The Inter-American Development Bank (IDB) is warning about exposure to "stranded asset risk" and how Latin America and the Caribbean (LAC) are responding to it. Its message comes as The Bahamas' exploration of its natural and mineral resources expands, highlighted by national debate about aragonite, as well as the Bahamas Petroleum Company's mandate to spud an exploratory well in 2017.
It's a different kind of risk assessment, centered on environment-related risks, such as changing resource landscapes, new government regulations, evolving social norms and consumer behavior, and litigation. The declining cost of energy from renewable sources is among the changes in the real economies of many countries that are driving the increasing discussion of stranded assets.
The term "stranded asset" refers to an asset that is worth less on the market than it is on a balance sheet due to the fact that it has become obsolete in advance of complete depreciation.
According to a report written by a team from the University of Oxford led by Ben Caldecott and published by the IDB, entitled "Stranded Assets: a Climate Risk Challenge", both asset owners and asset managers are coming under increasing pressure to measure and disclose their exposure to stranded asset risk. It appears that investors have begun to explore this exposure in-depth and are taking steps to reduce their exposure.
Caldecott and his fellow authors did a survey as part of the report; that survey found that for asset managers, there is growing pressure to offer low-carbon products, including divestment and carbon footprinting tools. As a result, many fund managers are now offering equity strategies with a low-carbon tilt. However, interviewees noted that few tools were readily available to reduce stranding risk for other asset classes. This absence of tools is a major theme in the survey results.
The survey also highlighted the absence of climate risk management strategies. It showed that 73 percent of participants did not have or did not know someone in their investment/financial organization responsible for ensuring that relevant climate risks had been considered. And the survey found that only 20 percent of respondents believe there is adequate information to properly analyze corporate exposure to climate change.
The authors write, "Many financial institutions in LAC are mainly concerned with the economic growth and governance of the companies in which they are invested, and less so about environmental issues. Indigenous communities' rights and threats to a company's social license to operate are on the radar of financial institutions, and are currently considered more salient than issues such as stranded assets. Pension funds across the region tend to be more receptive to the impact of climate change and stranded assets on their portfolios given their long-term mandates. The consideration of environmental issues has gained more traction with financial industry associations across the region."
Interestingly, the report adds that the size of financial markets and the ownership of pension funds in LAC are important in determining the adoption of responsible investment principles across the investment value chain. Pension funds in LAC - notably moreso in Latin America - tend to be owned by international financial institutions, which have yet to deploy their responsible investment experience in the region, even though on the global investment landscape, they are considered leaders in responsible investment integration in decision-making.
Caldecott et al conclude that stranded assets resulting from environment-related risk factors, including the effects of physical climate change and societal and regulatory responses to climate change, have become increasingly prominent.
"This has been driven in large part by changes in the real economy - the falling cost of renewables, for example - as well as by the attention generated by the Paris Agreement. There are growing calls for a new generation of data, analytical methods and tools to help financial institutions differentiate between assets and companies that are more or less exposed to environment-related risks. Developing this next generation of analytics is critically important if financial institutions are to take account of environment-related risks that can strand assets through their decision-making.
"Stranded assets could be a systemic risk to financial stability and should therefore be a topic of concern for central banks and financial regulators," the authors said.
"Greater attention to framing and diffusing risks and opportunities, and to providing diverse but practical management tools, is needed to support the uptake of responses to stranded assets. This is particularly the case in LAC, where other factors such as governance and development issues vie for primacy among investment priorities, and where there are more limited opportunities for sustainable options in the smaller financial markets," the report said.
K. Quincy Parker, Guardian Business Editor
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