Climate change is perhaps the most significant financial risk for investors over the long term, according to Ravi Menon, managing director of the Monetary Authority of Singapore (MAS).
Speaking at the recent IMAS-Bloomberg Investment Conference, Menon said this risk can materialize in two ways. Firstly, through physical risks from climate change itself, such as damage to properties and assets, disruption to supply chains, production stoppages, and reduced agricultural yields which can reduce growth and push prices higher.
The second risk could come from transition risks from government policies, technological advances, and shifts in demand patterns aimed at mitigating climate change and promoting sustainability.
“For example, the introduction of carbon pricing will change the earnings profiles of businesses, favouring firms and industries with cleaner technologies and lower carbon emissions relative to more carbon-intensive firms and industries,” Menon says.
The effects of climate change on the global economy and asset markets are hard to predict, but climate resilience is now a key dimension that asset managers will need to build into their portfolios.
“They (asset managers) need to ask some searching questions. How will climate change affect the businesses that the portfolio is invested in and which are the firms in the portfolio that have not made credible efforts to decarbonize their operations?” the MAS chief says.
“What are the investments that run the risk of being stranded assets in a net-zero world, and what are the investment opportunities as the world transitions to a low-carbon economy?”
Significant opportunities in Asia
Despite the new uncertainties, Menon highlights that there are also significant opportunities for sustainable investing in Asia.
Citing McKinsey’s estimates, he notes that net zero by 2050 would require about US$9.2 trillion of investment per year, out of which around one-third or US$3.1 trillion would be in the Asia Pacific.
Meanwhile, estimates from management consulting firm Bain shows that five sectors – renewable energy, electric vehicles, forest conservation, built environment, and sustainable farming – account for 60% of Southeast Asia’s carbon abatement potential.
Renewables such as solar and wind will reach an annual US$30 billion opportunity by 2030, while electric mobility will be an annual US$50 billion opportunity by the same period. To meet these hefty investment needs, Menon says, blended financing structures will be required.
“Many green and transition projects in emerging markets pose risks that are not commensurate with their expected returns. We need catalytic or concessional capital from multilateral banks, public and philanthropic sources to improve project bankability and private sector capital. We need to strengthen the financial ecosystem to deploy blended finance at scale,” Menon says.
This will involve looking beyond the financing of individual projects and moving to a portfolio approach whereby concentration risks can be reduced through a diversified pool of assets, the regulator says.
One way is via multi-asset funds which invest in small-scale renewable energy projects in specific markets. Securitization can also mobilize private institutional capital, by allowing capital to be recycled from holding typically illiquid green and transition assets.