Financial peril stems from natural hazards

In a world where natural disasters and environmental degradation pose significant threats to long-term assets, pension funds and sovereign wealth managers are stepping up to the challenge.

In 2022, floods in Pakistan devastated agriculture, a sector employing 40% of the workforce, driving up food prices and pushing the country to the brink of default. This stark reminder of the financial risks associated with environmental degradation has prompted long-term asset owners to take action.

One such action is comprehensive risk assessment. The Norwegian Public Pension Fund, for instance, assesses up to 96% of its portfolio for natural capital risks. This rigorous process identifies potential shocks that could reduce long-term asset value. They measure carbon footprints, use scenario analyses to evaluate potential climate impacts on portfolios, and divest from carbon-intensive companies.

Data-driven analysis is another key strategy. Some asset owners, like Singapore’s Temasek Holdings, use satellite monitoring and biodiversity data to evaluate natural-capital risks and opportunities. This approach allows for a more accurate understanding of the environmental impacts on investments.

Active stewardship is also crucial. Long-term investors engage with companies, policymakers, and markets to improve disclosure, set standards, and promote an orderly climate transition. Regulators like the Dutch Central Bank push pension funds to integrate sustainability risks proactively, balancing financial returns with long-term sustainability.

Adaptation and resilience are increasingly recognised as opportunities, not just mitigation. Investing in resilience reduces economic damages significantly, and frameworks like PCRAM 2.0 help identify and manage physical climate risks at the asset level.

This integration is important because natural and climate risks materialize as financial risks that threaten the stability and value of long-term assets. Physical climate events and environmental degradation can cause short- to medium-term shocks impacting economic stability and investment returns. For generational investors, ignoring these risks compromises the security of long-term liabilities such as pension payouts.

Moreover, integrating these risks supports the alignment of investments with global climate goals and can uncover new investment opportunities in a transitioning low-carbon economy.

The Taskforce on Nature-related Financial Disclosures (TNFD) has developed a set of disclosure recommendations and guidance for businesses and financial institutions to integrate nature into their decision-making. This is a significant step towards ensuring that investors, central banks, and institutions like the IMF take their responsibility seriously and integrate nature risk into all their activities.

New biodata technology is available to help investors act on nature-related risks. Asset owners, central banks, and institutions that lead in integrating nature risk into their activities will be those willing to move beyond silos, align capital with planetary boundaries, and invest not only in markets but also in the systems that support them.

The financial consequences of ecological instability are already being felt. Investors are facing the financial consequences of climate-vulnerable economies, including stranded agricultural assets and declining sovereign-credit ratings. Initiatives like the Debt Suspension Clause Alliance and the Global Hub for Debt Swaps for Development are aimed at addressing financial stability and environmental stability.

In conclusion, the integration of nature and climate risks by long-term asset owners reflects a shift from viewing environmental factors as externalities to recognising them as core financial risks and opportunities. This approach is essential for protecting and enhancing the long-term value of portfolios in a changing environmental context.

The devastating floods in Pakistan in 2022, affecting agriculture and driving up food prices, serve as a warning about the financial risks linked to environmental degradation, prompting long-term asset owners to take action.
In response, the Norwegian Public Pension Fund assesses natural capital risks in up to 96% of its portfolio, aiming to identify potential shocks that could diminish long-term asset value by measuring carbon footprints, conducting scenario analyses, and divesting from carbon-intensive companies.
Data-driven analysis, such as using satellite monitoring and biodiversity data, is another key strategy, allowing for a more accurate understanding of the environmental impacts on investments, as demonstrated by Singapore’s Temasek Holdings.
Active stewardship is crucial, with long-term investors engaging with companies, policymakers, and markets to improve disclosure, set standards, and promote an orderly climate transition, while regulators like the Dutch Central Bank encourage integrating sustainability risks proactively.
Integrating adaptation and resilience is increasingly recognized as an opportunity for reducing economic damages and identifying physical climate risks at the asset level, as guided by frameworks like PCRAM 2.0.
To ensure the integration of nature risks, the Taskforce on Nature-related Financial Disclosures (TNFD) has developed a set of recommendations and guidance for businesses and financial institutions, moving toward a future where investors, central banks, and institutions like the IMF integrate nature risk into their decision-making, protecting and enhancing the long-term value of portfolios in a changing environmental context.