Stephan Langen: Having a nice holiday amid climate risks?
This column was originally written in Dutch. This is an English translation.
By Stephan Langen, Head of Portfolio Management at ASN Impact Investors
Are you also fed up with the fickle weather in the Netherlands? Fortunately, the holiday season has arrived and we can leave this occasionally autumnal summer behind us in our own country and move to sunny places. Oh wait, it will be 35 to 45 degrees Celsius there! That's not really comfortable, is it?
Weather and climate are not the same, but climate change is becoming quite visible due to extreme weather, just like the climate damage that has now become unavoidable. Global heat records, forest fires in Siberia, torrential rain in the Alps, where streams and rivers break out because they can no longer cope with the persistent rainwater plus meltwater: I could go on and on.
Outside-in risks according to SFDR
This may also affect our investments. Companies and projects that contain our money can be hit by extreme weather conditions and therefore go out of business. Crops that fail, supply chains that break down. Climate engineers call these risks physical risks.
These physical risks fall within the SFDR definition of sustainability risk: an environmental, social or governance event or condition that, if it occurs, could have an actual or potentially material adverse effect on the value of the investment, the so-called 'outside-in' risks.
The financial impact of floods
Asset owners and asset managers must take the outside-in risks of their investments into account, also on the basis of the SFDR regulations. For example, they are expected to map out how flood risk impacts their portfolio and estimate the potential negative financial impact.
I think this in itself is a good approach. Mapping these outside-in risks makes us even more aware of the possible negative economic impact of climate change. It also shows how dependent our economic activity is on nature. So following on from the footprinting of greenhouse gas emissions and the biodiversity impact of portfolios, it seems to me to be a good development.
Avoid investments in the Netherlands?
The regulator requires us to also take these risks into account in our investment decisions. That in itself is not surprising, to do a thorough risk analysis before investing.
But now the following: the Netherlands has a high flood risk. This is due to our location in the delta of a number of major European rivers. It is therefore good that we map out the risk of flooding. But is that a reason not to invest in the Netherlands anymore? Should we go to Switzerland because that country is higher? Recent images from the Alps show that this region is not without risk either.
Capital to solutions
What we must guard against is that the means – risk management – becomes the goal. The regulator's aim is to prevent, reduce or remedy sustainability risks. We must let that goal guide our investment decisions. That is possible, as long as we make clear choices between harmful and non-harmful investments.
The 'inside-out' risks are important here. These are the risks resulting from the activities of companies and projects and their implementation on their environment and stakeholders. The binding element in these sustainability risks is that the outside-in risks that are often the result of climate change are precisely caused by the inside-out risks of our economic activities.
Avoiding the Netherlands does not seem to me to be a correct conclusion for those who want to include sustainability risks in investment decisions. In my opinion, the focus should be on preventing flood risk and other climate risks as much as possible. The purpose of the regulations is to direct capital to preventing and solving climate impact, so that we ensure the mitigation of, among other things, the flood risk.
Skin in the game
Avoiding investments in what you could consider risk areas does not contribute to this. You could even argue the other way around: your risk awareness increases further as soon as you have skin in the game. After all, you have an interest in mitigating climate risks because you have exposure.
If all investors now direct capital towards climate mitigation, if we all focus on reducing biodiversity loss and compensating for the damage suffered, we give ourselves the best chance of continuing to enjoy a pleasant holiday, in our own country or abroad.
So even when you return: continue to implement sustainability solutions in your investment portfolios.
Have a nice holiday!
Stephan Langen is Head of Portfolio Management at ASN Impact Investors. The information in this column is not intended as professional investment advice or as a recommendation to make certain investments.