BlackRock analysis helps define climate-change risk

By Siobhan Riding, Financial Times | avril 03, 2019
climate change risk

Investors underestimate the risks that extreme weather poses to their portfolios, according to landmark research by BlackRock that could drastically alter how the investment industry considers climate change in its risk management processes.

BlackRock’s study looked at three US asset classes — municipal bonds, commercial real estate and US utility stocks — and said climate change was already having a tangible effect on securities. It warned that the trend would only accelerate.

The study, published Thursday, said investors in the $3.8tn municipal bond market could experience losses as vulnerable cities saw their economies suffer, with gross domestic product dipping by more than 1 per cent.

BlackRock also expected securities backed by commercial real estate mortgages to face an average loss rate of up to 3.8 per cent as properties faced cash flow shortages after severe storms and floods.

The greater incidence of hurricanes and wildfires over the past 12 months has highlighted the effect of global warming. Investors, however, have been slow to take note of how climate risks could affect their portfolios.

Asset owners and asset managers have instead focused on how the shift to a lower-carbon economy will affect investments.

“Investors who are not thinking about climate-related risks, or who view them as issues far off in the future, may need to recalibrate their expectations,” BlackRock said.

The world’s largest asset manager noted that some investors regarded change such as rising sea levels as being outside their traditional outlook. As a result they had discounted risks “already lurking” in their portfolios.


The map shows the projected GDP impact in 2060-2080 on U.S. metropolitan areas under a “no climate action” scenario. Climate changes are measured relative to a 1980 baseline. The analysis includes the effect of changes in crime and mortality rates, labor productivity, heating and cooling demand, agricultural productivity for bulk commodity crops, and expected annual losses from coastal storms. It accounts for correlations across these variables and through time — and excludes a number of difficult to measure variables such as migration and inland flooding.

Brian Deese, head of sustainable investing at BlackRock and a former adviser on climate and energy policy to US president Barack Obama, said the lack of robust data had meant the extent of the underpricing of these risks had not been clear until now.

“Physical climate risks have been perennially hard to measure,” said Mr Deese. Part of the fault for this lies in outdated climate-science models, which do not take into account the “recent acceleration in the frequency and severity of extreme weather events”.

Another complication in measuring climate risk is the need for detail relating to the location of assets. For example, to measure a utility company’s exposure, investors have to know the location of its plants, property and equipment.

“Investor reaction ahead of forecasted hurricanes is muted because the exact location of landfall — and the power plants that will be affected — are not known with certainty,” said BlackRock.

Mr Deese described the analysis as a “breakthrough” due to the way it combined detailed asset-level information with updated climate models and big data.

BlackRock, which had research group Rhodium as its partner in the study, said it planned to build the data into investment and risk management processes used by its portfolio managers.

“The research demonstrates that if you are looking at these asset classes and you are not asking questions about how climate-related risks are affecting your investments, you are missing risks that are in the market today,” said Mr Deese.

Joanne Etherton from environmental law firm ClientEarth, said that BlackRock’s acknowledgment of the scale of climate-related financial risks was “a thunderbolt for investors”.

“The world’s largest asset manager has now accepted that markets are consistently underpricing physical climate risks — that means all investors should be taking a careful look at the models they are currently using and recalibrating their expected returns.”

BlackRock found that all major US metropolitan areas were already suffering mild to moderate losses in GDP as a result of cumulative change to the climate since 1980. Miami topped the list with estimated losses of more than 1 per cent. The city’s economic losses were predicted to rise to 4.5 per cent of GDP by the end of the century, mainly driven by hurricanes and rising seas.

BlackRock estimated that 58 per cent of metropolitan areas faced climate-related GDP hits of 1 per cent or more by 2060-80 unless decisive action was taken.

This situation has implications for municipal bonds underwritten by these cities. BlackRock said communities vulnerable to economic loss would account for 15 per cent of the market value of the S&P National Municipal Bond Index within the next decade.

It said that to avoid incurring losses on municipal bonds, investors needed to assess issuers’ resolve and financial ability to fund projects to mitigate climate risk.

Muni market share

The chart shows the estimated market value share of the muni market exposed to GDP losses of various magnitude through 2100 under a “no climate action” scenario. For example, roughly 20% of the market value of the current muni index is expected to come from regions suffering annualized average losses of up to 3% or more of GDP from climate change by 2060–2080. We use the upper bound of the 66%, or “likely,” range of losses to illustrate a plausible risk scenario.

Climate change is already taking a toll on US utility stocks. Hurricanes come top of BlackRock’s relative impact ranking due to the threat they pose to power and water supply.

The company applied climate scores to utility groups alongside their 10-year average price-to-earnings ratio. It found that the most climate-resilient utilities were already trading at a premium. It expected this premium to increase as the risk became clearer.

Such a scenario suggests that investors that give more weight to companies with low climate-risk exposure and less weight to those with high exposure will do well over time.

BlackRock also sounded the alarm on the effect that climate risk would have on commercial property underlying mortgage-backed securities.

The company combined climate science models with data for 60,000 such properties in the US and found that the median risk of a property tied to such loans being hit by the most severe level of hurricane had risen by 137 per cent since 1980. Both category 4 and 5 hurricanes on the Saffir-Simpson scale will cause “catastrophic damage”.

Moreover, the risk of a property being hit by a category 5 hurricane was expected to rise 275 per cent if no climate action was taken.

A separate analysis of hurricanes affecting Houston and Miami found that about 80 per cent of commercial properties tied to these loans fell outside flood zones, meaning their insurance cover could be inadequate.

All this could affect property cash flows and commercial loan defaults. BlackRock said the average expected loss rate on commercial mortgage-backed securities would rise to 3.8 per cent.

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