsoabletodemonstratetheminimumimpactthatcouldoccurregardlessofthelevelofpolicyresponseweseeinthecomingdecades.
Overthenext10years,theminimumimpactforthecoalsub-sectorcouldresultinexpectedannualreturnsfallingfrom5.
2%p.
a.
to3.
9%p.
a.
,andfortheoilsub-sectorfrom5.
3%p.
a.
to4.
0%p.
a.
Ourresultsshowthatregardlessoffuturepolicyaction,climatechangecouldsignificantlyimpactsectorreturnsoverthenext10years.
Inaddition,whiletheTransformationscenariomaybeviewedbymostinvestorsasmorecontentious,itpresentsapotentialriskthatisworthyofconsideration.
Thoseinvestorsthatremainunpreparedandareexposedtothesehigherrisksectors(andcompanies)aremostatriskofremaininginvestedin'strandedassets'.
Relatedactionsarediscussedinthenextsection.
29TheGenerationFoundation.
"StrandedCarbonAssets:WhyandHowInvestorsShouldIncorporateCarbonRisksIntoInvestmentDecisions.
",2013,availableathttp://genfound.
org/media/pdf-generation-foundation-stranded-carbon-assets-v1.
pdf,accessed11May2015.
62MERCER2015891011121314CLIMATEIMPACTONRETURNS—ASSETCLASSTherearealsomaterialimpactstobeconsideredattheassetclasslevel,withtheoutcomedependentontheeventuatingscenarioinmanycases.
AscanbeseenfromFigure11below,onlydevelopedmarketglobalequityisexpectedtoexperienceareductioninreturnsacrossallscenarios.
Fortheotherassetclasses,climatechangeisexpectedtoeitherhaveapositiveornegativeeffectonreturnsdependentonthefuturescenario.
Interestingly,over35years,timberandagricultureareamongtheassetclassesthathavethepotentialforthelargestadditionalreturnsorreductioninreturns.
Theseresultsmayunderplayimpactswithintheassetclasses.
Developedmarketsovereignbondsarenotviewedasclimaterisksensitiveatanaggregatelevel(theyremaindominatedbyothermacro-economicfactors),withsomeexceptionssuchasJapan,Australia,andNewZealand.
Figure11:ClimateImpactonReturns—byAssetClass(over35years)2134567Medianadditionalannualreturns-0.
8%-0.
6%-0.
4%-0.
2%0.
0%0.
2%0.
4%0.
6%0.
8%1.
0%AgricultureInfrastructureTimberEmergingMarketGlobalEquityRealEstateEmergingMarketDebtSmallCapEquityPrivateEquityLowVolatilityEquityMulti-assetCreditInvestmentGradeCreditPrivateDebtDevelopedMarketSovereignBondsDevelopedMarketGlobalEquityMinimumImpactAdditionalVariabilitySource:Mercer63Figures12-15illustratethepotentialclimateimpactonreturnsweseeacrossthedifferentassetclassesforeachscenario.
Figure12:AssetClassesUnderTransformationScenario(MedianAnnualReturnImpactOver35years)Medianadditionalannualreturns0.
82%0.
61%0.
59%0.
43%0.
35%0.
06%-0.
01%-0.
04%-0.
08%-0.
32%-0.
42%-0.
47%-0.
48%0.
00%0.
00%0.
00%Medianadditionalannualreturns0.
17%0.
25%0.
01%0.
06%0.
03%0.
15%0.
00%0.
00%0.
00%-0.
01%-0.
01%-0.
06%-0.
23%-0.
09%-0.
08%0.
00%InfrastructureTimberEmergingMarketGlobalEqualityRealEstateEmergingMarketDebtAgriculturePrivateDebtHedgeFundsInvestmentGradeCreditMulti-assetCreditDevelopedMarketGlobalEquitySmallCapEquityPrivateEquityLowVolatilityEquityDevelopedMarketSovereignBondsInfrastructureTimberEmergingMarketGlobalEqualityRealEstateEmergingMarketDebtAgriculturePrivateDebtHedgeFundsInvestmentGradeCreditMulti-assetCreditDevelopedMarketGlobalEquitySmallCapEquityPrivateEquityLowVolatilityEquityDevelopedMarketSovereignBondsFigure13:AssetClassesUnderCoordinationScenario(MedianAnnualreturnImpactOver35years)Source:MercerSource:Mercer64891011121314Figure14:AssetClassesUnderFragementation(LowerDamages)Scenario(MedianAnnualreturnImpactOver35years)Figure15:AssetClassesUnderFragementation(HigherDamages)Scenario(MedianAnnualreturnImpactOver35years)2134567-0.
20%-0.
29%-0.
04%-0.
11%0.
04%0.
00%0.
00%0.
00%0.
00%0.
00%0.
01%0.
02%0.
02%0.
02%-0.
14%0.
00%Medianadditionalannualreturns-0.
55%-0.
56%-0.
12%-0.
22%-0.
29%-0.
07%-0.
01%-0.
01%0.
00%0.
00%0.
00%-0.
06%-0.
24%-0.
09%-0.
08%0.
00%MedianadditionalannualreturnsInfrastructureTimberEmergingMarketGlobalEqualityRealEstateEmergingMarketDebtAgriculturePrivateDebtHedgeFundsInvestmentGradeCreditMulti-assetCreditDevelopedMarketGlobalEquitySmallCapEquityPrivateEquityLowVolatilityEquityDevelopedMarketSovereignBondsInfrastructureTimberEmergingMarketGlobalEqualityRealEstateEmergingMarketDebtAgriculturePrivateDebtHedgeFundsInvestmentGradeCreditMulti-assetCreditDevelopedMarketGlobalEquitySmallCapEquityPrivateEquityLowVolatilityEquityDevelopedMarketSovereignBondsSource:MercerSource:Mercer65Table3:SamplePortfolioAssetAllocationTOTALPORTFOLIOIMPLICATIONSAsdemonstratedabove,wecanexpectdifferentassetclassestohaveanincreaseordecreaseinexpectedreturnsdependingonthefuturescenario.
Thebelowdiagramsdepictanexampleinvestor'stotalportfolioexposuretoclimatechangerisksandopportunitiesundereachscenario.
Theclimatereturnportfolioimpactestimatesarebasedon10-yearfigures,consistentwiththetypicalstrategy-settingtimeframeforinvestors.
Ten-yearreturnimpactswilldifferfrom35-yearimpactsshownonpreviouspages,drivenbythepathwayoftheclimatescenario(i.
e.
therelativeimpactofeachTRIPfactorat2025versusat2050ineachscenario).
SeetheScenariossectionandAppendix2forfurtherdetail.
Thereferenceportfolioisdiversified,aspertheallocationinthetablebelow,withan85%exposuretogrowthassets.
Developed-marketGlobalEquityEmerging-marketGlobalEquityLow-volatilityEquitySmall-capEquityPrivateEquityHedgeFundsRealEstateInfrastructureTimberAgriculturePrivateDebtEmerging-marketDebtMulti-assetCreditDevelopedGovernmentBondsCorporateBonds17.
50%10.
00%7.
50%2.
50%5.
00%5.
00%10.
00%5.
00%2.
50%2.
50%5.
00%2.
50%10.
00%10.
00%5.
00%ASSETCLASSPERCENTAGEPORTFOLIOTheblackcirclerepresentsaportfolio,withthewidthofeachassetclasssectionrepresentingtherespectivepercentageweighting.
Assetclasssectionsthatareexpectedtoexperienceareductioninreturnsunderaspecificscenariowillmovetowardsthecentreofthecircle,andassetclasssectionsthatareexpectedtoexperienceadditionalreturnswillmoveoutwardsfromthecircle.
Investorsshouldprioritisetheiractionsforassetclassesbythosewiththelargestweightingsandlargestmovementsinwardsoroutwardsfromtheblackcircle.
Foratypicalinvestor,thegreatestriskexposureisexpectedtocomefromdevelopedmarketequitiesunderallscenarios.
Thisisreflectedbythefactthat,asdemonstratedabove,theonlyassetclasswithaminimumvulnerabilityisdevelopedmarketequities.
Althoughsmalltacticaladjustmentstothisassetclassweightingmaybepossible,theprimarywayinvestorswilllikelyreducethisriskexposureisthroughconsideringtheunderlyingsector-levelexposuresoftheassetclass.
Source:Mercer66891011121314Figure16:PortfolioImpacts—Transformation(MedianAnnualReturnImpactOver10years)Underthisscenario,weexpectgenerallylargerimpactscomparedtootherscenarios,althoughthenetportfolioimpactwillbesimilar.
Thiscouldmeanthat,ifeffectivelyanticipated,thisscenariocouldleadtothebiggestnetpositivereturnsforinvestorswhocanreducetheirassetclassriskexposuresandpursueassociatedopportunities.
Keyrisksrelatetodevelopedmarketequity,privateequity,andlowvolatilityequityexposures,withexpectedgainsdrivenbyemergingmarketequity,realestate,infrastructure,timber,andagriculture.
Portfoliore-allocationscouldbeconsidered,andadditionalriskmanagementmeasures(suchasindustry-sectorexposureanalysisandcompany-levelengagement)employed.
Theseareexploredfurtherinthefollowingsection.
2134567AdditionalreturnsDevelopedMarketGlobalEquity:-0.
82%EmergingMarketGlobalEquity:+0.
50%LowVolatilityEquity:-0.
52%SmallCapEquity:-0.
69%PrivateEquity:-0.
83%HedgeFunds:0.
0%RealEstate:+0.
45%Timber:+0.
47%%Agriculture:+0.
58%PrivateDebt:0.
00%EmergingMarketDebt:+0.
03%Multi-assetCredit:-0.
14%DevelopedMarketSovereignBonds:0.
00%Infrastructure:+0.
73%InvestmentGradeCredit:-0.
06%ReductioninreturnsSource:Mercer67INVESTINGINATIMEOFCLIMATECHANGEFigure17:PortfolioImpacts—Coordination(MedianAnnualReturnImpactOver10years)AssetclassimpactsundertheCoordinationscenarioaregenerallylesssignificant,withthelargestdownsideriskrelatingtoagricultureandsectorexposuresunderlyingglobaldevelopedmarketequityexposure.
Inthisscenario,thekeyfocusshouldbeonriskexposureswithinassetclasses—includinglistedandunlistedequities.
