Systemic Risk

| 27 March 2017
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While informed professionals in many sectors see climate risk as one of the biggest risks the world faces, most investment professionals give it a much lower priority. They are not yet awake to the fact that the systemic risks arising from climate change, and the associated loss of value across a diversified portfolio, cannot be avoided by conventional techniques such as diversification, stock picking or hedging.

In the words of John Holdren, former US Presidential Science Adviser, “We need to manage the unavoidable, and avoid the unmanageable.” Hedging, risk assessment and divestment are all about managing the unavoidable. Forceful stewardship and public engagement is about avoiding the unmanageable – i.e. systemic risk. Investors need to be alert to physical risk, transition risk, and legal and regulatory risk.

The actual risk in a particular case will be an interplay of these, with the total risk being multiplicative, not additive. Since these risks cannot be avoided using traditional risk management strategies, investors – especially those who have commitments to sustainability, long termism or are simply well diversified – will accept they have a share of responsibility for keeping average warming to below 2C (<2C), in particular by exercising forceful stewardship.

In a May 2016 event jointly organised with Mercer and Oliver Wyman, Preventable Surprises brought together a cross section of scientists, asset owners, asset managers and academics to explore why investors have been slow to take on board the concept of climate change, and what kind of communication about systemic risk could stimulate them to take action. A tentative conclusion was that communication needs to follow a SEE strategy of Scare (confront the risks), Encourage (acknowledge what is already happening and the positive opportunities from the transition to a low carbon world), and Empower (show that action is taking place across the whole financial system.)

This report details the discussion prompted by the event while this video captures impressions of event participants.