Climate risk disclosure and climate risk management in UK asset managers

Abstract

Purpose

Framed within global policy debates over the need for private financial flows to align with the capital requirements of the Paris Agreement, this paper examines UK asset managers in their approaches to disclosing and managing climate risk. This paper identifies and evaluates climate risk management practices among this under-researched investor group in their capacity to address fundamental behavioural obstacles to low-carbon investment.

Design/methodology/approach

This paper takes an inductive approach to document analysis, applying content and thematic analysis to the annual disclosures of the 28 largest UK asset managers (by assets under management), including the investment management arms of insurance and pension companies.

Findings

The main takeaway from this research is that today’s climate risk management strategies hold potential to effectively address traditionally climate risk-averse investor behaviour and investment processes in the UK asset management context. However, this research finds that the use of environmental, social and governance (ESG) investment strategies to mitigate climate risks is a “grey area” in which climate risk management practices are undefined within broad sustainability and responsible investment agendas. In doing so, this paper invites further research into the extent to which climate risks are considered in ESG investment.

Originality/value

This paper contributes to research in sustainable finance and behavioural finance, by identifying the latest climate risk management techniques used among UK-headquartered asset managers and uniquely evaluating these in their capacity to address barriers to low-carbon investment arising from organisational behaviours and processes.

Citation

Greenwood, N. and Warren, P. (2022), "Climate risk disclosure and climate risk management in UK asset managers", International Journal of Climate Change Strategies and Management, Vol. 14 No. 3, pp. 272-292. https://doi.org/10.1108/IJCCSM-09-2020-0104

1. Introduction

The alignment of financial flows with emissions reductions and climate-resilient development is required by Article 2.1c of the Paris Agreement. To limit global warming to 1.5°C, the Intergovernmental Panel on Climate Change (IPCC) (2019) estimates annual investments of around US$$2.4tn are needed to up to 2035, roughly equal to 2.4% of GDP. The Panel also estimates that current levels of investment into low-carbon energy technologies and energy efficiency must increase roughly sixfold for a 1.5°C climate (IPCC, 2019: 16). Crucially, consistency with mean temperatures below 2°C (with 66% probability) requires financial flows towards energy sector innovation to facilitate an energy system predominantly dependent on renewables [Organisation for Economic Cooperation and Development (OECD) 2017].

Yet, financial flows appear unaligned with decarbonisation targets as less than 1% of global institutional investors’ holdings are in low-carbon infrastructure assets (G20 Green Finance Study Group, 2016). Unaware or ignorant of the financial materiality of climate risks, investors are widely understood to continue relying on a risk pricing framework, which subsidises carbon intensive assets and activities (Krogstrup and Oman, 2019). Transforming the structures and behaviours underlying the financial system to enable Paris-aligned capital allocation evidently presents an unprecedented challenge.

Determined to “green” the financial sector, UK and EU policymakers are subsequently “reengineering” the financial system to divert private flows of capital from high carbon to low carbon assets (EU High-Level Expert Group on Sustainable Finance (EU HLEG), 2019; Department of Business, Energy and Industrial Strategy, 2019). The intended results are ambitious and far-reaching: achieving a sustainable financial system by renewing its institutional purpose to become a sponsor of the low carbon transition and, secondly, to transform the nature in which value is assigned to assets (EU HLEG, 2019). Spearheading this process is transparency through climate-related financial disclosure meaning investors must “measure, disclose, manage, and mitigate climate risks” (Climate Policy Initiative, 2019:7). To oversee this, the Financial Stability Board launched in 2017 the Taskforce for Climate-Related Financial Disclosures (TCFD) to encourage “informed, efficient capital allocation decisions” among investors by “develop[ing] more effective climate-related financial disclosures through their existing reporting processes” (TCFD, 2019: ii).

The practice of climate disclosure is increasingly widespread: the TCFD is endorsed globally by over 1069 financial companies responsible for assets of nearly $194 trillion (TCFD, 2021); the UK government plans to mandate TCFD-aligned disclosures from institutional investors in 2022 (BEIS, 2019), while France’s Energy Transition Act of 2015 already mandated environmental, social and governance (ESG) disclosures from asset managers and institutional investors (i.e. investment banks, pension funds, hedge funds, insurance companies and some private equity investors). Climate disclosure as a voluntary regulatory tool (except in France’s case) thus gains increasing legitimacy. Implicit, therefore, is the growing assumption that the practice will facilitate more efficient, low capital allocation through robust climate risk management following companies’ assessments of climate-related risks and their financial materiality (Ameli et al., 2019).

The study of climate-focused investment falls under the concept and practice of “green finance”. As Warren (2019) clarifies, “green finance” encompasses all forms of “green”-related investment and finance flows, including both climate finance and investment for climate mitigation and adaptation, and environmental finance for more local environmental and biodiversity management, as sub-components under this umbrella. More relevant, however, is “climate finance” which describes financial flows towards climate change mitigation and adaptation usually leveraged by state actors with higher risk appetites than private investors (Warren, 2019; Mazzucato and Semieniuk, 2018). However, in practitioner (“grey”) literature, the inclusion of climate risks into investment is widely considered as a practice within “sustainable finance” frameworks, such as the EU Action Plan on Sustainable Finance (EU HLEG, 2019). While sustainable finance broadly entails the incorporation ESG risks into investment decisions, recent calls by international stakeholders for greater alignment of the concept with decarbonisation exhibit the need for a clearer definition of climate risk within ESG approaches (The Investor Agenda, 2018).

