The urgent need for adaptation
While much of the climate narrative focuses on achieving ‘net zero’ in the decades ahead, it is becoming increasingly apparent just how dramatically our climate is already changing.
The last year has once again delivered record climate events with devastating impacts, including deadly heatwaves across Southern Asia, severe flooding in Pakistan, South Africa and Brazil, drought across China and south-western states in the US, and the collapse of an ice shelf in Antarctica, to name a few. In 2021, losses from climate-related events were estimated by Munich Re to be the second highest in history, with 2022 continuing the trend of high losses due to natural disasters1 — all presenting clear risks to society, businesses and the economy. Adapting to these physical impacts of climate change is therefore absolutely critical.
A year on from COP26 and freshly out of COP27, Climate Action Tracker shows that country pledges will still fail to limit warming to below 2°C, let alone the 1.5°C target. Even the most optimistic climate scenarios result in an increase in warming – and therefore a continued rise in the frequency and severity of extreme weather events and a worsening of chronic changes. This means it’s too late to focus on climate-change mitigation (i.e., decarbonization) alone. We need to ensure that our communities, businesses and economies are resilient to its impacts.
The widening adaptation gap
The 2022 Adaptation Gap Report identifies that, while adaptation finance is rising as a proportion of total climate financing (34% in 2020, compared to 14% in 2019), combined mitigation and adaptation flows have actually fallen over the last reporting period. The UNEP report estimates that the annual adaptation costs in developing countries alone will be $160-340 billion by 2030 and will nearly double again by 2050. By this assessment, adaptation finance needs are currently between 5 to 10 times higher than adaptation finance flows and growing. We highlight this adaptation gap as one of four critical interconnected gaps that need to be addressed.
In addition, it was agreed at COP15 in 2009 that developed nations would provide climate finance to developing nations of $100 billion a year by 2020 for mitigation and adaptation. That promise was broken, and much of the financing that has been provided is in the form of loans, not grants. But even if this figure had been met and entirely allocated to adaptation, it would still fall far short of what’s required. Indeed, in November 2022, delegates at COP27 emphasized that climate finance needs to increase from billions to trillions of dollars.
There was an encouragingly strong emphasis on adaptation at COP27, however, with the launch of the Sharm-el-Sheikh Adaptation Agenda that details clear outcomes to enhance resilience in the most vulnerable regions by 2030. Still, there needs to be a more integrated approach to mainstream adaptation finance, as current approaches tend to be piecemeal, localized and responsive to current impacts. Lessons learned from the pandemic must be applied to ensure coordinated global, national and local response to improve resilience and adaptation financing. There was wide acknowledgement at COP27 that the global financial system needs to more effectively mobilize private capital into adaptation solutions.
The Global Commission on Adaptation has identified $1.8 trillion in adaptation investments that could deliver net benefits of $7.1 trillion by 2030. However, despite this growing evidence of the benefits, less than 2% of adaptation finance currently comes from private sources.
There are a number of reasons why private investment in adaptation has been limited to date:
- The lack of adequate, disclosed climate-related risk data to inform investment planning;
- A need for clearer national-level action that ensures adaptation needs and goals are clearly identified and financial incentives for private participation are strengthened;
- The often-limited clarity on financial returns which may be indirect, and a generally stronger focus on social benefits rather than investor return.
It’s clear that public finance alone will not close this widening gap. So existing barriers to mobilizing private finance must be addressed to grow opportunities for private investors.It is time for investors to wake up to the reality of climate change and invest not just in mitigating its causes but also in adapting to its consequences.
The importance of investing in adaptation
Physical impacts of climate change affect every sector and region on the planet. Some are more severely impacted than others, however, and we highlight three particular sectors:
- Real assets. Changes to the climate require the adaptation of many areas of the economy. Infrastructure and property are particularly vulnerable as they face storm and flood damage, rising insurance costs, greater energy costs, and the potential need for backup generators and emergency systems. The way we build must change so real assets can withstand severe rain, storms, and higher temperatures. In addition, cooling systems need to be compatible with a low-emissions future.
- Utilities. A world of increasing climate extremes will require different infrastructure, such as much better drainage systems and ‘sponge city’ capabilities that allow densely developed areas to cope with flash floods from severe rainfalls. Electrical grids will need to be ‘hardened’ to cope with extreme weather and temperatures. Trials with durable electric microgrids in Texas showed they could keep both current and revenue flowing during widescale outages. Utility companies in the US, such as Consolidated Edison, are spending over $1 billion a year to improve resilience. Utility companies that are not building in resilience will be increasingly out of step as the world seeks to decarbonize.
- Agriculture. Agriculture must also change so that planting and harvesting seasons won’t be so affected by less predictable, and more extreme, weather. Restoring degraded pastures, maintaining and planting forests, and many other adaptations will help to both capture carbon and protect against the effects of extreme weather. Emerging market regions are particularly vulnerable to damage from climate change. Acting and investing now in the necessary adaptations will not only lead to lower costs than attempting to repair after further damage, but will help to stem the growing threat to global food security.
Without adaptation, businesses face physical damage and power outages. Extreme weather may also interfere with renewables providing a reliable energy source. It’s likely there will also be more supply-chain disruptions, insurance losses, commodity shortages and inflation. This presents a clear financial case for incorporating climate adaptation into investment decisions to build resilience.
Investment opportunities for adaptation and resilience
1. Understanding and incorporating the physical risks of climate change into decision-making
Financial institutions need to understand how the assets they invest in assess and manage the physical risks of climate change in line with the recommendations of the TCFD, and then integrate this into asset valuations. The Coalition for Climate Resilient Investment (CCRI) is a private sector-led initiative launched in 2019 which seeks to ensure that physical climate risks are systematically integrated into all investment decisions by 2025. The goal is to improve the pricing-in of climate change in order to de-risk the investment for financial partners, provide investor confidence, and help mobilize capital towards climate resilient investment. A key output of the initiative is the PCRAM framework, which provides a methodology for pricing physical climate risks into infrastructure investments.
Incorporating an assessment of acute and chronic physical risks is a core part of our due diligence process for new infrastructure investments, but this can differ considerably depending on the type of asset and its location.
2. Investing in adaptation solutions
There are vast opportunities for investors to become involved in helping countries and businesses strengthen resilience against climate extremes. This includes utility companies creating more weather-resistant grids, homebuilders specializing in heat- and flood-resistant designs, and governments advancing innovative resilience projects. These opportunities will only expand in the years ahead. Research by Munich Re has shown that linking adaptation and insurance – through, for example, restoring coral reefs that reduce storm damage, or by planting to alleviate flooding – could lead to reduced premiums and a six-fold return on investment.
Adaptation investments should be a growing and important part of the investment universe for climate-focused strategies. By including these opportunities alongside mitigation ideas, thematic investors can diversify their exposures while contributing to a critically underfunded part of the solution to climate change.
In fixed income, we believe it’s important to determine an understanding of the link between a bond issuer and its impact on adaptation. The table below highlights three examples of bond issuers and their approaches to adaptation.
1 Discussion of individual securities in this article is for informational purposes only and not meant as a buy or sell recommendation nor as an indication of any holdings in our products.
It’s time for investors to wake up to the reality of climate change today and invest not just in mitigating its causes, but also in adapting to its consequences. The need for adaptation solutions will only expand in the years ahead as temperatures continue to rise.
IMPORTANT INFORMATION
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Discussion of individual securities above is for informational purposes only and not meant as a buy or sell recommendation nor as an indication of any holdings in our products. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of any mentioned securities.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
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