DevelopedMarketGlobalEquity:-0.
30%EmergingMarketGlobalEquity:-0.
02%LowVolatilityEquity:+0.
02%SmallCapEquity:+0.
03%PrivateEquity:+0.
02%HedgeFunds:0.
00%Timber:-0.
61%Agriculture:-0.
61%PrivateDebt:0.
00%EmergingMarketDebt:0.
00%Multi-assetCredit:+0.
01%DevelopedMarketSovereignBonds:0.
00%RealEstate:-0.
05%Infrastructure:+0.
12%InvestmentGradeCredit:0.
00%AdditionalreturnsReductioninreturnsSource:Mercer68MERCER2015891011121314Figure18:PortfolioImpacts—Fragmentation(LowerDamages)(MedianAnnualReturnImpactOver10years)UnderbothFragmentation(LowerDamages)andFragmentation(HigherDamages),therearenoadditionalpositivereturnsexpected.
Thismeansthatforatypicalinvestorwhodoesnotconsidersector-levelexposures,thesescenarioswilllikelyonlyleadtoreducedreturns.
Themostsignificantnegativereturnimpactsareapparentintimber,agriculture,realestate,andequityallocations—bothinemerginganddevelopedmarkets.
2134567DevelopedMarketGlobalEquity:-0.
28%EmergingMarketGlobalEquity:-0.
27%LowVolatilityEquity:-0.
10%SmallCapEquity:-0.
14%PrivateEquity:-0.
16%HedgeFunds:0.
00%Timber:-0.
82%Agriculture:-0.
96%PrivateDebt:0.
00%EmergingMarketDebt:-0.
09%Multi-assetCredit:-0.
03%RealEstate:-0.
20%Infrastructure:-0.
18%AdditionalreturnsReductioninreturnsDevelopedMarketSovereignBonds:0.
00%InvestmentGradeCredit:-0.
02%Source:Mercer69INVESTINGINATIMEOFCLIMATECHANGEFigure19:PortfolioImpacts—Fragmentation(HigherDamages)(MedianAnnualReturnImpactOver10years)Themostsignificantnegativereturnimpactsareapparentintimber,agriculture,realestate,andequityallocations—bothinemerginganddevelopedmarkets.
Investorsshouldconsiderundertakinggeographicriskassessmentsattheportfoliolevel.
DevelopedMarketGlobalEquity:-0.
23%EmergingMarketGlobalEquity:-0.
25%LowVolatilityEquity:-0.
04%SmallCapEquity:-0.
06%PrivateEquity:-0.
07%HedgeFunds:0.
00%Timber:-0.
52%Agriculture:-0.
54%PrivateDebt:0.
00%EmergingMarketDebt:-0.
07%Multi-assetCredit:-0.
01%RealEstate:-0.
37%Infrastructure:-0.
18%AdditionalreturnsReductioninreturnsDevelopedMarketSovereignBonds:0.
00%InvestmentGradeCredit:-0.
01%Source:Mercer70MERCER2015891011121314FROMTHINKINGTODOING:NOWWHATThissectionprovidesinvestorswithfurtherguidanceonthe"nowwhat",inconsideringhowtoestablishanappropriategovernanceandimplementationframeworkformonitoringandmanagingclimaterisk.
ThekeyobjectiveforinvestorsistofirstunderstandtheirportfolioexposurestotheassetclassesandindustrysectorsmostsensitivetotheTRIPfactorsandthosewiththegreatestpotentialclimateimpactonreturnsand,second,positiontheirportfoliosaccordingly.
ConsistentwithourthinkingonthebestwaytoincorporateESGconsiderationsintotheinvestmentprocess,werecommendanintegratedapproachwithinsettingbeliefs,policy,process,andportfolios.
AssetoutinFigure20,thisenablesinvestorstointegrateclimateriskmanagementwithinabroaderriskmanagementfunctionduringtheinvestmentprocess.
30Mercer.
AnInvestmentFrameworkforSustainableGrowth,2014,availableathttp://www.
mercer.
com/services/investments/investment-opportunities/responsible-investment.
html,accessed11May201531SeethePortfolioDecarbonisationCoalition(http://unepfi.
org/pdc),whichfollowstheSeptember2014MontrealPledgesupportingportfoliodecarbonisationatthePRImeeting,athttp://montrealpledge.
org/Figure20:IntegratedModelforAddressingESGConsiderationsSource:Mercer,AnInvestmentFrameworkforSustainableGrowth30ESGPOLICYINTEGRATEDMODELBELIEFSPROCESSESPORTFOLIO2134567PORTFOLIODECARBONISATIONTheconceptof"portfoliodecarbonisation"31hasbeendeveloped,reflectingactiontakenbyinvestorstoreducethecarbon-intensityoftheirportfoliosovertime.
Thisgenerallybeginswithequitiesandcanadvancetocoverotherassetclasses.
TheadvantagesofthisapproachfromtheperspectiveoftheTRIPriskfactorsareasfollows:ItreducesthePolicyrisk(P)oftheportfolio,and,morebroadly,helpstoaddressmarketmispricingofcarbon.
Thelowerthecarbon-intensityoftheholdings,thelesssusceptibletheyshouldbetoincreasingcarbonpricingand/orrelatedregulation.
This,inturn,supportstheflowofcapitaltoaresilientlow-carboneconomy,whichshouldhelptoreducethelong-termphysicalImpactrisks(RandI).
Itcanalsoresultinincreasedinvestmentexposuretocompaniesorassetsbenefitingfromclimateactionstrategies,whicharemorelikelytobesupportedbynewTechnologysolutions(T).
71INVESTINGINATIMEOFCLIMATECHANGE32Anumberoflow-carbonindicesarenowavailablewhichcloselytracktheperformanceofkeybroad-basedindiceswhilesignificantlyreducingthecarbonfootprintoftheoverallportfolio.
33InvestorStatementonClimateChange,2014,availableathttp://1gkvgy43ybi53fr04g4elpcdhfr.
wpengine.
netdna-cdn.
com/wp-content/uploads/2014/09/GlobalInvestorStatement2014_Final.
pdf,accessed30April2015.
.
Embarkingonthisprocesswillleadtoanevolutionofportfoliosovertime,fromthetotalportfolioassetallocation,throughtoexposureswithinassetclasses,andanenhancedfocusonmonitoringandengagingwithmanagersonsectorexposuresandcompanypositions.
ClimaterisksmaybeaddressedalongsideandasapartofotherESGconsiderations.
Investorswillrequireagovernanceapproachthatenablesthemtobuildcapacitytomonitorandactonshorter-termclimateriskindicators(1–3years),aswellaslonger-term(10-yearplus)considerations.
Initially,investorsmaytakeasafeguardingposition.
Thismaydevelopintoamoreproactiveapproachintime.
SafeguardingInvestorsbelieveparticularindustrysectorsorassetclassesarelikelytobe"atrisk".
Inequityportfolios,theycanproactivelyseektomanageorchangesectorweights.
Atthecompanylevel,thismayincludetiltingtowardslesscarbon-intensecompanieswithinindustrysectors.
32ProactiveInvestorsbelievethatlow-carbonindustrysectororassetsarerelativelymoreattractiveoverthelong-term.
Theymaychoosetostructuredeliberatebiasesinportfoliosoverthecomingdecades.
Thiscouldinvolveachangeofoutlookonappropriatesectorclassificationsandmarketbenchmarks.
ACTIONSFORPOLICYMAKERSThekeyactionforpolicymakersistoputpoliciesinplacethatservetoreducethescenario-uncertaintyriskcurrentlyfacinginvestors,whichservesasabarriertoenactingthelow-carbontransitionthatavoidstheworstlong-termimpactsofclimaterisk.
TheGlobalInvestorCoalitionStatementonClimateChange(2014)33summarisedthisasfollows,callingongovernmentsto:Providestable,reliable,andeconomicallymeaningfulcarbonpricingthathelpsredirectinvestmentcommensuratewiththescaleoftheclimatechangechallenge.
Strengthenregulatorysupportforenergyefficiencyandrenewableenergy,wherethisisneededtofacilitatedeployment.
Supportinnovationinanddeploymentoflow-carbontechnologies,includingfinancingcleanenergyresearchanddevelopment.
Developplanstophaseoutsubsidiesforfossilfuels.
Ensurethatnationaladaptationstrategiesarestructuredtodeliverinvestment.
Considertheeffectofunintendedconstraintsfromfinancialregulationsoninvestmentsinlow-carbontechnologiesandinclimateresilience.
ThesepolicychangeswillultimatelyprotectinvestorsfromthenegativesensitivitiestheirassetshavetotheResourceAvailabilityandImpact(physicaldamages)riskfactors(thatis,thoseboxesshownasredonFigures8and9).
72MERCER201589101112131434Foradiscussionofthisapproach,see:http://www.
corporateknights.
com/channels/responsible-investing/make-killing-shorting-coal-companies-14279976/Developinvestmentbelief(s)ataBoard/Trusteeleveltoestablishasharedunderstandingandformalstrategicapproachtooversightofclimateriskacrossinternally-andexternally-managedinvestments.
ThiscouldbeasectionwithinabroaderESG-beliefsdocument,orstand-alone.
Theseinvestmentbeliefsarticulatetheoutlookonclimateriskandopportunityinthecontextofindustrybestpractice,beneficiarytimeframesandviews,fiduciaryduty,andstakeholderexpectations—evolvingalreadyadoptedbeliefs(ifany).
Reflectyourapproachtoclimateriskandopportunityinformalpoliciesincluding:referencestoriskmanagementtechniques;returntargets,constraintsandmeasuresofcompliance;engagementobjectivesandpriorities;andrelatedresources.
ClimaterisksmaybereferencedalongsideotherESGconsiderations.
Establishresourcingneedsandincorporateclimateriskwithincurrentinvestmentprocedures,inparticularriskmanagementprocedures,butalsoinareassuchasmanagerselectionandmonitoring,documentingthisasanyotherrisk.
Incorporateclimateriskinreportingandcommunicationtostakeholders,todiscloseannualclimatemetricsandactions.
Reviewandjoinrelevantcollaborativeindustryinitiativestoengagewithpolicymakers,accessongoingeducationandsharebestpractices.
