- Under a “Hothouse World” scenario, almost 30% of firms in the MSCI ACWI Investable Market Index may face significant heat risk and could lose USD 4 trillion in economic value, based on our model (data as of Sept. 12, 2022).
- The model showed consumer staples, utilities and energy among the most vulnerable sectors. On average, these companies could see around a quarter of their market value erased, with some potentially even going bust.
- Limiting global warming to 1.5°C, as defined by the Paris Agreement, could see these losses in market value reduced by two-thirds, on average.
Climate change is not a new phenomenon, but it is increasingly finding its way on to investors’ agendas, especially given the increased regulatory and reporting requirements. Climate-related extreme weather events have already had a material effect on companies,1 and investors are actively taking steps to understand the risks that companies may face in a hotter world. To help, we have calculated the financial impacts of physical climate risks under two diverging socio-economic scenarios: “Hothouse World”2 and “Paris-aligned Net Zero.”3
Turn up the heat, turn up the risks
Under a Hothouse World scenario, the world follows a pathway of rapid growth driven by a fossil-fuel-based, energy-intensive economy with no additional climate policies in place. By 2100, this leads to warming of around 5°C above pre-industrial levels. In contrast, the Paris-aligned Net Zero scenario assumes ambitious increases in the stringency of climate policies to reach net zero greenhouse gas emissions by 2050 and limit global warming to below 2°C.
The scenario that plays out will impact, in part, the frequency and intensity of extreme weather events. If temperatures do rise above 5°C from pre-industrial levels, MSCI’s physical climate risk model projects companies in some sectors will have to choose between two costly options, moving assets to other locations or shutting down their operations completely.
Consider, for example, the impact extreme heat events could have on a company wholly reliant on hydroelectric power. It could lose the entirety of its market value if all its operations were dependent on a river being at a certain water level. This past summer, we have already seen factories in the Chinese provinces of Sichuan and Chongqing being forced to temporarily shut down when hydropower supplies fell well below normal levels.4
As the exhibit below demonstrates, more than a quarter of companies in the MSCI ACWI Investable Market Index (IMI)5 could face significant heat risks in a Hothouse World, corresponding to a physical climate value-at-risk (Climate VaR)6 of -5% or lower (lower values refer to higher risks). When considering the combined effect of all weather extremes (listed on the y-axis below), this number increases to 43% of index constituents (around 2,900 companies).
Projected financial risks for companies caused by different weather extremes
Breakdown of physical climate change impacts for different types of weather extremes. The percentage of companies in the MSCI ACWI IMI Index at different levels of risk is shown. Risk levels are calculated using companies’ climate VaR based on data as of Sept. 12, 2022. Source: MSCI ESG Research.
High risk sectors could also be the key beneficiaries, depending on the scenario
Companies in the Global Industry Classification Standard (GICS®) 7consumer staples, utilities and energy sectors are particularly susceptible to the financial impacts of climate-related weather extremes, according to our model. On average, almost a quarter of their market value is at risk if temperatures reach 5°C above pre-industrial levels. Around 4% of these companies could even face a climate VaR of -100%, implying bankruptcy if the projected physical impacts were priced in.
Sectors most impacted by weather extremes may benefit most if global warming limited to 1.5°C
Impact of the climate scenarios on the market value of companies in the MSCI ACWI IMI Index. The average impact on a company for different GICS sectors is shown. Based on data as of Sept. 12, 2022. Source: MSCI ESG Research.
According to our model, by meeting the targets of net zero by 2050 and limiting global warming to 1.5°C, a large part of the severe risks and associated costs from climate-related weather extremes could be avoided. The benefits of this would be felt most by those companies in the most at-risk sectors, for which the physical climate VaR could be reduced by between 9 and 14 percentage points. The number of companies at risk in these sectors would decrease from 246 (26%) to 70 (7%).
Unabated climate change puts companies at severe risk from extreme weather events
Distribution of climate VaR for companies in the top risk sectors: Consumer staples, utilities and energy. In the 1.5°C Net Zero scenario the distribution is narrower with most companies having a climate VaR between 0 and -5%. In the 5°C Hothouse World scenario the distribution broadens with companies’ climate VaR shifting towards higher risks. Based on data as of Sept. 12, 2022. Source: MSCI ESG Research.
A growing problem, but it can be curbed
The coming decades are likely to see revenue losses and asset damage for companies exposed to physical climate risks.8 A future that relies on fossil fuels could expose almost a quarter of the market value of companies in the MSCI ACWI IMI to severe physical climate impacts. Conversely, reducing greenhouse gas emissions and keeping global warming to 1.5°C, as prescribed by the Paris Agreement and several emerging net zero initiatives in the finance industry,9 could decrease physical climate risks by an average of two-thirds for MSCI ACWI IMI constituents.
1Portala, Juliette, “Large companies’ assets at growing risk of climate impact – S&P Global.” Reuters, Sept. 15, 2022.
2The Hothouse World scenario is based on the SSP5-8.5 scenario provided by the IPCC.
3The Paris-aligned Net Zero scenario is based on the NGFS Below 2° scenario from The Network of Central Banks and Supervisors for Greening the Financial System, scenarios portal.
4Schiefelbein, Mark. “Yangtze shrinks as China's drought disrupts industry.” The Associated Press, Aug. 19, 2022.
5From the 9,248 constituents of the MSCI ACWI IMI index only 6,728 constituents are considered in this analysis where the required financial and asset location information was available at the time of writing.
6The physical climate VaR represents the net present value of the future costs attached to physical risks, expressed as a percentage of a company’s market value. The future costs reflect the additional costs due to climate change that come on top of costs from physical risks that companies are already facing. Transition risks and technology opportunities are not considered in this analysis.
7GICS, the global industry classification standard jointly developed by MSCI and S&P Global Market Intelligence.
8Portala, Juliette, “Large companies’ assets at growing risk of climate impact – S&P Global.” Reuters, Sept. 15, 2022.
9For example: UNFCCC Race to Zero Campaign including UN-convened Net Zero Asset Owner Alliance and Net Zero Asset Managers Initiative; UN-convened Net Zero Insurance Alliance; Glasgow Financial Alliance for Net Zero.
Catastrophic Droughts Put Utilities at Risk
Climate Stress Tests: Upping the Ante for Banks and Insurers
Stress Testing Portfolios for Climate-Change Risk
Introduction to Climate Scenarios (client access only)