The physical risks associated with climate change manifest in many different ways – from severe flooding, to water scarcity, rising sea levels and extreme temperatures. In short, the risks are represented by an ongoing decline in the quality and quantity of the earth’s natural capital.

The ensuing destruction presents challenges for the full spectrum of economic activity. Understanding these challenges is vital for protecting against the future, and is thus becoming a critical part of the global investment discussion.

Almost all products – and some services – rely on the world’s natural resources at some point along their supply chain, from the agro-commodities that form the basis of diets around the world, to the availability of water used for data centre cooling, or production of the natural fibres we use in clothing. It can also simply be the square kilometres of flat land in a temperate environment of a productive economy where companies choose to base their headquarters or operational facilities.

Numerous sectors could be impacted by the physical risks associated with climate change. One example is agriculture, which is particularly reliant on water availability: indeed, almost three-quarters of all water withdrawals are directed towards the sector. And yet, in many economies where the agricultural sector dominates, climate-exacerbated water-scarcity is a real and growing threat.

The challenge for agriculture doesn’t lie only with water. Temperature changes exacerbated by climate change can be a significant impediment to agricultural processes, too. Droughts and heatwaves can reduce harvest yields and drive up prices. Seven of the 10 countries facing the largest temperature increases globally in the two decades to 2016 also rank in the top 50 per centof economies most reliant on agricultural production.

Textile production, like agriculture, is both a perpetrator and a victim of climate change and another example of a sector we believe will increasingly face climate change related risks, particularly those associated with water scarcity. Some 10,000 to 20,000 litres of water is required to produce just 1kg of cotton – enough for one pair of jeans.

Textiles and agriculture are just two examples of sectors that face serious threats from climate change. The reality is that there are many more. One tool that we think investors can use to better understand these risks is mapping where sector supply chains are based around the world, and where natural resources are particularly at risk.

The downside risks of the physical impacts of climate change are often discussed, but what about the opportunity set? Cosmetics and personal-care companies are one example where water scarcity is both a downside and upside risk. The sector is rapidly deploying new personal care products in emerging markets. These products are solutions, in that they allow consumers to rely on less water for their use, via ‘fast rinse’ and waterless product formulations.

The physical impacts of climate change present direct risks and opportunities for entire economies too. Extreme weather events can leave destruction in their wake and thus drive up government expenditure and debt. South and South-East Asian economies have suffered from this recently. In India, for example, the 2018 floods in Kerala displaced over a million people and caused an estimated USD2.85 billion of damage to roads and infrastructure.

Apart from event risk, climate change presents other economic challenges. This includes inflationary risks as production of agro-commodities is challenged in light of climate events. Longer term, this can have implications for food scarcity. Climate change also poses risks to human health that could ultimately impact government spending on health risks.

‘Climate governance’ is now a critical part of the climate response for companies and governments. This means, having factors such as resources, institutional quality and regulatory oversight to mitigate and adapt to these risks.

Financial and institutional quality indicators are important for climate governance and typically tally with a country’s economic development, but also with aspects of climate governance, such as decarbonisation policies, that do not necessarily relate to a nation’s prosperity.

We are seeing a raft of ambitious ‘net zero’ pledges from governments and companies in the face of these risks. Many of these pledges will have specific implications for different business sectors.

We have explored various means by which different sectors will be affected by climate governance. One case study involves telecoms. This sector could increasingly be called on to provide innovative solutions for better climate governance, allowing the world to become more resilient in the face of climate risks.

There is growing pressure to improve communication infrastructure for the benefit of connectivity pre and post a climate weather event. Early-warning systems can alert communities to human and livestock evacuation plans, for instance, while mobile phones or the internet can help the provision of aid in the aftermath. These tools are critical for better climate governance.

First published 24th June 2021.

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