Flying Blind: What Do Investors Really Know About Climate Change Risks in the U.S. Equity and Municipal Debt Markets?

I ran across this new paper a few days ago.

Click to access WP67_Victor-et-al.pdf

The authors make two important arguments…

“First, the quality of disclosures is highly uneven and generally lousy. There are some signs that while
the volume of disclosure from corporate equities rose sharply over the last decade, anecdotal evidence
suggests quality has gone down. More firms are disclosing more general information that is essentially of
no utility to the marketplace.”

“Second, it is possible to achieve much greater levels of useful disclosure around the physical risks of
climate change by deploying new analytical tools, regulatory incentives, and business practices.”

It’s this second risk where I think the most important point is being made. There is much discussion and information today about the transitional risks of climate change but there is a shortage of analysis regarding the impacts of physical risks. The authors point out the reasons for this — basically that a) determining physical risk is harder and b) not a lot of people seem to care.

One thing that is interesting is that the article gives a lot of attention to the municipal bond market. Cities that are at most risk for climate change impacts do not see a premium on interests rates charged to them when they borrow money. This was a new area (and concept) to me and one I found interesting and educational.

I also take issue with a couple of points the authors make.
First, they discuss the fact that ESG reporting data shows there is much more reporting by compainies on transitional risks versus physical risks. However, as their data shows, the leaders in risk reporting are the extractive energy companies. By nature of their business model these companies face transitional risks which are existential to the companies. Physical risks, while perhaps substantial, are much smaller by comparision. This volume of transition risks dominates the numbers because of the nature of the companies doing the bulk of the reporting. They come around to this point – more or less – later in the paper.

Second, when discussing physical risks there is no discussion of resiliency. Many companies and municipalities with high physical risks have taken extra-ordinary steps to protect against physical risks. For example, my home, on the coast, sits behind a 4.5 meter high seawall which has saved it from hurricane-caused flooding on several occasions. While climate change may increase the frequency and even the intensity of hurricanes, I live in a place where there is most likely sufficient resiliency to protect against this particular climate change impact.

All of this aside, they do make some really good points regarding their two main findings.