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Climate Risks for Asset Managers

March 4, 2022

Climate change impacts are already manifesting in extreme weather events and increasing temperatures. The global response to these impacts is also making itself felt, through the concerted efforts of governments and businesses to transition the world economy to a low-carbon model. Both developments have profound implications for asset managers. Not only do climate-related financial risks threaten asset values and long-standing investment strategies, they have also compelled institutional and retail investors to demand greater transparency from institutions on their climate strategies.

Major asset owners are already reorienting their portfolios to capitalize on emerging climate opportunities and minimize their exposure to climate risks. For example, the UK’s largest private pension fund, the Universities Superannuation Scheme, is planning to move £5bn in equity holdings to track a climate transition benchmark made up of firms that rate highly on their decarbonization targets. In Canada, meanwhile, the managers of the country’s largest retirement fund — the CAD$550.5bn Canada Pension Plan Investment Board (CPP Investments) — announced an increase to its allocation to “green and transition assets” from CAD$67 billion to at least CAD$130 billion by 2030. Both USS and CPP Investments have pledged to align their portfolios with net-zero emissions by 2050.

This highlights the need for asset managers, which serve asset owners, to begin integrating climate-related information into their business strategies and investment activities. This means supporting investment teams in identifying and assessing climate risks and opportunities that are unique to the asset classes, regions, and sectors they operate in. 

The recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) can help asset managers achieve these goals. These are organized around four key pillars: Governance, Strategy, Risk Management, and Metrics and Targets.

1. Governance: starting at the top

To be effective, an asset manager’s climate strategy and risk management practices have to start at the top. The Governance pillar of the TCFD recommendations can help firms ensure their board and management are paying sufficient attention to climate change. Under the Governance pillar, the TCFD recommends that asset managers establish formal oversight functions, appoint senior officers to climate-focused roles, and assign responsibilities for climate change at the board and senior management levels. For asset managers, these recommendations extend across the different investment verticals and investment committees they may contain. 

Manifest Climate has also identified the following key elements for effective climate governance: establishing a clear, company-wide position on climate change, implementing a climate education program for employees, and ensuring climate expertise is fostered in-house that is capable of understanding firm-specific climate risks and opportunities.

2. Strategy: understanding how to navigate climate issues

The Strategy pillar of the TCFD recommendations asks asset managers to identify the actual and potential impacts of climate risks and opportunities to their businesses. With this information, they can establish clear plans in response — changes to their investment strategies, for example, or increased engagement with companies in their portfolios. The Strategy pillar also says that asset managers should use climate scenario analysis to assess their resilience to climate impacts and plan their responses accordingly.

The TCFD recommendations further outline a framework for asset managers to categorize and disclose the various climate impacts they may face across different time horizons, as well as across their relevant investment products and strategies. An ongoing challenge facing asset managers, however, is determining what constitutes a ‘material’ risk to their businesses.

Asset managers’ efforts and methodologies for determining materiality are evolving as more data and information become available. However, the TCFD makes clear that organizations should determine materiality for climate-related issues “consistent with how they determine the materiality of other information included in their annual financial filings.” Put another way, climate risk should not be treated differently from any other financial risk.

3. Risk Management: tackling internal processes

The TCFD’s Risk Management pillar focuses on surfacing information on asset managers’ risk management processes. This includes information on their overall portfolio risk management, as well as the processes at the individual product and investment strategy level.

Furthermore, asset managers are recommended to detail their engagement activities with investee companies to encourage better climate disclosure, which in turn could produce more detailed information on climate risks at the entity level.

Climate leaders in the asset management industry are using specialized climate risk tools and metrics to gauge the threats to their portfolios from transition and physical impacts. They have also implemented strongly pro-climate voting practices at investee’s shareholder meetings.

Building awareness of climate risks, and competence in tackling them, is essential to asset managers’ future success. Such firms need to incorporate climate at every stage of their existing risk management processes to succeed going forward.

4. Metrics and targets: let’s talk numbers

The Metrics and Targets pillar is designed to make asset managers publicly report how they account for, and monitor, their climate risks and opportunities. Again, the TCFD recommendations say that asset managers should describe what metrics they use at the investment product and strategy level — not just at the firm level. They are also encouraged to describe how aligned their products and strategies are with a “well below 2°C scenario.” This requires firms to build out ‘implied temperature ratings’, or similar tools, that can describe the warming trajectory of each product and strategy they market.

The TCFD provides guidance on reporting metrics and establishing targets that asset managers can learn from. However, the framework offers firms broad latitude when it comes to choosing exactly which metrics and/or approaches to use.

Manifest Climate’s SaaS platform

Are you an asset manager wanting to enhance your understanding of climate risks and opportunities? We can help. Manifest Climate is one of North America’s largest climate technology solution providers, with a web-based software platform that offers firms a fast, flexible and affordable way to master climate-related risks and opportunities. We help our clients understand where they stand today on climate, identify best practices to move forward, and develop climate-related expertise.

As climate experts and TCFD leaders, we understand the full scale of the climate challenge to asset managers. Our climate experts have been joining the dots between climate science, law, accounting, finance, and real-world corporate decision-making for over a decade. Wherever you are on your climate journey and whatever you want to achieve, we can help.

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