Examining measures to unlock private finance towards Paris Agreement objectives therefore requires a sharpened focus on climate risks and opportunities. Will the practice of climate disclosure as a tool within “sustainable finance”, critics ask, facilitate necessary recognition of the financial materiality of climate risks to reliably induce the management of those risks? Indeed, UK policymakers acknowledge that “disclosure is only useful if it guides decision-making” in organisations (BEIS, 2019, p. 24). Accordingly, this research questions whether and how climate-related financial disclosure fulfils its fundamental purpose of enabling the management of climate risks within the financial organisation. It argues that although deep-rooted investment behaviours which fuel carbon-intensive investment concern the climate risk judgements of individuals, the effectiveness of climate disclosure (and management) practices should be evaluated at the organisational-level at which decision-making frameworks which dictate risk judgements and are crystallised. The main takeaway from the research is that today’s climate risk management strategies hold potential to effectively address traditionally climate risk-averse investor behaviour and investment processes in the UK asset management context, but that the use of ESG investment strategies to mitigate climate risks is a “grey area” in which climate risk management practices are undefined within broad sustainability and responsible investment agendas.

The paper is structured as follows: Section 2 outlines and evaluates the theoretical context and previous literature framing the study, presenting research gaps which contribute to the core research question. The research design is discussed in Section 3 where the overarching philosophy, method and data analysis techniques are justified. Section 4 culminates the study’s findings before outlining conclusions and suggestions for further research in Section 5.

2. Literature review

2.1 Investor behaviour and climate risk mispricing in the financial sector

The growth in research into climate risks faced by the financial sector has mirrored the rising agenda of sustainable finance. This work has distilled climate-related risks largely into three main categories. The Prudential Regulation Authority (PRA) defines physical risks as originating from weather-related events such as floods and storms and their direct impacts such as property damage, supply chain disruption and resource scarcity (PRA, 2015). Transition risks are financial risks associated with the subsequent societal response to climate change, such as policies to facilitate a low-carbon economy. Such a transition “brings both value creation and destruction that can potentially impact the financial viability of assets on corporate and government balance sheets, a situation that can in turn impact the credit-worthiness and valuation of financial assets” (Thöma and Chenet 2017, p. 82). Insurance companies are particularly exposed to liability risks whereby losses suffered from climate change effects cause actors to recover losses from responsible parties, who may transfer the cost to insurance firms under third-party liability contracts (PRA, 2015). These climate-related risks, as Weitzman. (2011) warns, are defined by “deep uncertainty” linked to the potential for catastrophic outcomes “outside the range of [current] experience” which are inherently difficult to measure and predict (p. 278).

Alongside pervasive uncertainty, behavioural factors are shown to contribute to climate risk mispricing within finance, leading to overinvestment into carbon intensive assets and activities (Krogstrup and Oman, 2019). The behavioural finance literature has theorised mispricing behaviours by financial actors: grounded in behavioural economics, its principle of “bounded rationality” departs from Fama’s (1970) neo-classical ideal of “perfect information” in “efficient” markets. Instead, it describes financial actors’ decisions in the face of complex problems as products of limited knowledge (Simon, 1967; Shiller, 2003). This notion has been applied within environmental and energy economics to explain suboptimal investment into renewable energy and other climate change objectives.

Arguing against the efficient markets hypothesis to explain low-carbon investment deficits, Thöma and Chenet (2017) showed that agents reduce complexity by omitting or underweighting large, long-term and potentially “fat-tailed” climate-related risks from financial valuation models, whose contingencies are challenging to quantify (Weitzman, 2011; De Fries et al., 2019). Putting a similar emphasis on financial market actors, Ameli et al. (2019) and Hall et al. (2017) conducted practitioner interviews to determine the barriers to renewable energy finance, finding lack of climate-related knowledge and “short-termism” among the important inhibiting factors. Here, investors are described to ignore long-term value drivers including climate issues in favour of outperforming financial benchmarks to contribute to short-term returns and industry competitiveness. In their aversion to climate risk, investors are subsequently depicted as boundedly rational “satisficers” instead of perfectly informed, rational decision-makers (Hall et al., 2017).

The investment environment has also been alluded to as a determinant of carbon intensive investment. As one interviewee in Ameli et al.’s (2019) study encapsulated, “it may be perfectly economically rational for individual investors to ignore climate risks and continue to invest in carbon-intensive assets, if they judge and perceive that is how the market overall is behaving and will behave in the near future” (p. 575). This demonstrates a self-perpetuating pattern whereby collective short-term rationality (or irrationality) within the existing institutional rationality of carbon-intensive investment strengthens structural constraints to renewable energy investment (Hall et al., 2017). Although this field describes investor behaviour as bound to investment environments, specific insights into investors’ organisational contexts is scarce. Research in this area would enrich academic understanding of the financial organisation’s role in enabling Paris-aligned capital allocation.

2.2 Climate risk management in finance: a rationale

The extent of climate risk mispricing by financial institutions is well-evidenced in the stranded assets literature. Stranded assets are defined as “assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities” (Caldecott et al., 2013, p. 7). This is a far-reaching concept capturing the effect of climate-related factors on value across geographies, sectors and asset classes to communicate the risk of devaluation under stringent climate policy and carbon budgets (Caldecott et al., 2013; Caldecott, 2017). Saygin et al. (2019), for example, estimated the cumulative value stranded assets for existing and pipelined power sector assets across the G20 to be US$1.56tn up to 2030 in a Delayed Policy scenario, or US$792bn in a Renewable Energy Roadmap scenario aligned to compliance with Paris Agreement carbon budgets.