Assessclimaterisks/exposuresattheportfolio,assetandindustrysectorlevel,which,forinvestmentmanagers,includescompany-leveldetail.
Rebalance/reallocateandadaptportfoliostoreducedownsiderisk.
Someinvestorshaveadoptedhedgingstrategies.
34Investanappropriateproportionofeachassetclassinlow-carbonandsustainabilitythemes,takingintoaccountopportunitiesfocusedonmitigationandadaptation.
Requireinvestmentmanagerstoprovideinformationontheirinvestmentanalysisandvoting/engagementapproachtoclimate-specificrisksandopportunities,aspartoftheirESGintegrationprocesses,asappropriate.
Oncetheinformationisbeingreportedandmonitored,additionalstepscanbeconsideredaccordingly.
ConsiderTRIPfactorexposureatcompany/individualassetlevelandencouragegreaterdisclosureofrelatedinformationbyopaquecompanies.
Oncereportingisinplace,additionalstepscanbeconsideredaccordingly.
InvestmentBeliefsInvestmentPoliciesPortfolioSpecificSystemic(Market-Wide)RiskAssessmentRiskReduction,Transfer,HedgingIdentifyOpportunitiesEngageInvestmentManagersEngageCompanies1.
BELIEFSACTIVITYTYPETOTALPORTFOLIO2.
POLICIES3.
PROCESSES4.
PORTFOLIOTable4:OverviewofActionsWithinaFour-stepProcess213456773Gatherviewsfrominvestmentcommitteesandstaffonkeybeliefsandprioritiesthatarespecifictotherelevantassetclass.
Developknowledgethroughresearchtounderstandpastexperienceintherelevantassetclass,currentstakeholderneeds,andfutureexpectations.
Establishassetclassspecificpoliciesasappropriate,andapplyacrossinternallyandexternallymanagedinvestments.
Encouragemandatorycompanyreportingonclimateriskandrelatedmetrics.
AssessholdingsagainstTRIPindustry-sensitivities.
Carbonfootprintingcanisolatecompany-levelsensitivitytoclimatepolicychanges.
Reviewexistingmanagerapproachestoensureclimateriskanalysisisintegrated.
Engage(supra)nationalbodiesandencourageregulationsthatenablecapitaltofloweasilyintoclimatemitigationandadaptation;encouragenaturalcapitalvaluation.
ReviewexistingmanagerapproachestoTRIPfactorassessment,supplementedbypossibleholdingsanalysis.
Promotefundingforclimateresilienceprojects.
AssessprivatemarketholdingsagainstTRIPindustry-sectorsensitivities.
Conductgeographicexposureassessmentforrealassetholdings.
Enhancemandatesofexternalserviceproviders(suchasassetconsultants,legal,andinvestmentmanagers),toexplicitlyincludeconsiderationofclimaterisk,wherepossible.
Developassetclass-specificmetricsformonitoring;forexample,carbonfootprinting,andreportingonpotentialenergyefficiencygainsacrossprivatemarketsholdings.
InvestmentBeliefsInvestmentPoliciesPortfolioSpecificSystemic(Market-Wide)RiskAssessment1.
BELIEFSACTIVITYTYPEEQUITIESFIXEDINCOMEALTERNATIVES*2.
POLICIES3.
PROCESSES4.
PORTFOLIOTable5:OverviewofActionsWithinaFour-stepProcess:DescriptiveActivitiesbyAssetClass*Alternativesareanaggregationofotherassetclasses,includingrealestate,privateequity,infrastructure,timber,andagriculture74891011121314Optionsdependonportfolioanalysis,implementationconsiderations,andscenariosignpostsovertime.
Mayincludeexitingpositionswithhighestclimateriskexposure,creation/adoptionofalternativeindicesthatexhibittargetedclimate-friendlysectorbiases,settingportfoliodecarbonisationtargets,and/orengagementactions.
Showpreferenceformanagersthatintegrateclimateanalysisandactiveownershipintheirinvestmentprocess.
Opportunitiescoverbothmitigationandadaptationthemes,includinglow-carboninvestments,cleanenergy,water,agriculture,andbroadsustainabilitythemes.
Allocatetomanagersthatinvestincompanieswithexpertiseinresilient/sustainableinfrastructuredevelopment/management.
Potentialgrowthopportunitiesingreenbondsandsocial-impactbonds,whichprovidesomefocusonlow-carboninvesting.
Numerousexamples,suchasclean-energyinfrastructure,low-carbontransport,dedicatedtimberlandfunds,cleantechprivateequity,resilientinfrastructureprojects(e.
g.
flooddefences),insurance-linkedsecurities(ILS),catastrophebonds,andfirmsdrivinginnovativesolutionstoclimate-relatedrisks(e.
g.
microinsurance).
Portfoliodecarbonisation—potentiallythroughexitingpositions(orsectors)withthehighestclimaterisk.
Showpreferenceformanagersthatintegrateclimateriskininvestmentanalysisanddecision-making.
Engageincreditdefaultswapstohedgecreditriskofvulnerableissuers.
Employsameactionsasforpublicequities,anddriveresponsesspecifictoriskassessmentfindings,suchasensuringappropriateinsurancecoveracrossportfolios.
Derivativesmayalsobeanoptiontoconsider.
Encouragedisclosureofclimate/carbonexposure,askcompanieswithlargecarbonfootprintsforGHG-reductionplans(mitigation);addresscorporatelobbying;askcompanieswithlargeexposuretoweatherorresourcerisksforclimateriskmanagementplans(adaptation).
Developstrategyforvotingandengagementwithmanagers/companies.
Workwithmanagerstodevelop/enhancetheirapproachtoclimateriskmanagement.
Sameaspublicequities,thoughmosteffectiveifconductedattimeofdebtissuance;encourageborrowerdisclosureofenvironmentalriskinformation;engagewithtargetcompaniesorpublicissuerstoencourageissuanceofclimate/greenbonds.
Developstrategyforengagementwithmanagers/debtissuersattimeofissue.
Workwithmanagerstodevelop/enhancetheirapproachtoclimateriskmanagement(strategicuseofESGratings).
Sameaspublicequities,inmanycases,withspecificengagementtopicsforeachassetclass,forexample,realestateandretrofittingproperties.
Workwithmanagerstodevelop/enhancetheirapproachtoclimateriskmanagement(strategicuseofESGratings).
ACTIVITYTYPEEQUITIESFIXEDINCOMEALTERNATIVES*4.
PORTFOLIO(CONTINUED)Table5:OverviewofActionsWithinaFour-stepProcess:DescriptiveActivitiesbyAssetClass(Continued)RiskReduction,Transfer,HedgingIdentifyOpportunitiesEngageInvestmentManagersEngageCompanies21345677576891011121314CLOSINGREFLECTIONSLONG-TERMINVESTORSASCLIMATESTAKEHOLDERSThisstudyhasprovidedMerceranditsstudypartnerstheopportunitytoidentifyinterestingimplicationsoftheclimatescenariosandTRIPfactors,andassociatedactionsforinvestorstoconsider.
Ourstudyconsideredthecoming35years,stretchingthepracticalperspectiveofthetypicallong-terminvestor.
Thechallengesofshort-termismarewelldocumentedintheindustry,andtheissueofclimatechangecompoundsthisissue.
Astudyontheimpactofclimatechangewouldberemisswithoutreferencetolonger-termimplicationsandopportunities.
Appendix2looksbeyondthenext35yearstoconsiderhowourclimatescenariosarelikelytounfoldto2100.
ThephysicalimplicationsareprogressivelyworseasweconsideraCoordinationscenarioortheFragmentationscenarios.
Investingtoadaptnowiswidelyarguedtopresentamoreattractiveeconomicoutcomethanrelyingontheconceptofgreaterwealthinthefuturetoprovidesolutions.
Althoughmanyoftheworstprojectedclimateimpactscouldstillbeavoidedbyholdingwarmingbelow2°C,thiswouldrequiresubstantialpolicy,technology,economic,institutional,andbehaviouralchange.
Forinvestors,thekeyquestioniswhethertheywillactivelytakearoleinencouraginga2°CoutcomeinlinewithourTransformationscenario.
Investorshavetwokeyleverstheycanusetohelpsteerinthisdirection:investmentandengagement.
Itisinterestingtoconsider"what'srequired"fromthelong-terminvestmentcommunitytomeetthischallenge.
Numerousindustrygroupsareworkingondifferentcomponents,yetamoreconcretemappingof"fromhere,tothere"isrequirediftheseeffortsaretobecoordinatedformaximumeffort.
2134567"Forinvestors,thekeyquestioniswhethertheywillactivelytakearoleinencouraginga2°CoutcomeinlinewithourTransformationscenario.
"77INVESTORSAS'FUTURETAKERS'OR'FUTUREMAKERS'Allinvestorswillbeinfluencedbywhicheverglobalpoliticalandphysicalclimatescenarioemergesoverthecomingdecades.
Inthissense,theyareall"futuretakers"inthecontextofclimatechange,althoughinvestorswillfacethisissuewithdifferentlevelsofresilience—withthoseinvestorsunpreparedfortheminimumreturnimpactexpectedtoaccompanyanyofthefuturescenarioseffectivelynegatingtheirbestpossibleoutcome.
Ontheotherendofthespectrumistheemergenceofagroupofinvestorsthatwecouldterm"futuremakers".
Theseinvestorsfeelcompelledbythemagnitudeofthelonger-termriskofclimatechangetoseektoinfluencewhichscenariocomestopass.
Collaboratively,theseinstitutionalinvestorsarerecognisingthattheyhaveapotentiallymeaningfulroletoplayinechoingthepositionthathasbeentakenby1.
Willignoretherisksandopportunitiesassociatedwithdifferentclimatescenariostothepotentialdetrimentoflong-termreturnswithinandacrossindustrysectorsandassetclasses.
THECRITICALQUESTIONFORFIDUCIARIESIS:WHICHCATEGORYBESTDESCRIBESYOURAPPROACH2.
Willincludeconsiderationofclimaterisksacrosstheirportfolios,takingactionacrossandwithinassetclassesandindustrysectorsasappropriatetomanagethem.
3.
Willbuildupontheclimate-awarefuture-takerpositionandmakeaconcertedefforttoinfluencesystemic,market-wideoutcomes.
