According to the last Climate Vulnerability Monitor [1], the impact of climate change during the 21st century on the global financial assets is expected to be $2.5 trillion USD. This is why the World Economic Forum has chosen Failure of climate change mitigation and adaptation as one of the Top 5 global risks [2].

Although the uncertainty is significant, the total funding needed for adaptation by 2030 is expected to be between $49 – 171 billion per year across the globe [3]. The IPCC, however, estimates that in 2014, the total funding for climate change adaptation was $22.5 billion [4]. This leaves a gap of between $65.6 and $95.6 billion per year. So, how can we fill this gap? The financial sector, particularly pension funds, may have a crucial role in answering this question.

“average global flood losses by 2050 are projected to be $60–63 billion per year”

As the World Economic Forum remarks, climate change and economic risks are strongly interconnected [2]. Since the main impacts of climate change will happen in the long-run (increased probability and intensity of floods, sea level rise, etc.), climate change will mainly affect long-term investors such as pension funds.

Pension funds typically have significant amounts of money to invest and are one of the major investors.  For instance, the three largest pension funds hold about $5000 billion in assets [5], more than 30 times larger than the gap named before. As long-term shareholders, they are essential for building a more sustainable economy.

 

By ignoring the impact of environmental issues on portfolios, pension funds are taking an unnecessary risk that cannot be neglected any longer. For example, sea-level rise and extreme weather events represent a major threat to PPE assets: average global flood losses by 2050 are projected to be $60–63 billion per year [7].  Likewise, several studies show how considering environmental risks lead to investment outperformance. [8] [9]

what can pension funds do?

The first solution is to exclude certain investments where the environmental criteria are not accomplished. This mechanism is sometimes called screening. The environmental criteria are designed to show the performance in aspects such as GHG emissions or sustainability practices. Different organisations and benchmarks inform about environmental standards to simplify the process of screening. One of the most well-known is CDP, a British organisation that helps major corporations to disclose the GHG emissions to improve their reputation[10].

Other practices are:

Wealth vs wellbeing

However, this may not be enough. The proposed methods do not change the primary goal of pension funds, which is increasing pension’s beneficiary’s wealth.

Why can this be a problem? Let me explain this by an example: imagine that the National Social Security Fund of China has the opportunity of investing in a Carbon Power Plant in the province of Shanxi. It is possible that even after considering the environmental impacts such as possible floods, the power plant will still be profitable. However, apart from emitting carbon, these power plants also emit fine particulate matter – an air pollutant that causes the air to appear smoggy – and that is not carbon taxable. Then, the population living close enough to the plant, perhaps most of them pensioner, will suffer the impacts. Exposure to these kinds of particles causes cardiovascular and lung diseases. This leakage, where pension funds create wealth by reducing the health of some pension beneficiaries, shows a failure of the traditional financing techniques.

Other public bodies had already faced similar problems. For instance, the UK created the Measuring National Well-being Programme in 2010 [11]. Its aim is to develop measures of the well-being of the nation to help in policy making. Pension funds should ask themselves what the purpose of investing is. Is it worth investing in projects that increase the wealth but reduce the overall wellbeing of the pension beneficiaries?  Perhaps, it is time for the financial sector to start using new decision tools that maximise welfare instead of wealth.