Report Calls on Investors to Focus on Climate ‘Blind Spots’

Adaption and carbon removal investments are being overlooked, according to ISS ESG.

Institutional investors may not be fully appreciating the full range of opportunities for returns as they adjust their portfolios in recognition of climate risks, according to a new report by ISS ESG, the responsible investment arm of Institutional Shareholder Services.

Noting the increased efforts required of policymakers at COP26 and beyond to set the world on a path to the UN’s 1.5 degrees Celsius warming targets, the report suggests investors should make greater use of scenario analysis techniques in order to track tradeoffs in their portfolios between climate risk transition and adaption to the physical impacts of climate change.

“This type of analysis can come in many shapes and sizes and can deal with carbon target alignment, physical impact, risk preparedness or a range of other aspects of different alternative futures,” says the report, titled ‘Seeing past the blind spots in climate finance’.

Investors can use transition scenarios to identify the impact of various warming scenarios on their portfolios, as well as the contribution of those portfolios to alternative scenarios. In addition, physical risk scenarios can help investors understand the valuation impact of physical risks according to differing levels of warming.

Although investors are using physical risk analysis to identify which assets in a portfolio will be hardest hit by climate change, ISS ESG says the question of how to invest in adaption “is not generally considered”.

As possible examples of opportunities aligned to the need to adapt to the physical risks of climate change, ISS ESG cites investment in flood risk control, new crop varieties, efficient irrigation systems, sustainable forest management, early warning and information sharing systems, and soil and water conservation.

“In light of the International Energy Agency’s Net Zero Roadmap, investors must now anticipate an overhaul of many countries’ climate change action plans which will impact fossil fuel sector returns and investment stewardship strategies, while generating a new wave of clean energy investment opportunities, and sustainability bonds, as governments move towards accelerated targets,” said Viola Lutz, Head of Climate Solutions at ISS ESG.

The UN’s Intergovernmental Panel on Climate Change is due to release its adaption report in October.

The ISS ESG report also says investors are largely ignoring opportunities to invest in carbon removal technologies, which it says require rapid development to sequestrate greenhouse gas (GHG) emissions at the rate required to achieve net-zero 2050 targets.

Natural and technology-based removals are not of sufficient scale to remove 10 gigatons of GHG emissions annually, the estimated rate required to achieve net-zero targets. ISS ESG says investment in necessary technologies have been “largely overlooked”, beyond a small number of high profile projects, such as Microsoft’s pledge to remove all emissions caused by the company since its foundation.

The report says investors are beginning to invest more heavily in carbon removal, citing insurance group Aviva’s announcement in March of a £100 million investment in nature-based solutions by 2030 to remove residual emissions, as part of its net-zero 2040 strategy.

“Carbon removal can’t rely just on planting trees ‐ it requires contributions from emerging solutions such as oceanic and technology‐based removals. We need every means available to achieve Zero,” the report said.

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