Thiswillinvolveexplicitlyengagingwithpolicymakersandotherkeystakeholders(suchasindustrygroupsandhigh-profilecompanies)inordertoseektoreduceadditionaluncertaintyandachievecarbonmitigationinlinewitha2oCworld.
CLIMATE-UNAWAREFUTURETAKERSCLIMATE-AWAREFUTURETAKERSCLIMATE-AWAREFUTUREMAKERSFigure21:FromFutureTakertoFutureMakermostcountries(includingmajorpowersliketheUSandChina)inrecognisingthescientificevidencethatlimitingglobalwarmingto2°Cisrequiredtoavoid"dangerous"interferencewiththeclimate.
Moreover,theyarerecognisingtheneedtoencouragepolicymakersandbusinessestoprepareaccordingly.
Someinvestors,foranumberofreasons(includingtheirsize,resources,orgovernanceconstraints)arenotlikelytoadoptaninfluencingrole,yetwestillexpecttoseeanincreaseinthenumberofsuchinvestorsoverthecomingyears.
ThreedifferentinvestorperspectivescanbesummarisedinFigure21.
Weencourageinvestorstoprogressalongthesephasestotheextenttheycan.
78891011121314Mercerwouldliketothankthefollowingforward-thinkingorganisationsfortheirsupportandcontributions,withoutwhichthisimportantclimatechangestudywouldnothavebeenpossible.
TheyarecollectivelyresponsibleformorethanUS$1.
5trillioninassetsfrompensionandsovereignwealthfunds,endowments,insurers,privatebanks,andinvestmentmanagers.
ACKNOWLEDGEMENTSPUBLICREPORTPARTNERSIFC,amemberoftheWorldBankGroup,isthelargestglobaldevelopmentinstitutionfocusedexclusivelyontheprivatesector.
Workingwithprivateenterprisesinabout100countries,weuseourcapital,expertise,andinfluencetohelpeliminateextremepovertyandboostsharedprosperity.
InFY14,weprovidedmorethan$22billioninfinancingtoimprovelivesindevelopingcountriesandtacklethemosturgentchallengesofdevelopment.
Formoreinformation,visitwww.
ifc.
org.
TheDepartmentforInternationalDevelopment(DFID)leadstheUKgovernment'sworktoendextremepoverty.
AministerialDepartment,itsoverallaimistoreducepovertyinpoorercountries,inparticularthroughachievingtheMillenniumDevelopmentGoals(MDGs).
DFIDworksdirectlyin28prioritycountriesacrossAfrica,Asia,andtheMiddleEast,andhasregionalprogrammesinAfrica,Asia,theMiddleEastandNorthAfrica,andtheCaribbean,aswellasdevelopmentrelationshipswiththreeOverseasTerritories—StHelena,thePitcairnIslands,andMontserrat.
www.
dfid.
gov.
uk.
2134567Inpartnershipwith79PARTNERSThankyoutothemanyindividualswhohaverepresentedthesepartnerorganisationsandactivelyparticipatedthroughouteachstageofthestudy,providingvaluableinsightsandcontributions.
AllianzClimateSolutionsGmbH—Germany*BaillieGifford&Company—UK*BBCPensionTrust—UKBritishTelecomPensionScheme(BTPS)UK*ChurchofEnglandNationalInvestingBodies—UKTheCaliforniaStateTeachers'RetirementSystem(CalSTRS)—USConstructionandBuildingIndustrySuper(Cbus)—AustraliaConnecticutPensionFund—USCreditSuisse—US*TheEnvironmentAgencyPensionFund(EAPF)—UKFrstaAP-fonden(AP1)—SwedenGuardiansofNewZealandSuperannuationFund(NZSuper)—NewZealandTheNewYorkStateCommonRetirementFund(CRF)—USQueenslandInvestmentCorporation(QIC)Limited—AustraliaStateSuperFinancialServices(SSFS)—AustraliaWWF-UK—UK*Researchpartners808910111213142134567TheNERAteamhasdrawnonitsworld-recognisedexpertiseontheeconomicsofenergyandenvironmentalpoliciestodevelopsomeofthescenariosandconductanalysis,groundedintheclimatechangemodellingliterature,toassessthepotentialimpactsofthosescenariosongeographicregionsandsectors.
Thanksto:DrDavidHarrisonJrSeniorvicepresidentandco-chairofNERA'sGlobalEnvironmentPracticeDrNoahKaufman35SeniorconsultantinNERA'sEnvironmentPracticeConorCoughlinResearchassociateinNERA'sEnvironmentPracticeTheGuyCarpenterteamhasapplieditsin-depthknowledgeofarangeofclimateperils,suchasflooding,hurricanes,anddroughtstosupplementNERA'sresearchwithanalysisonthephysicalimpactsresultingfromclimatechangeoverthecomingdecades.
Thanksto:AlexBernhardt36LeadonphysicalimpactandresourceavailabilityrisksDesmondCarrollandPeterWeiImpactresearch,modelling,andindexation35NoahjoinedtheAdvisoryGroupforthestudywhenhestartedanewroleattheWorldResourcesInstituteinMarch2015.
36AlexjoinedMercerastheUSHeadofResponsibleInvestmentinMarch2015.
MARSH&MCLENNANCOMPANIESTheauthorofthisreport,Mercer,isaleadingglobalinvestmentconsultant,andhasbeengrowingaspecialistteaminsustainableinvestingsince2004.
Thisreportbuildsonourexaminationofclimatechangeandstrategicassetallocationimplicationsinourseminal2011study,andourexpertiseinstrategysettingandlong-terminvesting.
ThankstothenumerouspeopleacrossMercerwhowereinvolvedandcontributed,particularly:CoreTeamJaneAmbachtsheerAlexBernhardtHelgaBirgdenKateBrettVanessaHodgeAledJonesKarenLockridgeRodneyMarmilicJillianReidTomSnapeChristinaTeagueLeadershipSponsorsDebClarkeGlobalHeadofInvestmentResearch,MercerSimonO'ReganPresident,EuroPacRegion,MercerAdditionalContributorsBrianBirnbaumDavidColemanMichaelCrossSarikaGoelHendrieKosterHarryLiemStevenSowdenNickSykesThienTranLucyTusaNickWhite81ADVISORYGROUPTheAdvisoryGrouphasprovidedasoundingboardandindustryinsightsintodifferentelementsofthestudy.
Advisersaredrawnfromacademia,climatemodelling,greenfinance,traditionalfinance,andrisk.
Wethankouradvisersfortheircontributionsandforsharingtheirexpertise.
Thanksto:DrRobBauerUniversityofMaastricht,NetherlandsDrBarbaraBuchnerClimatePolicyInitiative,Italy/GlobalSagarikaChatterjeePrinciplesforResponsibleInvestment(PRI),UKPaulDickinsonCarbonDisclosureProject,UKNathanFabianInvestorGrouponClimateChange,Australia/GlobalMarkFultonCarbonTrackerInitiative,CERES,EnergyTransitionAdvisors,US/AustraliaSeanKidneyClimateBondsInitiative,UK/GlobalBobLittermanAssetOwnersDisclosureProject,FinancialAnalystsJournal,USNickRobinsUNEnvironmentProgramme,UKMikeWilkinsStandardandPoor'sRatingsServices,UKDrPaulWilsonRMS,UKHeleneWinchLowCarbon,UKWealsothankDrMylesAllenfromtheUniversityofOxfordforhisinput.
82891011121314APPENDIX1—CLIMATEMODELSTheimpactsofclimatechangeontheglobaleconomyincludetheeffectsofmitigationactivitiesontheonehandandphysicaldamagesontheother.
Physicaldamagesmayalsobepartiallyorwhollyavertedthroughadaptationactivities.
Quantitativeprojectionsofclimatechangeimpactsdependupontheuseofhighlyaggregated,large-scaleintegratedassessmentmodels(IAMs).
IAMsareintegratedinthesensethattheyuseclimatescienceandeconomicdatatogether.
IAMsarediverseinstructurebutcanbedescribedasstylisedrepresentationsoftherelevantinteractionsofnaturalandhumansystems.
Thesemodelstakeasetofinputassumptions(forexample,populationgrowth,baselineGDPgrowth,technologicalchange)andproducelong-termprojectionsofvariousoutputs(forexample,mitigationcosts,physicaldamages).
Forthepurposeofprovidingdetailedquantitativeimpactestimates,IAMsarethebesttoolavailable.
Theirknownlimitations,andthewaywehaveattemptedtoaddresssomeofthoselimitations,areoutlinedinthisappendixtothereport.
.
Currentmodels,although"integrated",donottendtoconsiderthecruciallinkagesandfeedbacksbetweenthethreeimpactcategoriesofmitigation,physicaldamages,andadaptation.
Notably,therolesofadaptationanddamagesinlarge-scalemitigationmodelsaregenerallyignored.
37IntergovernmentalPanelonClimateChange—WorkinggroupIII.
"Chapter6"inFifthAssessmentReport(AR5).
TheIntergovernmentalPanelonClimateChange(IPCC)initsFifthAssessmentReport(AR5)citesthisdisconnectasa"majorgapinthe…literature.
"37Thus,weprovideseparateestimatesfromtheliteratureofmitigationcostsandofadaptationandphysicaldamages,usingprominentIAMsthatcapturetheseimpactsindependently.
However,expertsmaytakedifferentviewsonthenecessaryadjustmentstothesemodelsandassumptions,sotheoutcomeofthemodels—andtheconclusionsasaresultoftheseadjustments—maybemateriallydifferent.
Further,IAMsare,bytheirnature,highlysimplifiednumericalrepresentationsofextraordinarilycomplexsystems.
Assuch,theymustignoredriversthataredifficultorimpossibletoquantify(forexample,politicalforces)andmostoftenassumefullyfunctioningmarketsandcompetitivebehaviourtoarriveatcost-minimisingoutcomes.
Moreover,arrivingatusableeconomicdamageestimatesforclimatechangerequiresinterpretationbetweenassumptionsaroundpotentialfuturehumanactionsandtheirpotentialimpactonGDPwithseverallayersofinterpolationbetween.
Acceptingthatallofthisintroducesuncertaintyatmanystagesofthemodellingprocess(seeFigure22),IAMsremainthemostconcretefoundationwehavetoprovidedetailedquantitativeimpactestimates.
213456783MITIGATIONCOSTSModelsofmitigationcostsarediversebutaremosteasilydistinguishedbylevelofdetail(full-economyversuspartial-economy).
