Schroders is today unveiling the latest addition to its climate change investment toolkit, the Carbon Value at Risk (Carbon VAR) model, designed to help investors more accurately assess the risks higher carbon prices pose for companies, industries and investment portfolios.
Schroders' Carbon VAR model shows that some 20% of the profits generated by global companies are at risk if carbon prices rise to the levels required to meet the temperature change commitments international leaders made at the 2015 Paris Agreement.
In the most exposed sectors, like construction, steel and commodity chemicals, sector profits could drop 80%.
Schroders' Sustainability team estimates that if the world is to limit itself to the 2°C temperature rise target agreed in Paris, carbon prices will have to increase from under $5 a tonne currently to well over $100 a tonne in order to incentivise decarbonisation on the scale needed.
Carbon pricing is a vital lever for climate policymakers to reduce emissions, and higher costs will increase the pressure on carbon-exposed businesses' profitability. There are signs of renewed appetite in the European Union and China in particular to increase carbon pricing and expand its scope.
Traditional analysis, such as carbon footprints and fossil fuel exposure, assess companies in isolation and fail to reflect how higher carbon prices would affect their profitability in the future.
Investment products and funds that rely on more simplistic approaches may leave investors more exposed to climate risks than they had originally anticipated.
Andy Howard, Head of Sustainable Research, Schroders, said:
"The tools investors have to measure or manage climate risk have barely changed for a decade. Carbon footprints continue to dominate but at best provide an incomplete and, at worst, a misleading picture of the risks carbon pricing presents to investors.
"Carbon VAR is a new approach. It reflects the way companies make money and how their profits would change if carbon prices rose significantly. The results don't bear much resemblance to carbon footprints, underlining the dangers of assuming funds or portfolios with low footprints will be insulated if policies toughen.
"Schroders will continue to invest in building and strengthening tools which help us protect our clients' investments."
The Carbon VAR model is being used by Schroders' portfolio management teams, as part of their broader investment toolkit.
In July, Schroders' Sustainability team launched the Climate Progress Dashboard, which assesses the long-term temperature rise trajectory the world is on course for.
For a more detailed explanation of Schroders' Carbon VAR model, please download the attached document.