President, North America
Stranded Assets: The Potential Cost of Climate Change
While I suspect that most readers are familiar with the potentially devastating impact of changes in global climate patterns, I’m less confident that ‘stranding of assets’ comes to mind as the increasingly common consequence of these changes. Defined as assets that have suffered from unanticipated or premature write-downs, devaluation or conversion to liabilities, only recently have environmental factors such as climate change, and society’s attitude toward it, become part of the causation conversation. And, although asset-stranding is an inevitable risk of operating in a market economy, it is more significant when related to environmental factors due to a scale of potential loss.
For instance, widespread societal pressure in China to reduce its dependence on thermal coal, along with an increase in renewable energy generation, has negatively impacted coal-mining assets in Australia. Which other business sectors are at risk? Unfortunately, asset-stranding scenarios abound; Mandatory energy efficiency improvements would reduce the value of the least efficient housing stock, and simultaneously increase the value of the most efficient housing stock. Or, imagine the upstream energy liabilities that could result from third-party claims against companies (and their directors and officers) alleging responsibility for climate change.
In a report published by Lloyd’s last month, researchers suggest that changes to the physical environment driven by climate change, and society’s response to these changes, could potentially strand entire regions and global industries within a short timeframe, leading to direct and indirect impacts on investment strategies and liabilities.
What can companies in their role as investors be doing to identify and mitigate stranded asset risks? Stress-testing is a good place to start. We need more rigorous analysis of portfolio exposures to environmental-related risks. That means testing assets against a larger number of extreme future scenarios.
Screening is also critical. Investors will need to either exclude some investments from their portfolios or include certain investments based on specified environmental qualifications. And, for some the answer may be closer involvement in the governance processes of businesses in which they invest, leaving open the possibility of removing specific investments from their portfolios if not satisfied with management’s engagement to improve outcomes.
Working together, investors might press for enhanced transparency in the disclosure practices of companies in which they invest and collaborate on the development of regional, national and international legislation when it comes to environmental change.
Although thinking through the future effects of climate change and the stranding of assets might be cause for alarm, it’s reassuring to know that there are a number of individual and collective actions companies, including insurers, can take to ensure we’re better prepared to respond.