Partial-economymodelsdescribeoneormoresectorsoftheeconomywitha"bottomup"levelofdetailandtreattherestoftheeconomyexogenously.
Partial-economyestimatesofmitigationcostsrelyonmodelsthatrepresenttheenergysectorindetailandcalculatewithin-sectorabatementcosts.
Full-economymodels,ontheotherhand,representthemacroeconomicfeedbacksacrossalleconomicsectors(describedinsignificantlylessdetail)toarriveataneconomy-wide,generalequilibriumsolution.
Detailedenergy-sectorimpactsarenotprovidedinsuch"topdown"models.
Inrecentyears,effortshavebeenmadetodevelop"hybrid"modelsthatpairadetailed,bottom-upapproachtotheenergysectorwithageneralequilibriumrepresentationoftheeconomy.
TheWITCHmodel,developedbytheclimatechangegroupatFondazioneEniEnricoMattei(FEEM),isoneofthemostwell-regardedofthesehybridmodelsandisthesourceofourmitigationcostestimates.
IntheWITCHmodel,economicandenvironmentalpathwaysaresimultaneouslyselectedby12regionstomaximiseeachregion'sfutureconsumptionstream.
Incentivestomitigateclimatechangeareimplementedinthemodelbyacaponemissionswithallowancesallocatedtoeachregion.
Theseallowancesaresubsequentlytradedbetweenregionsbasedontheallowancepriceandtherelativemitigationopportunities.
TheWITCHmodelincludestechnologicaladvancementintheenergysectorthatisdrivenbyregionalinvestmentsinresearchanddevelopment.
TheWITCHmodelisaswellrespectedasanyofitskind.
Ithasbeenusedextensivelyinacademicpublicationsand"modelinter-comparisonstudies"suchastheStanfordEnergyModellingForum.
ThemitigationcostestimatescitedinIPCCAR5arebasedonresultsfromWITCHandsimilarmodels.
Ofcourse,asadynamicmodeloftheglobaleconomyandenergysystem,WITCHalsomakesnumeroussimplifyingassumptions.
Regionshave"perfectforesight",meaningthatnothinginthemodeloccursunexpectedly.
Itisnotpossibletomodellessefficient(butmorepoliticallyfeasible)publicpoliciesorprivate-sector-drivenmitigationinWITCH.
HumanActivitiesGHGEmissionsAtmosphericConcentrationsTemperatureChangesChangesinGDPFigure22:DegreesofUncertaintyinIntegratedAssessmentModellingIAMMethodologyforCalculatingEconomicDamagesSource:Mercer84891011121314PHYSICALDAMAGESANDADAPTATIONCOSTSThethreemostprominentmodelsusedtoestimatethephysicaldamagesassociatedwithclimatechangearetheFUND,DICE,andPAGEmodels.
38Thesemodelsinclude(relativelysimple)climatemodulesthattranslateforecastgreenhousegasemissionsintotemperaturechangesandotherphysicaleffects.
Themodelsthenrelyonhighlyaggregated"damagefunctions"totranslateprojectedclimateoutcomesintomonetisedphysicaldamageestimates(generallystatedasapercentageofGDP).
Theformofthesedamagefunctionsvariesacrossmodels,asdoesthelevelofregionalandsectorialdetail.
FUNDandDICEarewidelyusedbyeconomistsandpolicymakers.
AlongwiththePAGEmodel,theyarethefocusofIPCCAR5'sdiscussionof"aggregateclimatedamages.
"39AllthreemodelswerealsousedbytheUnitedStatesGovernmenttoestimatea"socialcostofcarbon"forregulatoryimpactanalyses.
Thereismuchliteratureonthelimitationsofmodelsthatestimatetheeconomiceffectsofthephysicaldamagesfromclimatechange.
Theuncertaintiesassociatedwithprojectionsoftheglobaleconomyandenergysystem,projectionsofchangesintheclimateassociatedwithchangesintheeconomy,andprojectionsofmonetarydamagesduetochangesintheclimateareallimmense.
AccordingtoIPCCAR5,"thereliabilityofdamagefunctionsincurrentIAMsislow.
"40BaseduponthisconsensusofuncertaintyaroundIAMoutputs,wehaveendeavouredtoundertakeaqualitativeanalysisofallmajorFUNDresultstodeterminetheiraccuracyanddegreeofrelevancetothesectors,regions,andassetclassesconsideredinthisstudy.
WehavealsoendeavouredtosupplementFUNDresultswheregapshavebeenidentifiedandcouldbereadilyfilledusingcurrentresearchandavailabledata.
MoreonourmethodologyforgroundingandsupplementingFUNDisincludedinthefollowingsections.
INVESTINGINATIMEOFCLIMATECHANGE38TheClimateFrameworkforUncertainty,NegotiationandDistribution(FUND);DynamicIntegratedClimate-Economy(DICE);PolicyAnalysisoftheGReenhouseEffect(PAGE)39IPCC—WorkingGroupIII,"Chapter3".
40Ibid.
41IPCC—WorkingGroupIII,"Chapter10".
FUNDFUNDwasdevelopedbytheeconomistsDavidAnthoffandRichardTol,whohelpedtowritethechapteroneconomicsforIPCCAR5.
41FUNDiscomprisedofbottom-updamagefunctionsfor16regionsand15impactcategories—amajoradvantageovertheDICEandPAGEmodels,whichincludetop-downglobaldamagefunctionswithalmostnosectorialdetail.
Additionally,damagesinFUNDdependonboththelevelandrateofclimatechange,andthedamagefunctionsexplicitlyconsideradaptationinvarioussectors.
TheDICEmodel,developedbyWilliamNordhaus,includesadaptationonlyimplicitlyviatheunderlyingclimatechangestudiestowhichitsdamagefunctioniscalibrated.
ThemajoradvantageofDICEisthatdamagesfromclimatechangereduceinvestment,leadingtoworseeconomicoutcomesinthefuture;economicgrowthintheFUNDandPAGEmodelsisexogenous.
213456785USAUnitedStatesofAmericaANZAustraliaandNewZealandCAMCentralAmericaCHIChinaCANCanadaCEECentralandEasternEuropeSAMSouthAmericaNAFNorthAfricaWEUWesternEuropeFSUFormerSovietUnionSASSouthAsiaSSASubSaharanAfricaJPKJapanandSouthKoreaMDEMiddleEastSEASouthEastAsiaSISSmallIslandStatesFUNDregionsFUNDdamageestimatesFigure23:FUNDModelRegionsandDamageEstimatesHeatingexpendituresCoolingexpendituresDrylandlossWetlandlossCoastalprotectionImmigrationcostTropicalstormsExtratropicalstormsVector-bornediseasesCardiovascularandrespiratorymortalityDiarrhoeaAgricultureForestryWaterresourcesEnergy(heating/cooling)Sealevelrise(SLR)BiodiversityExtremeweatherHumanhealth86891011121314FUNDRESULTSTheFragmentation–HigherDamagesScenarioshowsresultsscaleduptoalignwiththedamagefunctioninDICE(formoreonthisfourthscenario,see"ValidatingandSupplementing").
TheoverallnetdamageestimatecomingoutofFUNDbeforeanyMercersupplementationforthethreeunmodifiedscenariosrangesfrom-0.
45%(Fragmentation/Transformation)to-0.
42%(Coordination)ofglobalGDP,meaningthenetimpactofclimatechangeoverthistimehorizonisshownaseconomicallypositive.
ThisresultisoverwhelminglydrivenbytheAgriculturedamagefunction.
Thenetresultforthefourthscenariowithscaled-updamagesis0.
89%ofglobalGDP.
Separately,wehaveattemptedtofillgapsintheFUNDdamageestimatesbydevelopingnewfunctionsthataddressdamageandperiltypesotherwiseneglectedbythemodel.
Wherewarranted,wehavealsoreviewedkeyFUNDdamagefunctionsthatcontributesignificantlytooveralldamageestimatesduringthestudyperiodforreasonabilityanddirectionalaccuracybaseduponcurrentresearchandexpertjudgment.
Insomecases,thisreviewhasresultedinjudgmentaladjustmentstoFUNDmodeloutputs,whichserveasaninputintothefinalinvestmentmodelling.
872134567VALIDATINGANDSUPPLEMENTINGTHEMODELSIAMsareoftenusedbypolicymakerstoassessthe"socialcostofcarbon"(SCC).
ParaphrasingtheUnitedStatesEnvironmentalProtectionAgency,42theSCCismeanttobeacomprehensiveestimateofclimatechangedamagesandincludes,butisnotlimitedto,changesinnetagriculturalproductivity,humanhealth,andpropertydamagesfromchangestoweatherrisk.
However,givencurrentmodellinganddatalimitations,noneoftheIAMsincludeanassessmentofallimportantdamagesorperils.
FUNDisuniqueamongIAMsinthesectorialandregionaldetailitprovides,makingituniquelysuitableforthisstudyforwhichsuchdetailisimportanttodeterminingthedifferingeffectsofclimatechangeondiverseinvestmentassetclasses.
However,asistheinevitableconsequenceofdevelopingabottom-upmodel,variousimpactcategoriesremainunquantifiedorunderrepresentedinFUND.
Moreover,someoftheresearchunderlyingFUNDimpactestimatesnaturallylagsbehindcurrentresearch.
TheseissuesarenotexcessivelyproblematicforthepurposesofthisstudysolongastheresultsofFUND'smacroeconomicdamageestimatesareatleastdirectionallyinline(oratleastnotmarkedlyoutofline)withmostcurrentthinkingwithrespecttolikelydamagesfromclimatechange.
However,overallFUNDdamageestimatesarenotablylowerthandamageestimatesproducedbyothersimilarmodels(thatis,PAGEandDICE)overthetimehorizonconsideredinthisreport.
Possiblecausesoftherelativelylowdamageestimatesinclude"missing"damagecategoriesduetobottom-updamagefunctionsandoptimisticassumptionswithrespecttoagriculturaladaptationandproduction.
AlthoughneitheroftheIAMsis"right",thisdiscordancecallsintoquestionthedirectionalvalidityofFUNDresults,necessitatingsomesupplementationandauthentication.
Toadjustfortheserelativelylowdamageestimates(andtheuncertaintysurroundingtheoutputofdamagefunctions),wehavetakenatwo-prongedapproachtosupplementation.