The key principle voiced in this literature is the financial materiality of climate risk, or their capacity to impact the financial value of assets on corporate and government balance sheets (Thöma and Chenet, 2017). Responding to potential value at risk, academic and investor communities are increasingly exploring the financial sector’s exposure to climate-related risks through the assets managed within investors’ portfolios.

Particular academic attention has been paid to institutional investors’ (insurance and pension funds) exposure to climate risk. Battiston et al. (2017) conducted a stress test of the EU financial system, estimating that about 7% of equity portfolios managed in insurance and pension funds are exposed to the fossil fuel industry. Exposure to “climate policy-relevant sectors” collectively, however, including fossil-fuel, utilities, energy-intensive, housing and transport sectors, extended roughly 45% of their equity portfolios. Meanwhile, the UK Prudential Regulatory Authority’s (PRA) (2015) climate risk assessment for the UK insurance sector focused especially on the direct impacts of natural catastrophes, windstorms and flood-related hazards in the UK on insurers’ balance sheets. Their position as financial asset owners at the top of the investment chain may explain disproportionate academic scrutiny of pension funds and insurance companies (Silver, 2017).

The climate risk management approaches of insurers and pension funds have accordingly received substantial academic attention. Thöma et al. (2019) conducted surveys with Swiss insurance and pension funds to determine the effectiveness of climate risk measurement and disclosure on the management of climate risks. Focusing on the “rescaling” of organisational logics in response to climate risk, Thistlethwaite and Wood (2018) analysed responses of US insurance firms to the 2015 National Association of Insurance Commissioners Climate Risk Disclosure Survey to find 39% of firms (n = 71) had incorporated climate risks into at least one of three categories: corporate governance, underwriting and investments. Similarly, Ameli et al. (2019) focused on the issue of integrating climate risks into the organisational investment strategies of insurance and pension funds.

However, recent grey literature points to asset managers (AMs) as an important group of investors to study in their exposures and approaches to climate change. ShareAction (2020) used surveys to comprehensively rank 75 global AMs’ approaches to responsible investment, which were categorised into company voting policies, use and support of TCFD reporting techniques, oversight of responsible investment and ESG investment strategies. Objectivity in this study’s conclusions are compromised, however, as AMs were ranked against ShareAction’s own benchmark. Furthermore, the exact extent to which climate-related risks were considered within respondents’ ESG investment approaches was unclear.

Meanwhile, InfluenceMap (2019) studied the alignment of portfolios belonging to the 15 largest global asset management groups (by assets under management) to Paris Agreement objectives. The study used the 2° Investing Initiative’s Paris Agreement Capital Transition Assessment model which uses asset-level data to calculate Paris alignment of 50,000 portfolios in terms of exposure to the automotive, coal mining, oil and gas and power sectors. It found that collective portfolios in the global asset management industry own 33% more coal producing assets than prescribed by the Paris Agreement, 36% for automobiles, 17% for oil and 16% for power (InfluenceMap, 2019). This demonstrates high exposure to transition risk among this group as a result of significant misalignment to the Paris Agreement. It also potentially points to a preference for investee engagement over divestment as a climate risk management technique by AMs (InfluenceMap, 2019). More broadly, however, both studies highlight the close scrutiny under which AMs are held by stakeholders and therefore a need to expand academic attention elsewhere in the financial system.

In academic literature, Silver (2017) described AMs as companies to whom institutional and private investors delegate management of “some or all” of their funds. As investment management service providers, they are selected according to past-performance, investment style or specialisation in a certain area, must usually perform against set benchmarks, and are reviewed on their quarterly returns (Silver, 2017). Under the issue of climate risk mispricing, Thöma and Chenet (2017) describe AMs as subject to the principal-agent problem where the incentives of the principal (asset owner) are unaligned with the agent (asset manager). They describe the subsequent tendency by “short term asset managers [to] externalise the long-term costs associated with their investments to asset owners” at some potential short-term benefit (p. 90), which may be “rational” within the surrounding institution of short-term remuneration. Despite their significant role and the prevalence of climate risk aversion (and therefore carbon intensive investment) within this group, AMs’ approaches to managing climate-related risks are yet to be academically explored.

2.3 Re-engineering the financial system: encouraging climate risk management

To address deep-rooted investor behaviour and encourage low carbon investment, it is argued that policies must address investor risk perceptions. Polzin et al. (2019) meta-analysis of previous studies evaluating renewable energy policies revealed the importance of policy stringency, predictability and credibility in affecting risk-return profiles of renewable energy investments. Masini and Menichetti (2012) found that a priori beliefs around renewable energy (determined by educational background, previous experience and trust in renewable energy technology) determined portfolio construction more strongly than market beliefs. Similarly, Wüstenhagen and Menichetti (2012) illuminate the importance of cognitive biases which lead to conservatism in adjusting to new information in the “less familiar territory of renewable energies” (p. 5). Though the latter two studies are fairly dated, as renewable energy investment may have become more common since the Paris Agreement in 2015, these findings underline the importance of policies which tackle investors’ decision-making routines and processes around climate risk.

