Sharemarket investors are failing to properly price in the risk of climate change inflicting damage on companies and economies, a new analysis by the International Monetary Fund has warned. The Washington-based fund’s Global Financial Stability Report examines the impact of climate change physical risk on financial stability, including the loss of life and property as well as disruptions to economic activity.

Investors ignoring climate change risks, IMF warns

From the IMF report (chapter 5):

The projected increase in the frequency and severity of disasters due to climate change is a potential threat to financial stability. Equity markets are a key segment of the global financial system, provide a data-rich envi- ronment, and are sensitive to long-term risks, making them fertile ground for investigating how projected future physical risk affects financial markets and institutions.

Looking back over the past 50 years shows a generally modest impact of large disasters on equity markets, bank stocks, and non–life insurance stocks, although country characteristics matter. Higher insurance penetration and greater sovereign financial strength have helped dampen the adverse effects of large disasters on equity markets and financial institutions. While projections of climatic variables and their economic impact are subject to ahigh degree of uncertainty, aggregate equity valuations as of 2019 do not appear to reflect the predicted changes in physical risk under various climate change scenarios.

This suggests that equity investors may not be paying sufficient attention to climate change risks. Beyond policy measures to mitigate and adapt to climate change, actions to enhance insurance penetration and strengthen sover- eign financial health will be instrumental in reducing the adverse effects of climatic disasters on financial stability. Moreover, better measurement and disclosure of exposures to climatic disasters are needed to facilitate the pricing of climate-change-related physical risks.