3.
0%2.
5%2.
0%1.
5%1.
0%0.
0%-0.
5%-1.
0%-1.
5%0.
751.
02.
01.
252.
252.
52.
753.
03.
251.
51.
750.
5%Economicdamagesduetoclimatechange(%ofglobalGDP)Temperaturechangeabovepre-Industrialaverage(degreesCelsius)Figure24:FUNDvsDICEDamageFunctionComparison42UnitedStateEnvironmentalProtectionAgency.
"TheSocialCostofCarbon,"availableathttp://www.
epa.
gov/climatechange/EPAactivites/economics/scc.
html,accessed26March2015.
DICEmodel:Globaldamagefunctionsforasingleeconomicsector.
TotaldamagesarecalibratedtoIPCCglobaldamageestimatesat3-4degreeswarming.
FUNDmodel:Onlydamagefunctionwithsufficientsectoral/regionaldetail.
Totaldamageslowduetoagriculturalgainsandreducedheatingcosts.
8889101112131443WeacknowledgerecentcritiquesoftherelativelylowseverityoftheDICEdamagefunctioninextremisandthealternativesespousedbyDietsandStern(2014)andWeitzman(2012),andascomparativelyanalyzedbyCovingtonandThamotheram(2015).
However,forthepurposesofthisstudy,thedifferencesbetweentheDICEdamagefunctionandthemorerecentalternativesoutto2050werenotsignificantenoughtowarrantaswitchawayfromthemoreestablishedDICEcurve.
First,wehaveincludedonescenarioinwhichFUNDdamagesare"scaledup"tomatchtheestimatesfromtheDICEglobaldamagefunction.
Althoughthison-levellingwasconductedlinearlywithnodifferentiationbetweendamageestimates,itnonethelessallowsustomaintainthebenefitofFUND'sgranularitywhileobservingwhatdamagesmightotherwiselooklikeinamorepessimisticscenario.
43Second,toassureareasonablycompleteassessmentoftheestimatessuppliedorneglectedbyFUND,wecreatedatwo-tieredtaxonomyinwhichthepotentialphysicalimpactsofclimatechangearecategorisedbothbydamagetypeandclimateperil/resourcecategory.
Usingthistaxonomy,wewereabletodeterminewhichdamagetypesandclimateperils/resourcesareunderrepresentedbyFUNDandfillgapswherepossible.
Inshort,FUND'streatmentofdamagesfromthephysicalimpactsofclimatechangeresultingfromextremeweatherisverylightandtheonlyphysicalimpactestimateinFUNDthataccountsexplicitlyforpropertydamageisExtratropicalStorms(lossoflifeisalsoconsidered).
Thisdoesnotpaintafullpictureofcatastrophicclimate"Wedevelopedanobjectiveindexationmethodologythatallowedustoassigncountry-leveldamagevaluestoareasoutsideoftheUSusingGDPandvariousrelativemeasuresofexposure.
"21345678944Theterm"climateperils"isusedhereintorefertoanyhazardthatisinfluencedbyclimateconditionsandcouldpotentiallycauseeconomicdamage.
Thistermisdifferentiablefromtheterm"climatologicalperils"usedlaterontocategorisethosephysicalimpactsthatareinfluencedpredominantlybytemperatureorprecipitationshortfallsorexcesses.
SeetableinAppendix2sectionfordetail.
45GuyCarpenter.
"GlobalWarming:TheEvolvingRiskLandscape,"2013,availableathttp://gcportal.
guycarp.
com/portal/extranet/popup/insights/reportsPDF/2013/2013%20September%20Climate%20Change%20Reportvid=1,accessed26March2015.
46RhodiumGroup.
"AmericanClimateProspectus:EconomicRisksintheUnitedStates,"2014,availableatwww.
climateprospectus.
org,accessed26March2015.
RhodiumGroup.
"Technicalappendix:DetailedSectoralModels,"2014,availableathttp://rhg.
com/wp-content/uploads/2014/10/Appendix-III-Sectoral-models.
pdf,accessed26March2015(additionaldetailprovidedbyRMSdirecttoGuyCarpenterforthepurposesofthisreport).
47CostofCarbonProject.
"FlammablePlanet:WildfiresandtheSocialCostofCarbon,"availableathttp://costofcarbon.
org/files/Flammable_Planet__Wildfires_and_Social_Cost_of_Carbon.
pdf,accessed26March2015.
48Country-levelindicatorssampledfromtheND-GAINIndex(http://index.
gain.
org/),including1)projectedchangeofsealevelriseimpact;2)coastalvulnerablepopulation;and3)projectedchangeofheatwavehazard.
49AnthoffD,TolRSJ.
"FUND—ClimateFrameworkforUncertainty,NegotiationandDistribution:TechnicalDescription(Version3.
9),"2014,availableatwww.
fund-model.
org/versions,accessed26March2015.
perils44ortheirpotentialinfluenceonthebuiltenvironment.
Flood(bothinlandandcoastal)andWildfireinparticularwouldalsoneedtobeconsideredtoallowforamorecomprehensivetreatment.
Additionally,althoughbothExtratropicalStormsandSLRareconsidered,theconsequencesoftheirinteractionarenot.
Finally,theimpactsofpotentiallymorefrequentandsevereDroughtisnotconsideredintheAgricultureestimateandseveralother,albeitauxiliaryclimateperilsintermsofaggregateeconomicimpact(forexample,Tornado/Hail)areignoredaltogether.
Judgingfromourdirectexperiencewithcatastropheriskmodelling,knowledgeofcurrentclimatechangeresearch,andourownanalysisofclimatechange45toaddresstheabovementionedgapsinphysicalimpactestimates,weidentifiedoutofthoseperilsnototherwisequantifiedbyFUNDthetwoacuteclimate-drivenrisksthatwebelievedwouldhavethelargestpotentialimpactontheeconomyoverthetermofinterestforthisstudy(thenext35years)—namelyCoastalFloodandWildfire.
WethenidentifiedtwoleadingrecentpiecesofresearchestimatingtheinfluenceofclimatechangeonthesetwoperilsintheUSandproducingeconomicestimatesofdamage.
ForCoastalFlood,weusedthedetailedtechnicalresultsdevelopedbyRMSfortheRiskyBusinessProjectUSnationaleconomicclimatechangeriskassessment,46andforWildfireweusedtheresearchsummaryandanalysisproducedbytheCostofCarbonProjectinitsreport,FlammablePlanet.
47Usingthesebest-in-classresourcesandtheirrobusteconomiclossestimatesfortheUS,wethendevelopedanobjectiveindexationmethodologythatallowedustoassigncountry-leveldamagevaluestoareasoutsideoftheUSusingGDPandvariousrelativemeasuresofexposure.
48Thisresultedinglobaleconomicdamageestimatesat2030and2050forthetwoperilsotherwiseunquantifiedbyFUND.
Appendix2includesanoverallsummaryofdamageestimatesat2050,includingthesupplementaldamageestimatesproducedexclusivelyforthisreport.
ChartsareprovidedshowingdetailbyperilandtheaggregateinfluenceofResourceAvailabilityversusPhysicalImpactdamages(gains)foreachscenario.
Insum,therangeoftotalnetdamageestimatesat2050forthethreemainscenariosis-0.
09%(Fragmentation)to-0.
20%(Transformation)ofglobalGDP.
Theequivalentnumberforthescaled-upFragmentationscenariois1.
53%ofglobalGDPorUS$2.
6trillion.
OnthesideofFUNDvalidation,weconductedathoroughreviewoftheFUNDtechnicaldocumentation49toassesstheappropriatenessofeachFUNDdamageestimateinthecontextofthisreport.
GiventhatAgriculturaldamages(gains)represent~70%oftheabsolutevalueoftotaldamageestimatesproducedbyFUNDat2050,mostofourfocusforthethreemainclimatescenarios,intermsofvalidation,hasbeenonthisparticularestimate.
Theresultofourvalidationprocesswastomodifytheagriculturalimpactsinourinvestmentmodelsothattheeffectsofgreaterwarmingonagriculturereflecteconomicdamagesratherthangains.
90891011121314SCENARIO1—TRANSFORMATIONATRANSFORMEDWORLDTheyearis2050.
Investorsandgovernmentshaveworkedcollaborativelyandwithsuccesstomitigatethelong-termeffectsofclimatechange.
Actionhasbeendecisive,withstrongprivate-sectordemandforcleanenergy,backedbypublicandprivateinvestmentinsupply.
Emissionspeakedat2020,reducingtotwo-thirdsof2012levels.
Energygenerationviafossilfuelsin2050hasreduced40%from2012levels.
Therehasbeena90%decreaseintheemissionsintensityofelectricity,transformingenergysupplyandusage.
However,suchtransformationhasnotcomeaboutwithoutahighdegreeofdisruptionandsignificantfinancialcostassociatedwithmitigationactivities,broughtonbyearlierandhighercarbonpricing.
Manyinvestorswhoassumedthefuturewouldmirrorthepasthavemissedoutonkeyopportunitiesandsomehavebeenleftholdingontodevaluedorevenvalueless"stranded"assets.
Annualincrementalenergyefficiencyinvestmentsintransport,industry,andbuildingsrosebyapproximatelyUS$336billion.
Strongclimateaction.
Emissionspeakedby2020thenreducedby56%by2050versus2010levels.
Fossilfuelsrepresentlessthanhalfoftheenergymixat2050.
Estimatedannualemissionsof22GtCO2eat2050IEA2°CScenario.
50IEAWorldEnergyOutlook51andWorldEnergyInvestmentOutlook522014projectionsextendedfrom2040and2035,respectively.
FUNDdamages.
GuyCarpenterphysicaldamagesupplements.
Yetappreciationoftheso-called"socialcostofcarbon"trumpedconcernsaboutthefinancialcostofmitigation,inpartduetoengagementbyinvestorswithregulators.
Climatepolicyandrelatedgovernmentsupportprovidedthecriticalimpetustoadvanceinvestmentinlow-carbonpowersources.
Hadtherebeennolong-termcleanenergypolicygoalsandpolicieskeptchanging,cleanenergyinvestmentwouldhavebeenhindered.