Responding to the financial materiality of climate risks and deep-rooted behaviours underlying carbon intensive investment, the UK Green Finance Strategy affirmed its mandate for institutional investors to disclose climate-related risks in line with the TCFD from 2022 (BEIS, 2019). While voluntary environmental disclosure has been shown to increase the share prices of firms during periods when climate change tops the public agenda (Kim and Lyon, 2011), the intended effect of climate-related financial disclosure as guided by the TCFD on financial performance is more nuanced: through transparent reporting of climate risk, investors are encouraged to identify and manage material climate risks, integrating these into overarching risk management frameworks to protect the company and its assets (TCFD, 2019; Financial Reporting Council, 2019).

As a narrowly researched tool, academic debates over the usefulness of climate disclosure are fragmented, but visibly contested. On one hand, scholars from the evolutionary perspective may see value in its capacity to tackle entrenched climate-risk mismanagement practices and invoke lasting change in the institutional “rationality” of finance (Hall et al., 2019; Chenet and Thöma, 2017). As a voluntary “private environmental governance” tool, adopters of climate disclosure may authoritatively steer themselves and others towards climate goals (Thistlethwaite, 2014). On the other, Cullen (2018) believes that self-governance through reporting and disclosure is insufficient to tackle such pervasive barriers to robust climate risk management. Furthermore, structural barriers in finance limit liquidity (available cash flow) towards renewable energy assets, casting doubt on the validity of disclosure as a market-based tool which assumes a “readily available stream of investment capital” to fund an energy transition (Hall et al., 2017). Following Ameli et al. (2019), the onus placed on climate disclosure to facilitate Paris-aligned investment through robust climate risk management must be interrogated.

In response to the research gaps presented, this study asks: To what extent does the disclosure of climate-related risks strengthen organisational approaches to managing climate risks among UK asset managers? In doing so, it makes several contributions. It firstly answers to the paucity of research into the approaches taken among asset managers to disclose and manage climate-related risks. With the mandate approaching for UK-headquartered institutional investors to disclose climate risks, the study also fills a geographical research gap, exclusively determining techniques within the UK financial sector. Furthermore, it uniquely examines the effectiveness of climate disclosure among AMs in relation to behavioural issues of incorporating climate risk into investment decisions and processes. In response to the research gap into the importance of organisational environments which can dictate investors’ risk judgements, it measures effectiveness at the organisational level. The following chapter will justify the research design elements chosen to answer the research question above.

3. Research design

3.1 Methodology

Deviating from notions of rational utility maximation in neoclassical economics, the argument of behavioural finance is that the actions of investors are driven by a priori beliefs, preferences and individual appetites for risk (Masini and Menichetti, 2012). An interpretivist philosophical approach is taken to understand the uniqueness and complexity of individual reasoning which motivates observable and socially constructed investment practices.

Suited to newly emerging fields, an inductive approach is used to generate, analyse and reflect upon data to build new theory when existing concepts are deemed inappropriate (Saunders et al., 2009). Although theories of sustainable business such as corporate social responsibility (Kletter et al., 2014), “triple bottom line” (Elkington, 1994) and “creating shared value” (Porter and Kramer, 2011) advocate broadened value systems for businesses, their core principle that companies respond ultimately to stakeholder demands are misaligned with companies’ need to mitigate both risks posed by climate change itself (physical risk) and its societal response (transition risk).

To then understand the contextual nature of integrating climate risk into investment decisions, a qualitative case-study approach was chosen to conduct “an empirical investigation of a particular contemporary phenomenon within its real-life context” (Robson, 2002, p. 178). Through “intensity” of study (Ghauri et al., 2020), this approach is suited to detailed study of observed practices within their organisational settings.

3.2 Method

To understand organisational approaches to climate risk this study takes a mono-method approach to document analysis, using a total of 45 annual reports and financial disclosures belonging to 28 AMs as its data source. A previous study by Krüger et al. (2019) successfully compiled climate risk management approaches among AMs, banks, pension funds, insurance companies and mutual funds across the USA, UK, Canada and Germany using surveys. Although comprehensive, the sample of 439 investors built through investor conference attendants, an online survey database, email invitations and personal contacts may have been biased towards investors with awareness or motivation to engage with the ESG research agenda (shown in the 41% of portfolios integrating ESG issues compared to 18% in another study) (Krüger et al., 2019). In contrast, collecting data through publicly available company documents from a quota sample of organisations allowed a realistic view of climate risk perceptions among investors.

As argued by Kletter et al. (2014), applying document analysis to company annual reports is especially useful for studying the implemented structures and processes within organisations which may otherwise be difficult to obtain through interviews where the primary objective is accessing individuals’ perspectives beyond routines and behaviours (Arskey and Knight, 2011). That is, while interviews have effectively been used to study investor attitudes towards renewable energy investment prospects (Ameli et al., 2019; Hall et al., 2017), annual reports reveal reported practices and strategies under both mandatory and voluntary reporting requirements (Hakim, 2000; Stanton and Stanton, 2002).

3.3 Analysis

A large sample of AMs was sought to obtain robust findings of current industry practices. The top 28 UK-headquartered AMs as of 2019 were selected from The Top 400 Global AMs list by IPE Research. (2019). Quota sampling allowed inclusion of UK investors according to their AUM, ensuring a purposeful and representative sample of the most influential organisations to answer the research question.

