A recent analysis that we released quantifies the climate-related exposure that Malaysian financial institutions have through their financed emissions. Our report found significant concentrations of exposure to financed greenhouse gas (GHG) emissions in bank financing to electricity, gas & water, transportation, storage & communications, and manufacturing. These sectors collectively represent 70% of banks Scope 3 financed emissions exposure.
This holds relevance for MENA based investors and financial institutions who have direct exposure to Malaysia through their investments in financial institutions or assets based in Malaysia. GHG emissions coming from these sectors represents a real cost that is currently unpriced. It is unaccounted for when financial institutions and investors that make their investment decisions based only on the financial information released by these companies.
By undercounting the costs faced by these and other sectors who rely on electricity, transportation and other large sources of GHG emissions like waste management, the analysis understates the costs these companies will face in coming years. From a bank’s perspective the prospect of these costs shifting from unpriced externality to measured cost represents a risk that could raise the likelihood that the company defaults on its financing.
The most direct way for these externalities to become internalized is a carbon tax, but there are other ways that would have a similar effect. For example, the European Union’s proposal for a carbon border adjustment would affect companies that export to Europe through the embedded GHG emission in their products. Another way that the externality of GHG emissions becomes internalized is through regulations to shift the economy into alignment with Paris Agreement targets that raise costs indirectly for significant GHG emissions sources.
Investors are starting to factor these issues into their investment decisions already, even while GHG emissions are largely unpriced. Many of the global investors who are among the $5 trillion of asset owners making net zero pledges under the UN-convened Net Zero Asset Owners Alliance who will look at the financed emissions of Malaysian financial assets and institutions also hold shares, bonds and sukuk of financial institutions in the MENA region.
All of these financial institutions are likely to face some level of engagement from global investors looking to better understand their process for managing climate-related financial risk. The newly released 2020 Status Report from the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) found that the Middle East and Africa had among the lowest level of disclosures relating to climate-related financial risks.
Among the least disclosed aspects of climate-related financial risks companies in this region were management’s role in evaluating climate-related risks (14% of sampled companies), an integration of climate-related risks into risk management practices (10%) and the resilience of a company’s strategy to risks related to climate change (10%). MENA-based financial institutions and investors who have exposure to Malaysia should be aware of the risks that are not being recognized yet as an element of financial costs.
This makes traditional analysis of risk exposures incomplete in the context of what the UN-supported Principles for Responsible Investment refers to as the ‘Inevitable Policy Response”. An important take-away is that as the Paris Agreement continues to operate as intended, there will be rising costs faced by businesses who are misaligned with its targets. There will also be beneficial opportunities for businesses that adapt their business strategy to operate in alignment with Paris Agreement targets.
For investors and financial institutions looking out over the coming 3 to 5 years, the data is becoming more and more available to identify where these risks and opportunities exist. It’s now up to each investor or financial institution to begin to prepare for how they factor future costs of GHG emissions into their risk management today.
Larry Fink, CEO of BlackRock, which manages $7 trillion in assets, succinctly summed up the issue for those coming from a financial perspective. Climate change, he said, is “driving a profound reassessment of risk and asset values. And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself.”
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