Thistransformedworldhascomeatalowerfinancialcostthanexpectedbyinvestors,whowereabletobenefitfrominvestmentopportunitiesingrowingsectors,emergingmarkets,andinfrastructuretooffsetlossesindecliningsectors.
TRANSFORMATIONDESCRIPTIONMODELS/REFERENCES50InternationalEnergyAgency.
"ScenariosandProjections,"2014,availableathttp://www.
iea.
org/publications/scenariosandprojections/,accessed2April2015.
51InternationalEnergyAgency.
"WorldEnergyOutlook,"2014,availableathttp://www.
worldenergyoutlook.
org/publications/weo-2014/,accessed2April2015.
52InternationalEnergyAgency.
"WorldEnergyInvestmentOutlook,"2014,availableathttp://www.
iea.
org/publications/freepublications/publication/WEIO2014.
pdf,accessed2April2015.
APPENDIX2—SCENARIODETAIL213456791SCENARIO2—COORDINATIONAWORLDOFACTIONIt's2050,butwe'vefallenshortoftheTransformationscenario.
Still,theworldislessvolatilethanitmightotherwisehavebeen(seenexttwoFragmentationscenarios).
Therehasbeensomeclimateaction,withinvestorsandgovernmentsworkingcollaborativelyratherthangoingtheirownway.
Arangeofpositiveandsuccessfulclimatepolicyactionshavebeenintroduced.
Thishasincludedpricingcarbontoreflectitsultimatecost—thoughconsiderablylessthanforTransformation.
Copenhagenandsubsequentpolicypledgeswereallfulfilledby2030.
Thisprovidedastrongfinancialimperative,motivatingindustryresearchanddevelopmentofalternatives.
Private-sectordemandforcleanenergyisstrongin2050,backedbypublicandprivateinvestmentinsupply.
Energygenerationviafossilfuelshasbeenreduced25%on2010levels.
Therehasbeena30%reductioningreenhousegasessince2030.
Someclimateaction.
Emissionspeakafter2030thenreducesby27%versus2010levels.
Estimatedannualemissionsof37GtCO2eat2050.
NERACoordinationpathway.
FUNDdamages.
GuyCarpenterphysicaldamagesupplements.
AspredictedintheWorldEconomicForumGlobalRisksReport2015,wateravailabilityhasbecomeamajorriskforsocietiesandinvestorsin2050.
Intheworstaffectedregions—theFormerSovietUnion(FSU),MiddleEast(ME),andCentralEasternEurope(CEE)—wateravailabilityiscreatinggeopoliticaltensionsonthebackofrelatedfoodsecurityandagricultureissues,furthercompoundingtheglobalrisks.
Thereisanetbenefitforforestryinmostregions,exceptforAustralia,NewZealandandtheFSU.
COORDINATIONDESCRIPTIONMODELS/REFERENCES92891011121314SCENARIOS3AND4—FRAGMENTATION(LOWERANDHIGHERDAMAGES)Theyearis2050andtheabilityofcompaniestodobusinessissignificantlydisruptedinachallengingphysicalenvironmentduetolimitedclimateaction.
Withhindsight,itiscleartoseethefaultliesintheinabilityofmajoreconomiestocoordinateandworktogether,andtheunwillingnessoffossil-fuel-richcountriestojoininmitigationefforts.
Carbonremainedcheapforfartoolong.
Highrelianceonfossilfuelsasaprimaryenergysourcepersists,withenergygenerationviafossilfuelsin2050just14%lowerthan2010levels.
Therehasbeena33%increaseingreenhousegasesversus2010levels.
ThoughCopenhagenandsubsequentpolicypledgeswereallfulfilledby2030,limitedactiontookplacethereafter.
Eachmajoreconomyimplementedpolicyindifferenttimeframes,andonanad-hocbasis.
Theoldturn-of-the-centurytargetoflimitingglobalwarmthtojust2°Cby210053isalong-losthope.
Theworldisalmost2°Cwarmerthanin2010already.
Businessesmakeeffortstorealign,butatsignificantcost,muchtotheconsternationofshareholdersandpension/super-fundmembers,whosedreamsofacomfortableretirementarechallengedbyaless-hospitableenvironment.
53VictorDG,Kennel,CF.
"Climatepolicy:Ditchthe2°Cwarminggoal,"Nature:InternationalWeeklyJournalofScience,1October2014,availableathttp://www.
nature.
com/news/climate-policy-ditch-the-2-c-warming-goal-1.
16018,accessed2April2015.
54GlobalWarming:TheEvolvingRiskLandscape,GuyCarpenterClimateChangeReport,September2013,p.
5andassociatedpressrelease.
AFRAGMENTEDWORLDLOWERDAMAGESThereismorefrequentandintenseflooding,coastalstormsurges,andwildfires,nottomentiontheincreasingseverityofcyclones/hurricanesandtsunamis.
Ahighersealevel,"thesinglegreatestthreatposedbyglobalwarming,"asnotedina2013GuyCarpenterreport54onglobalrisk,hasbecomearealchallengetoovercome,notjustanotherpotentialrisktomitigate.
AHOT,HOTWORLDHIGHERDAMAGESEmissionspeakedafter2040andanyemissionreductionindevelopedmarketshasbeenoffsetatagloballevelbytheincreaseofemissionsinemergingmarkets.
EstimateddamagesasapercentageofGDParethehighestofanyofthescenarios(0.
80%economiclossat2050fromresourcessuchaswater)andphysicaldamagesfromwildfire,coastalfloodingandextremetemperaturesasaresultofchangesinlong-termweatherpatternsandfloodingduetosealevelrise.
Limitedclimateaction.
Emissionsgrewby33%at2050versus2010levels.
Fossilfuelsrepresent85%oftheenergymixat2050.
Estimatedannualemissionsof67GtCO2eat2050.
LowerDamages:NERACoordinationpathway.
Lowerdamages(FUND).
GuyCarpenterphysicaldamagesupplements.
HigherDamages:NERAFragmentationpathway.
Higherdamages(FUNDwithDICEdamagelevel).
GuyCarpenterphysicaldamagesupplements.
FRAGMENTATIONDESCRIPTIONMODELS/REFERENCES213456793FUTUREPATHWAYSOFTHECLIMATERISKFACTORSWhatarethefuturepathwaysfortheclimatechangeriskfactors:Technology(T),ResourceAvailability(R),Impactofphysicaldamages(I)andPolicy(P)undereachofthefourclimatechangescenariosThisquestionisattheheartofwhatwecall"scripting",whichisaprocesstoquantifythepathwaysintheinvestmentmodeltoisolatehowtheTRIPfactorsshouldgeneratetheirrelativeimpactthroughtime.
Thepathwaysarebasedonthefollowingelements:Therateofinvestmentrequiredintotechnologiesdesignedtofacilitatethetransitiontoalow-carboneconomy.
Potentialshiftsinlong-termweatherpatternsandresultanteconomicimpactsasaconsequenceofglobalwarming.
Potentialshiftsinthelevelofeconomicdamagescausedbyshiftsinthefrequencyand/orseverityofcatastrophicweatherevents,suchasfloodsandhurricanes.
ThetimeframeofCO2emissionspeaking,potentialchangestotheenergymixoutto2050,andmodelledmitigationcostestimates.
Giventhelimitedquantitativeevidencecurrentlyavailable,informationfromthemostrelevantsourceshasbeenaggregated,withthoughtfuladjustmentswherenecessary.
Educated,althoughultimatelysubjectiveassumptionshavealsobeenmadetofillholesintheavailabledataorclimatemodellingwhenrequired.
Thechartsonthefollowingtwopagesindicatethepathwaysfortheclimatechangeriskfactorsundereachoftheclimatechangescenarios.
Thepathwaysareatranslationofthescenariosdeveloped(usingtheclimatechangeIntegratedAssessmentModels(IAMs)andliteraturereview)intoMercer'sinvestmentmodellingprocess.
Theyshowtherelativemagnitudeoftheclimatechangeriskfactorstoeachotherunderthefourdifferentscenariosovertime.
Forexample,ifPolicyisexpectedtocauseeconomiccostofUS$5atyear-35ofthemodel,andResourceAvailabilityisexpectedtocauseeconomicdamageofUS$1atyear-35ofthemodel,theratiooftheirrespectiveapplicationinthatyearshouldbe5:1.
94891011121314WecanseethatthedominantclimatechangeriskfactorimpactisPolicyundertheTransformationscenario.
Investmentflowsintothelow-carboneconomy—asindicatedthroughtheTechnologyriskfactor—arealsosizable.
PolicyisclearlyconnectedtotheroleofTechnology.
Thetwofactorsarefairlywelllinkedwithtechnologyinvestmentflowsandareexpectedtocorrelatetoalargedegreewiththeextentofpolicyinterventions,buttheremaybeadecouplinginthefuturewheresuccessfulnewtechnologyislessreliantonpolicysettings.
ResourceAvailabilityandImpact(physicaldamages)havesomeinfluence,buttheimpactislimitedforthetimeframeofthestudy.
Physicaldamagesareexpectedtobegreaterbeyond2050.
PolicyactionislimitedundertheCoordinationscenario.
Despitethelackofpolicyintervention,technologyinnovationattractsinvestmentflows.
Assuch,theTechnologyriskfactoristhemostsignificantclimateriskfactorundertheCoordinationscenario.
Policyinterventionsbegintoincreasetowardstheendoftheprojectionperiod.
SimilartoTransformation,PolicyandTechnologyaredominantrelativetoResourceAvailabilityandImpact(physicaldamages).
Figure25:TransformationScenario—PathwaysoftheClimateChangeRiskFactorsto2050Figure26:CoordinationScenario—PathwaysoftheClimateChangeRiskFactorsto2050TransformationScenario2015201720192021202320252027202920312033203520372039204120432045204720492050CoordinationScenario2015201720192021202320252027202920312033203520372039204120432045204720492050TechnologyResourceAvailabilityImpact(PhysicalDamages)PolicyTechnologyResourceAvailabilityImpact(PhysicalDamages)Policy2134567Source:MercerSource:Mercer95INVESTINGINATIMEOFCLIMATECHANGENotethattheTechnologyandPolicypathwaysarethesamefortheFragmentation(LowerDamages)andFragmentation(HigherDamages)scenariosasbothofthesescenariosfollowthesameGHGemissionspathways.