A pilot study conducted to determine data availability found that companies considering climate risk largely report through within the TCFD framework in annual reports. To maintain consistency and validity, two separately published TCFD reports were also included in the sample while corporate social responsibility, responsible investment ESG reports were excluded. This is because the latter comprised wide-ranging information on corporate sustainability and limited focus on approaches to manage risks arising from climate change, rendering them out of the scope of the research question.

Within the total sample of 45 documents, three types of annual report were identified (Table 1). To collect climate risk management approaches used by AMs, thematic and content analysis using NVivo12 was carried out across the document sample for efficient and transparent analysis (Ghauri et al., 2020). Content analysis allowed objective coding and categorisation of stated practices within a large textual data set (Vaismoradi et al., 2013). This involved “open coding” guided by the data to generate new theory, where units of data (passages of text describing stated company practices) belonging to the same phenomenon were categorised. This generated a raw data set of climate risk disclosure and management techniques which were further organised into broader thematic categories in the next stage.

Thematic analysis was used to identify and analyse themes emerging from coded patterns. After gathering data into representative categories, the coded textual dataset was further categorised according to company characteristics, disclosure techniques and existing themes within the disciplines of behavioural and sustainable finance. Whereas categories are descriptive “surface” points of content, themes express more latent content (Vaismoradi et al., 2013). Consequently, thematic analysis of coded textual data allowed relation to existing theory to enrich findings and expanded the relevance of quantifiable practices to answer the research question (Graneheim and Lundman, 2004).

4. Results and discussion

The following chapter presents and discusses the study’s findings. Section 4.1 introduces three categories of climate risk reporting, pinpointing companies which either acknowledge or overlook the financial materiality of climate-related risks in their reports. Section 4.2 presents and analyses approaches currently taken among AMs to mitigate climate-related risks. Separating climate-specific approaches from ESG investment, Section 4.3 discusses the “grey area” of climate risk management through ESG approaches. Turning to analyse the approaches of companies largely silent on climate risk, Section 4.4 further discusses the absence of climate risk from ESG strategies.

4.1 Categorising climate risk disclosure

The climate disclosure group comprises 15 companies who acknowledge the financial materiality of climate change in their disclosures. Disclosure techniques varied within this group with reporting of climate-related risks among the principal risks facing the company being most common (Figure 1). Risks outlined in this section of annual reports are key thematic issues managed within the overarching risk management framework with the potential to materially affect a company’s business model and financial performance. They contributed to each company’s “viability statement”, a mandatory reporting requirement of the UK Corporate Governance Code, which indicated whether the company’s business model and risk management functions were adequate for its continuing existence (Financial Reporting Council, 2017). As discussed in this chapter, this reporting technique is a key determinant of climate risk mitigation (Figures 2, 3 and 4).

All “affiliated AMs” (AMs in group or parent structures embedded in other industries) perceived climate change as a principal and growing risk facing investors and considered physical and transition risks separately. In-depth consideration of climate risk exposure in this cohort may be attributed to their embeddedness in other industries. Aviva, Legal and General and Prudential reported the importance of assessing physical risk on claims profiles as major insurance companies whose approaches to climate risk are closely regulated (Prudential Regulation Authority, 2015). Similarly, HSBC (banking) reported the monitoring of natural hazard exposures through retail mortgages as a “priority” for the company’s banking function. Affiliated asset managers also formed the majority (4 out of 7) of companies disclosing climate risks within a risk-control framework, which followed a risk-outlook-control structure: each thematic risk area responded to by outlooks on risk probability and corresponding mitigating actions.

In contrast to the climate disclosure group, the 10 companies whose reports revealed no mention of climate-related risks were classed as “zero disclosure”. This may relate to different reporting techniques, outlined in Chapter 3, which did not detail business models and risk management frameworks: Insight Investment, Fidelity International and BlueBay Asset Management published fund summaries, while Northill Capital, Marathon Asset Management and Walter Scott and Partners disclosed minimum requirement reports. These formats differed to the rest of the document sample, whose strategic reports contained more extensive information on climate risk perception and management approaches. Nevertheless, the absence of climate risks from this group’s mandatory risk factor statements led to their categorisation as zero disclosure.

Lastly, the limited disclosure group comprised three companies who did not include climate risks in their risk factor statements or reported limited exposure to climate change. Statements showing an ambiguous stance on the financial materiality of climate change, such as “there is increasing recognition that ESG risks and issues can have a material effect on the value of an issuer’s debt or equity” (Ashmore Group, 2019, p. 45) and “climate change does carry potentially significant implications for the underlying assets in our funds” (MAN Group, 2019, p. 34) also contributed to this category. These sharply contrasted to concrete statements about climate change as major risks to the businesses in the climate disclosure group, leading to their categorisation as limited disclosure companies.

4.2 Organisational approaches to climate risk management

The climate disclosure group were found to mitigate climate risk through both ESG investment approaches and techniques exclusively associated with climate change. Climate risk management approaches were determined by identifying disclosed practices directly related to climate change and synonymous terms such as “climate”, “climate risk”, “climate factors”, “carbon”, “carbon emissions”, “fossil fuels” and “renewable energy”. These were grouped into areas of organisational strategies (Table 2).

