ESG offers opportunities and risks

Sustainability risks include all risks arising from environmental, social or governance (ESG) factors. These include climate risks, both physical risks and transition risks. Transition risk concerns the financial risks that are the direct consequence of the transition to a low-carbon, sustainable or 'green' economy. Companies that do not fall into step can be affected by, for example, new legislation and regulations coming into force. They may even have to cease certain activities, with or without compensation from the government.

Then there is physical climate risk: the risk that activities and assets are compromised by extreme weather, such as heat and flooding. Globally, in 2020 natural disasters caused USD 190 billion in damage, of which USD 81 billion was insured¹. Climate-related damage is one of the biggest cost items for non-life insurers.

Working on transition risks can eventually reduce the physical climate risks. By cutting carbon emissions, for example, companies also reduce potential physical risks and thus also financial risks in the long run.

Identifying physical climate risks is still a difficult task because little is known about extreme weather and the regions it may affect. In addition, few companies report on this risk and the location of company assets and operations is not always known.

At this point, physical sustainability risks can be estimated for approximately 50% of investments. We expect more data to become available soon when the European Commission's Sustainable Finance Regulation comes into force. Companies will then have to report on sustainability risks.

A good example of a sustainability risk is the pricing of carbon emissions. At the moment, energy companies and heavy industry in the EU must buy rights to emit CO₂. The European Commission plans to introduce this for several more sectors, including transport, and also to gradually issue fewer emission allowances. Such systems already exist in Canada and China and certain parts of the United States.

In Europe, the carbon price rose from EUR 38 to 80 per tonne of CO₂ in 2021, with some analysts expecting it to go as high as EUR 108 by 2030. For companies, this makes it attractive to drastically reduce their carbon emissions. After all, lower emissions lead to lower costs for companies, higher margins and a possible competitive advantage.

It should be clear that, with a view to ESG risk, it makes sense to invest in leaders in the field of sustainability. These companies have often been in the process of becoming more sustainable for some time, which logically means they are less affected by changing regulations, for example. For our sustainable investment products and services, we apply the so-called ‘best-in-class’ approach.

For our other investment products and services, we engage in discussions with company managements on sustainability risks, often together with institutional investors, in order to better assess and encourage companies to operate in a more sustainable way.

With socially responsible investment (SRI), the knife cuts both ways: contributing to a sustainable world leads to greater protection against sustainability risks. This improves the stability of the portfolio as well as its potential returns.

_{1 Source: Swiss Re (2021), AFM report on the impact of climate change on non-life insurance.}