Thedifferencebetweenthesetwoscenariosrelatestothescaled-uplevelofdamagesunderFragmentation(HigherDamages),whichisrepresentedbychangesinthetwoclimatechangeriskfactorsassociatedwiththephysicalimpactsofclimatechange:ResourceAvailability(theimpactonresources,suchaswater,asaresultofchangesinlong-termweatherpatterns),andImpactofphysicaldamages(theimpactofcatastrophessuchasfloodingcausedbysealevelrises).
TheResourceAvailabilitypathwayrisesmoreslowlyforFragmentation(HigherDamages)thantheotherthreescenariosbetween2015and2030(recognisingthatagriculturalgainsinsomeregionswilloffsetlossesduringthisperiod),butthenrisessteeplyafter2030inrecognitionofgrowingresourcechallengesunderthisemissionstrajectoryandusingamoreseveredamagefunction(DICE).
IntheTransformation,CoordinationandFragmentation(LowerDamages)scenariostheResourceAvailabilitypathwayrisesto2030,butthenplateausanddeclinesaspotentialeconomicresourcegainsfromclimatechangebegintofall.
Itwouldbeexpectedtoriseagainovertimeasexpectedeconomicgainsswitchtolosses.
Figure27:Fragmentation(LowerDamages)—PathwaysoftheClimateChangeRiskFactorsto2050Figure28:Fragmentation(HigherDamages)—PathwaysoftheClimateChangeRiskFactorsto2050Fragmentation(HigherDamages)2023202520292015201720192021202720312033203520372039204120432045204720492050Fragmentation(LowerDamages)2023202520292015201720192021202720312033203520372039204120432045204720492050TechnologyResourceAvailabilityImpact(PhysicalDamages)PolicyTechnologyResourceAvailabilityImpact(PhysicalDamages)PolicySource:MercerSource:Mercer96MERCER2015891011121314DETERMININGTHE'P'AND'T'FACTORSPolicy(P)isclearlyconnectedtotheroleofTechnology(T).
Thetwofactorsarefairlywelllinkedwithtechnologyinvestmentflowsexpectedtocorrelatetoalargedegreewiththeextentofpolicyinterventions,buttheremaybeadecouplinginfuturewhensuccessfulnewtechnologyislessreliantonpolicysettings.
TheTechnologyfactorismaterialunderallfourclimatechangescenarios.
However,thedevelopmentpathwayforTechnologyremainshighlyuncertainandthisfactorremainsoneofthemostdifficulttoquantifygivenitscomplexinteractionwithmitigationandadaptationactivities,anduncertaintysurroundingresearchanddevelopmentsuccessesorfailures.
Transformation4090130155Coordination1536105210Fragmentation4102141PRICEOFCARBON($US2013/TCO2)2020203020402050Estimatesofthe"leastcostofcarbon"offerarelativeindicatorofthestrengthoftheclimatepolicesaimedatreducingGHGemissions.
Inpractice,acomprehensiveclimatepolicystrategymayincludemanytargets,mandates,regulations,measures,andsoon.
Thespecificmeasuresmayalsovarybyregion,dependingontheirambition,carbonintensity,andlocalcircumstances.
Thus,actualpoliciesandmeasuresusedmaynotrepresenttheleastcostlyapproach,asassumedwithacarbonprice.
Inthisstudy,wehavenotassessed,norassumed,thecost-effectivenessofmeasuresemployed.
Wehaveonlysoughttoreflectthestrengthofthemarketdriversmobilisingeconomicshiftswithineachscenario.
Figure29:CarbonPricingPathwaysbyScenarioCarbonPriceCurves($2013/TONCO2E)21345672015201720192021202320252027202920312033203520372039204120432045204720492049FragmentationCoordinationTransformationSource:WitchModelOutput(Coordination;Fragmentation);IEA450ppmScenario(Transformation);MercerAdjustments/Analysis.
97INVESTINGINATIMEOFCLIMATECHANGEFUTUREPATHWAYSAT2100Thefollowingpagesoutlinetheglobalandregionalchangesthatcouldbeexpectedin2100withthedifferenttemperaturechangesintheclimatescenariosweexplored.
55VictorDG,Kennel,CF.
"Climatepolicy:Ditchthe2°Cwarminggoal,"Nature:InternationalWeeklyJournalofScience,1October2014,availableathttp://www.
nature.
com/news/climate-policy-ditch-the-2-c-warming-goal-1.
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Table6:KeyPhysicalImpactsofDifferentClimatePathwaysat210055TRANSFORMATIONCOORDINATIONFRAGMENTATION(LOWER/HIGHERDAMAGES)2oCglobalmeansurfacetemperaturechange(relativeto1850–1900).
3oCglobalmeansurfacetemperaturechange(relativeto1850–1900).
4oCglobalmeansurfacetemperaturechange(relativeto1850–1900).
Sealevelsrisebyaround40cm.
20%lesswateravailability.
40%increaseinthestrongestNorthAtlanticcyclonesSealevelsrisebyaround50cm.
30%lesswateravailability.
Sealevelsrisebyaround70cm.
Coastalinundation.
50%lesswateravailability.
80%increaseinthestrongestNorthAtlanticcyclones.
Heatwavessimilartorecentyears,causingheat-relateddeaths,forestfires,andharvestloss.
Aggregatenegativeimpactsonfoodproductionandpricestability.
Individuallocationswillbenefitfromincreasedyieldsatthistemperature.
Increasedchanceoffamine.
Potentialforincreasedagricultureyieldseroded.
Hightemperaturesandhumiditycompromisenormalhumanactivities(e.
g.
growingfoodorworkingoutdoors).
Risktomarinefisheriesposesriskofreducedfoodsupplyandemployment.
Lowtomediumriskofdeclineinfishstocks.
Permanentlossofarcticseaice.
Veryhighriskofdamagefromwildfires.
Mediumtohighriskofadeclineinfishstocks.
Oceanacidificationrisktomarineecosystems.
Impactsby2100PhysicalsystemsHumansystemsBiologicalsystems98891011121314TRANSFORMATION:WHATDOESA2°CWORLDLOOKLIKEEuropefacesincreasedeconomiclossesbyfloodinginriverbasinsandcoasts,drivenbygrowingurbanisationandcoastalerosion.
Addingtothestrainisthepotentialformorewaterrestrictions,significantreductioninwaterfromgroundwatersourcesandincreasedwaterdemand.
Risingtemperatures,particularlyinSouthernEurope,haveanegativeimpactoneconomiesandpeopleareaffectedbyextreme-heatevents,impactinghealthandlabourproductivity,cropproduction,andairquality.
However,highadaptationcanpreventmostofthepredicteddamagesinthisscenario,particularlybyintroducingfloodprotectionandwater-efficiencytechnologies.
Someimpactsmaybepositive,suchasreducedcold-waveriskinwinter.
Overthelong-term,NorthAmericafaceshighriskat2°Cofwildfire-inducedlossofecosystemintegrity,propertyloss,andhumanmorbidityandmortalityasaresultofincreasedevaporationandtemperaturetrends.
Thisisevenwithhigh-adaptationpoliciesinplace.
Thisadaptationistosomeextentconstrainedbyrapidprivatepropertydevelopmentinhigh-riskareas.
Thegeneralpopulationmayexperienceanimpactonpublichealthandwaterqualityduetosea-levelrises,extremeprecipitation,andcyclones.
SouthAmericafacesissueswithwateravailabilityinregionsdependentonglaciermelt.
InCentralAmerica,thereareconcernsoffloodingandlandslidesduetoextremerainfall.
Withouthighlevelsofadaptation,thebroaderregionwillsufferfromdecreasedfoodproductionandquality.
Asia'slong-termrisksincludeincreasedriver,coastal,andurbanflooding,leadingtowidespreaddamagetoinfrastructure,livelihoods,andsettlement.
Large-scaleadaptationofvulnerableinfrastructures—forexample,water,energy,andwastemanagement—wouldberequired,andwoulddrasticallyreducetherisksposed.
Thehumanimpactofextremeheateventsstandstobehighevenwithconcertedadaptationwithincreasedheat-relatedmortalityanddrought-relatedwaterandfoodshortagescausingmalnutrition.
213456799COORDINATION:WHATDOESA3°CWORLDLOOKLIKEManyimpactsmaybeirreversibleby3°C.
TheimpactsdescribedaboveinEurope,theAmericas,andAsiastandtobemorepronouncedthanwith2°Cwarming.
Somehigh-riskimpacts,forexample,increasetheriskofdroughtandhighertemperaturesinNorthAmericabringingevengreaterharm,andsignificantadaptationeffortswouldhavelittleeffect.
SouthAmerica'sfoodproductionfaceshugeriskswithcurrentlevelsofadaptation,althoughfollowingapathofhighadaptationcouldbringtheserisksdownsignificantly.
Asia'smortalityriskfromrisingtemperaturesispredictedtoremainveryhighevenwithsignificantlevelsofadaptation.
FRAGMENTATION:WHATDOESA4°CWORLDLOOKLIKEExtremeheatwaves,thatwithoutglobalwarmingwouldbeexpectedtooccuronceineveryseveralhundredyears,willbeexperiencedmuchmorefrequently.
Theeffectswouldnotbeevenlydistributed.
Thelargestwarmingwouldbeexpectedtooccuroverland,andrangefrom4°Cto10°C.
Increasesof6°CormoreinaveragemonthlysummertemperatureswouldbeexpectedintheMediterranean,NorthAfrica,theMiddleEast,andpartsoftheUS.
Sea-levelriseof0.
5–1metreby2100islikely,withhigherlevelsalsopossible.
SomeofthemosthighlyvulnerablecitiesarelocatedinMexico,Venezuela,India,Bangladesh,Indonesia,thePhilippines,Vietnam,andMozambique.
Themostvulnerableregionsareinthetropics,sub-tropics,andtowardsthepoles,wheremultipleimpactsarelikelytocometogether.
Agriculture,waterresources,humanhealth,biodiversity,andecosystemservicesarelikelytobeseverelyimpacted.
Thiscouldleadtolarge-scaledisplacementofpopulationsandconsequencesforhumansecurityandeconomicandtradesystems.
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ch/report/ar5/,accessed20March2102891011121314IMPORTANTNOTICES2015MercerLLC('Mercer'),InternationalFinanceCorporationandtheUKDepartmentforInternationalDevelopment.
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