The oversight of climate risks was a vital aspect of climate risk management. Eleven companies reported board to executive-level oversight of climate risk. While board-level oversight indicated discussions of climate risks at leadership-level, executive level handling of climate risk saw key roles such as Chief Executive Officer, Chief Investment Officers and Chief Operating Officers implementing climate risk strategies into operational and investment functions. The specific oversight of climate risk management across company risk functions, however, was found in nine companies, all within the climate disclosure group. Risk Committee responsibilities included assisting the Board in risk management oversight, monitoring controls for risk management within operations and reviewing assessments of emerging risk scenarios alongside monitoring and mitigating actions. Accordingly, Risk Committee oversight of climate risk more strongly indicated integration of climate-related risks into risk management functions.

Facilitating internal climate risk training and engagement with policymakers and climate governance initiatives demonstrated efforts to increase internal climate risk capabilities. Common initiatives included the Carbon Disclosure Project, Transition Pathway Initiative and Climate Action 100+. Alongside engagement with policymakers on climate matters, this demonstrated support of industry principles of climate risk management and access to external climate risk expertise (Thistlethwaite, 2014). Facilitating internal climate risk training may address issues of climate information deficits to inform investors’ risk judgements and while building their knowledge and experience of climate investment techniques (Wüstenhagen and Menichetti, 2012; Ameli et al., 2019).

Complementary to capability-building measures, the study found incentives such as decarbonisation targets (reported among five companies) linked to climate objectives to address behaviour at investment-team level. Following Shrivastava and Addas. (2014) would necessitate discussion of climate risks “at the very least”, opening opportunities for implementation of decarbonisation strategies down the line (p. 33). In behavioural terms, they demonstrate forms ‘standards and engagement’ to tackle deep-rooted investment routines by allowing organisational performance reviews against climate-related targets as well as financial benchmarks (Grubb, 2014).

Another incentive-based measure identified was climate-linked remuneration policy. While HSBC was the only company to disclose remuneration policy linked specifically to climate objectives, Investec and LGIM integrated ESG into performance appraisals. This measure answers demands for addressing remuneration structures which currently under-reward Paris-aligned investment, fuelling short-term investment behaviour (Ameli et al., 2019). Overall, both climate-focused incentives and financial rewards evidence efforts to address short-termism and climate risk aversion by stimulating assessments of climate risk factors by employees at the portfolio level.

The analysis found evidence within 6 climate disclosure AMs of climate risk assessment at portfolio level, at which decision-making culminates financial valuations which integrate investors’ risk judgements (Wüstenhagen and Menichetti, 2012). While Investec and Schroders merely stated that climate risks are managed in portfolios, others gave more comprehensive accounts of their strategies. Both Standard Life Aberdeen and Newton Investment Management reported that climate risk analysis informed risk-return profiles of assets, leading to more optimal capital allocation. Newton Investment Management (2019) described their process of portfolio-level climate-risk assessment in the greatest detail: the “investment team will review company reports, third-party data providers and dedicated climate-change research, and may also speak to company management or directors, external analysts, consultants, subject-matter experts or non-governmental organisations to better understand and evaluate potential risks and opportunities” (p. 22). In this case, managing climate risks at portfolio level culminated knowledge-seeking efforts which mirror Newton Investment Management’s (2019) science-based climate risk disclosure: “Science tells us that climate change could result in a deterioration in investment performance in some sectors, either as the world moves to a low-carbon future, or – more concerningly – as the growing physical impacts of global warming negatively affect the economy and society” (p. 3).

Overall, however, establishing investment processes informed by climate risk demonstrated incorporation of climate risk considerations into the investment decision-making process. Although this appears to be non-financial assessment (as it does not equate to re-pricing assets according to climate risks), it demonstrates climate risk information being made relevant to each investment decision (Hall et al., 2017).

Climate-focused active management, whereby asset managers sought to influence investee companies through engagement and voting, was another key aspect of climate-informed investment strategy. The disclosures of eight companies practicing this revealed a key pattern. Although climate-focused active management broadly involves engaging with companies to improve their approaches to climate change, active management of specifically high-emitting investee companies was practiced by all eight active climate investors. Further, seven companies within this subset engaged with investees through Climate Action 100+, an institutional investor initiative encouraging the use of investor voting power to enforce disclosure and management of climate risks within their “focus list” of the highest global emitters. Legal and General Investment Management and Aviva Investors, both affiliated AMs, further reported their use of divestment from companies who fall below minimum thresholds of climate action as a tool to motivate heightened climate risk disclosure and management.

Other climate-focused investment strategies to manage climate risk included exclusionary climate investment. Four AMs reported exclusionary approaches around thermal coal as well as applying carbon-based exclusions within screening processes on certain funds. Exclusionary investment appeared non-standardised within and across companies. Instead, reports belonging to the climate disclosure group only associated exclusionary investment approaches with climate or sustainability-focused funds, such as LGIM’s Future World Fund and Aviva Investors’ European Equity Climate Transition Fund.

In parallel with exclusionary approaches, opportunity-driven climate investment saw capital allocation towards climate change mitigation activities, namely renewable energy infrastructure. While eight companies stated investment accomplishments in terms of investment sums towards low carbon and renewable energy infrastructure, the practice of climate change mitigation investment was distilled further into fund holdings in mitigation activities (11 climate disclosure companies showed this) and climate investment products such as climate impact investment (reported by two companies) and climate-focused funds. Seven climate disclosure companies launched climate-focused funds, whose portfolios were described to comprise climate change mitigation and adaptation.

