The United Nations-supported Principles of Responsible Investment (PRI) is warning of an “inevitable policy response” to climate change that will place portfolios at risk for investment managers who have high exposure to environment-polluting assets.

The London-based PRI’s warning is timely given the grave predictions of the effects of a rise in the pre-industrial global temperature to 1.5 degrees celsius recently released by the UN’s Intergovernmental Panel on Climate Change (IPCC). PRI is a non-government organization that fosters the growth of investment practices aligned to environmental, social and governance (ESG) considerations.

In a report published in early October the IPCC warned that there is just a dozen years left in which to contain global warming to a maximum 1.5C. Beyond this level there is a significant risk of droughts, floods, extreme heat and the threat of displacement and poverty for hundreds of millions of the world’s population.

According to the PRI’s research, even full implementation of the Nationally Determined Contributions (NDCs) which were framed under the auspices of the 2016 Paris COP21 climate change agreement will lead to temperature increases in the magnitude of 2.6-3.4 degrees celsius relative to pre-industrial levels.

That increase would potentially prove disastrous, materially in terms of climate-related global disasters, but also from the point of view of portfolio risk. 

Such an increase “poses significant risks to investors and service providers, as global warming at that scale would have large and detrimental impacts on global economies, society and investment portfolios,” according to a recent published PRI white paper.

The PRI’s analysts are of the opinion that companies and investors have not fully grasped the implications of an inevitable-policy-response (IPR) trajectory and the impact it would have on the value-at-risk (VaR) in their portfolios.

Asia is the world’s biggest emitter of greenhouse gases, and in this context there is a relatively low probability of an IPR from the region.

A coordinated policy response from the region framed in the context of the regulations already put in place by China, India and Asean and the commitments of the COP 21 Paris climate agreement, seems likely within the next five to 10 years.

China is arguably making more strides in implementing COP21 than any other leading developed nation and it behoves them to lead the regional policy response from the region.

The sizeable carbon footprints of Japan, India, China and individual countries within Asean and their heavy reliance on fossil fuels will solidify the case for a regional IPR along with the VaR adjustments which would be consequent, including heightened volatility within portfolios and the risk of stranded assets, as companies which rely on fossil fuel for revenue discover that policy change renders those assets redundant.

The PRI envisages a situation in which a widespread IPR will precipitate substantial shifts in capital allocation from high to low carbon activities which necessitates consequent alterations to strategic asset allocation in the face of accelerated policy and technological transformation.

Estimates of the cost of physical damages to financial assets as the result of 1.5C-2C global temperature warming are estimated as ranging from a value impairment of 2%-10% of an equity portfolio with exposure to carbon intensive holdings.