Why banks and investors find heat risks easy to ignore

Reuters

7 days ago

LONDON, July 16 (Reuters) - Heatwaves, which climate change has long made more frequent and taxing in tropical and desert regions, are now becoming more common in Europe. This summer's heatwave killed 2,300 people across Europe in the days leading up to July 2.
Scientists confirm that global warming is making heatwave events more intense, more frequent and more widespread. Businesses from bakeries to museums have seen impacts from lower spending to forced closure, leaving profits wilting in the sun.
Increasingly, economists link extreme heat to economic losses visible in everything from falling agricultural yields to lower worker productivity and in some cases a shuttering of all business activity.
European Central Bank research says heatwaves can substantially reduce productivity, opens new tab, increase food prices and lower economic growth. Allianz, the German fund manager and insurer, said this month that this year's heatwaves may have knocked half a percentage point off European GDP.
But it is difficult to translate these economic impacts into financial losses. In many cases, fund managers and banks say they are unable to really assess how physical shocks like heatwaves and droughts transmit to asset prices.
Hedge fund giant Man Group gave it a stab and found U.S.-listed firms with facilities concentrated in heat-sensitive regions showed higher volatility during anomalously warm summers. But markets were not pricing in, opens new tab this risk, Man Group researchers said.
"Very few asset managers are very actively looking at what can be done in portfolios to position them for resistance or resilience to more frequent catastrophes," Allianz Group's chief investment officer Ludovic Subran told me.
I put the predicament to Miles Parker, a senior lead economist at the European Central Bank who recently published a blog post on heatwaves, opens new tab. Parker has spent 17 years researching links between climate, the economy and financial performance, though he's not a banking supervisor.
One issue for banks, Parker said, is that the damage caused by heatwaves is not as easy to quantify or assess as that caused by storms or floods, where bridges or houses may be physically destroyed.
"In terms of bank exposure, the loan loss there is obvious," he said. "When it comes to droughts and heatwaves, you don't have this direct physical damage, but there's still economic damage."
Heatwaves reduce regional economic activity, lower incomes, and raise the risk of higher unemployment and more defaults from companies and households.
"Even though it's not physical damage in these events, there is still risk to a bank loan book, and these indirect impacts can be quite big," he said.
Another challenge for banks is how to quantify the prolonged and often indirect impact of the heatwave. ECB research from November showed regional activity can be 1.5% lower two years after a heatwave, opens new tab. While a business that has borrowed from a bank may not be directly exposed to physical risk, its supply chains and the local economy it operates in may be.
"These indirect impacts can matter," he said. "So I think it's important for an institution to take into account this indirect general equilibrium risk."
On the whole, investors like insurance and pension managers are the ones paying more attention to heat risk because they have to think longer-term.
Subran tells me Allianz is actively working with asset managers to try to pick stocks or bonds with a higher tolerance for heatwaves, though the effort is complicated by a lack of data and clear adaptation.
"When you are an insurer, you have to [look at this], that's your mission. That's your purpose," he said. "When you are an asset manager, you have fewer tools. When you're a hedge fund, you don't care."
(The opinions expressed here are those of the author, a columnist for Reuters.)