The analysis found measurement and analysis of climate risk as a key component of climate risk management. Measurement techniques were conceptualised into “exposure analysis” and “climate risk pricing” approaches. Measuring exposure to climate change for assets or liabilities involved assessing the nature of climate-related risks and measuring the probability of financial losses as a result of those risks. This encompassed both backward-looking techniques such as carbon footprinting (calculating the emissions associated with investment activities through carbon intensity analysis) and forward-looking scenario analysis of the energy system to understand transition risks across key sectors. Climate risk pricing, however, furthers exposure analysis to determine the value of financial loss from climate risk materialisation (Thöma and Chenet, 2017). Both methods were undertaken exclusively by climate disclosure companies.

While 10 companies (shown in Figure 5) conducted climate risk exposure analysis, a subset of eight (shown in Figure 6) priced climate risk, with Legal and General using the most techniques overall to analyse and price climate risk exposure. The most common climate exposure analysis technique was indeed carbon footprinting (used in eight companies), while the majority of climate risk pricing was conducted against global warming scenarios. While Legal and General and Aviva integrated transition and physical risks in their modelling of financial impacts, Schroders modelled value at risk from the two types of risk separately.

Climate risk measurement and analysis practices were strongly linked to two disclosure techniques: 12 out of 13 climate disclosure AMs acknowledging climate change as a principal risk and all AMs reporting climate change within risk-control frameworks engaged in both measurement techniques. The emphasis on risk outlook and probability in risk-control frameworks likely explains this as companies must examine the extent of climate risk to report and justify the appropriate mitigating response.

Although climate risk exposure analysis demonstrates a first step towards understanding climate-related implications of investments, AMs conducting climate risk pricing answer directly to the specific issue of climate risk integration in financial valuation processes. By pricing climate risks and incorporating these into asset values, investors can determine the financial impact of climate risks and respond by channelling capital away from carbon intensive assets towards low-carbon technologies and activities (Thöma and Chenet, 2017; Krogstrup and Oman, 2019).

Overall, the presence of both exposure analysis and pricing techniques in among climate disclosure AMs exemplify crystallised organisational processes which enable the incorporation of climate risk analysis into investment decisions. However, climate risk measurement techniques which value climate-related risks in monetary terms must be distinguished from those revealing exposures to these risks.

4.3 Climate-focused environmental, social and governance approaches

Crucially, climate risk management practices are distinguished from broader techniques associated with environmental issues or the environmental component – ‘E’ - of ESG investment. While a portion of climate disclosure companies reported that climate risks were managed through ESG approaches, zero disclosure and limited disclosure companies engaged in ESG investment practices which could not be associated with the specific issue of climate change. Climate-focused ESG investment was therefore differentiated from ESG investment more broadly by identifying statements which directly evidenced this practice, such as “we assess the climate-related risks and opportunities as a core part of our responsible investment approach through Environmental, Social and Governance (ESG) integration” (Standard Life Aberdeen, 2019 b, p. 4) and “[our] climate change strategy is a key component of our wider ESG strategy” (M&G plc, 2019, p. 30). The analysis found that nine climate disclosure companies mitigated climate risks using ESG investment strategies.

Although “ESG integration” - the assessment of ESG risk factors in the investment decision-making process - across all investment products at portfolio level was a commonly recorded practice within this group (reported by six companies), the extent to which climate risks are prioritised relative to social and good governance objectives within these strategies is unclear in reports. Furthermore, evidence of subjective or non-standardised incorporation of ESG factors among three companies – Prudential, Royal London Asset Management and M&G – accordingly indicates non-standardised integration of climate risk into decision-making. Incomplete incorporation was identified in the following statements: “In 2019, RLAM extended the breadth and depth of ESG integration, and this is not embedded across investment strategies […] We continue to increase our coverage” (Royal London Group, 2019, p. 38) and “we are currently working towards the full integration of ESG considerations across our investment portfolio” (M&G plc, 2019, p. 28); and subjective incorporation in “ESG issues are incorporated into our fundamental analysis and integrated into our decision-making process when we believe they could have a material impact on a company’s valuation and financial performance” (Prudential plc, 2019, p. 78). Therefore, although climate risks were reported as managed through ESG investment, this does not ensure consistent management across all investment functions.

4.4 Zero and limited disclosure of climate risk

The reports of zero disclosure and limited disclosure companies (13 in total) were analysed to determine the extent of climate risk management among companies who did not disclose material climate risks. Instead, these companies broadly reported ESG investment strategies which were not directly related to climate risks, including ESG modelling; active investment based on ESG factors; ESG funds and investment products; incorporation of ESG factors into decisions; use of ESG data providers; ESG scoring of companies; and “non-financial analysis”. Reports belonging to three companies (Walter Scott and Partners, Marathon AM and Northill Capital) revealed no climate related or ESG approaches.

In total, 5 of 13 limited and zero disclosure companies incorporate ESG into investment processes. Compared to “ESG integration” discussed in the last chapter, however, ESG among zero and limited disclosure companies was incorporated on an ad hoc and subjective basis. For example, Janus Henderson Group plc (2019) reported that their “investment teams define the ESG considerations they believe are material to their investment approach” (p. 5) while MAN Group plc (2019) “[sought] to apply the best practices in responsible investment relevant to the particular investment strategy” (p. 49). Only Ashmore Group plc (2019) reported that ESG risks were “explicitly integrated into the bottom up process across all fixed income and equity strategies” (p. 47).

This non-standardised pattern applied to the group of five zero disclosure whose annual reports were fund summaries. Out of 350 funds within in this group, the analysis found 10 ESG or sustainability-themed funds. Three companies’ ESG strategies applied to these funds used screening – shrinking the investment universe – to meet the fund’s own ESG or sustainability criteria. While BlueBay Asset Management excluded companies on the Norwegian Government Pension Fund Global exclusion list, Insight excluded according to its own undisclosed criteria. Fidelity International’s only ESG fund invested thematically into water and waste management companies which were not linked to climate-related objectives. Baillie Gifford’s Positive Change Equities Fund reported application of “inhouse, proprietary research on positive impact” in the stock picking process. Only Brown Advisory reported use of negative screens specific to fossil fuels. Analysis also showed that such strategies were only applied to the ESG or sustainability-themed funds. Additionally, holdings in oil and gas companies in BlueBay Asset Management and Insight’s ESG funds further points to non-standardised climate risk management within ESG strategies. Further research is needed to determine the extent to which climate factors are implemented within ESG criteria applied during stock selection.

5. Conclusion

This study has explored the theory and practice of climate risk disclosure and management in the financial sector. In doing so, it responds to growing academic debates surrounding the potential for climate-related financial disclosure to facilitate the alignment of private investment with Paris Agreement capital requirements. More specifically, it addresses the paucity of academic research into the effectiveness of climate disclosure among UK asset managers and the techniques adopted within this group to measure and mitigate financially material climate-related risks. By measuring the effectiveness of organisational climate risk management approaches from a behavioural finance perspective, this research has focused on barriers to low-carbon investment arising from deep-rooted investment behaviours and processes in financial organisations.

The disclosure of climate change as a financially material risk is found to greatly determine the incorporation of climate risk into overarching risk management frameworks. UK asset managers who acknowledged the financial materiality of climate change as a principal risk facing the company collectively engaged in distinguishable climate risk management techniques which answer to fundamental behavioural issues associated with carbon-intensive investment. Measures which build knowledge of climate risk, provide oversight of climate risk and reward climate-related performance have the potential to influence investor behaviour by increasing information, awareness and motivation to manage climate risks. To cement changes in investment behaviour, climate-informed investment strategies and products, climate risk measurement (through carbon footprinting and forward-looking scenario analysis) and investment into climate change mitigation activities represent organisational processes of climate-informed investment routines. In contrast, asset managers who did not acknowledge the financial materiality of climate risk engaged in ESG investment approaches associated with broad sustainability issues rather than climate-related risks.

Overall, the main takeaway from the research is that today’s climate risk management strategies hold potential to effectively address traditionally climate risk-averse investor behaviour and investment processes in the UK asset management context, but that the use of ESG investment strategies to mitigate climate risks is a “grey area” in which climate risk management practices are undefined within broad sustainability and responsible investment agendas. The use of ESG investment as a mitigating response to climate risks represented a unique finding of this research. Although ESG investment among the climate disclosure group was directly associated to climate risk management, as opposed to limited and zero disclosure companies, the extent to which climate change is prioritised within ESG investment across the sample is unclear. Further research is needed to explore this practice as it becomes increasingly used to approach climate risks within the financial sector (9 of the 13 asset managers who reported climate change as a principal risk reported ESG investment as the appropriate mitigating response).

While document analysis pragmatically determined specific techniques used within the sample, interviews with investors themselves on this question may expand academic understanding of how they are applied. Furthermore, robust data collection for this study depended on the extensive reporting of business models, investment strategies and risk management processes by the majority of companies. The minimalistic reporting styles of some annual reports, which led to their categorisation as disengaged from climate risk practices, may not reflect actions taken in reality. Here, further research using a case study approach on one or few companies which draws on alternative data sources could thoroughly examine climate risk measurement and monitoring processes within investment teams and organisational risk functions.

Figures

Figure 1.

Climate risk disclosure categories

Figure 2.

Graph showing different disclosure techniques among “climate disclosure” group

Figure 3.

Asset managers divided into brackets of assets under management AUM data

Figure 4.

Proportion of asset managers within single-service, group or parent structures

Figure 5.

Number of climate risk exposure analysis techniques practiced per company

Figure 6.

Number of climate risk pricing techniques taken per company

Table 1.

Description of annual report categories included in sample

Ref.	Report category	Description
1	Strategic annual reports	Reports containing largely qualitative information about company philosophy, strategy, business model, key performance indicators, risk management approaches, governance or leadership structures, corporate governance and remuneration, and audited financial statements
2	Fund summaries	Financial statements and performance summaries of funds
3	Minimum requirement reports	basic disclosures fulfilling minimal reporting requirements containing brief summaries of business activity, risks and audited financial statements

Source: Authors’ own

Table 2.

Climate risk management strategy framework for UK asset management

Behavioural impact	Strategies	Activities/Processes
Investment behaviours	Create incentives	Key performance indicators; decarbonisation or net-zero targets; remuneration incentives
	Establishing oversight	Company Board; Executive Board (CEO, CIO, COO) and Risk Committee; Climate Risk Working Groups
	Building knowledge and skills	Climate risk training; climate research groups; policy/industry initiative engagement
Investment processes	Climate-focused investment strategies	Negative/positive screening; company scoring; portfolio-level climate factor analysis
	Climate risk data and measurement	ESG and climate data solutions; carbon footprint analysis; climate scenario analysis