Environmental factors

11 minute read

There are a number of trends and factors, sometimes referred to as ‘megatrends’ that researchers and practitioners have identified as sources of risks to companies, economies and societies if left unaddressed.

The CFA Institute has identified three key areas of environmental concern.

Environmental megatrends:

1. Climate change

The change of climate, directly or indirectly attributed to human activity, is a global issue with both micro and macro manifestations and impacts.

The 2006 Stern Review concluded that “climate change is a unique challenge for economies and the biggest market failure ever seen … no one can predict the consequences of climate change with complete certainty; but we do now know enough to understand the risks.”¹

Read: Pages 8- 9 of the Executive summary from the McKinsey Global Institute Climate risk and response report highlights some of the socioeconomic impacts of climate change.

Key points:

As average temperatures rise, acute hazards such as heat waves and floods grow in frequency and severity, and chronic hazards, such as drought and rising sea levels, intensify.
Climate change already has substantial physical impacts at a local level in regions across the world. The affected regions will continue to grow in number and size, directly affecting the five socioeconomic systems: liveability and workability, food systems, physical assets, infrastructure services and natural capital.
The socioeconomic impacts of climate change will likely be non-linear as system thresholds are breached and have knock-on effects.
Most of the past increases in direct impact from hazards have come from greater exposure to hazards versus increases in their mean and tail intensity. In the future, hazard intensification will likely assume a greater role.
The global socioeconomic impacts of climate change could be substantial. A changing climate affects human beings, as well as physical and natural capital.
Financial markets could bring forward risk recognition in affected regions, with consequences for capital allocation and insurance. Greater understanding of climate risk could make long-duration borrowing unavailable, impact insurance cost and availability, and reduce terminal values.
Countries and regions with lower per-capita economic growth levels are generally more at risk.
Addressing physical climate risk will require more systematic risk management, accelerating adaptation, and decarbonisation.

Sectors that are carbon intensive are at particular risk from climate change, including:

Oil, gas and coal
Heavy industrial sectors (e.g. petrochemicals, steel, cement)
Buildings and transport

The risks from climate change can be either physical or transition risks:

Transitions risks are caused by changes in climate and energy policies, a shift to low-carbon technologies and liability issues.

Physical risks are either acute or chronic and are caused by extreme weather events or longer-term shifts in climate patterns.

There are two possible approaches to respond to climate change:

Mitigation – i.e., reducing and stabilising the levels of heat trapping greenhouse gas (GHG) emissions in the atmosphere, or

Adaptation – adapting to the climate change already taking place.

The Intergovernmental Panel on Climate Change (IPCC) explores four potential futures depending on what policies governments take to cut emissions. The graphic below identifies some of the potential impacts businesses face in these four scenarios² :

2. Pressures on natural resources: water, biodiversity, land use and forestry and marine resources

The CFA identifies several factors putting increasing pressure on natural resources;

Population growth
Health improvements leading to people living longer
Economic growth
Increased consumption in developed and emerging economies

Water

Water is a vital resource, for a range of agricultural, industrial, household energy generation, recreational and environmental activities. The World Economic Forum views water allocation and use as an interrelated economic system that must balance social development and environmental interests. A decision to allocate more water to any one sector means that less water is available for other uses. ³

Water scarcity is the lack of freshwater resources and is one of the largest global risks of the next decade. UN Water reports that more than two billion people globally experience high water stress, and about four billion people experience severe water scarcity at least one month of the year.⁴

Biodiversity

The Convention on Biological Diversity defines biodiversity as: the “variability among living organisms from all sources including, among other things, terrestrial, marine and other aquatic ecosystems and the ecological complexes of which they are part; this includes diversity within species, between species and of ecosystems”.⁵

Recommended Watch: BBC documentary – Extinction: The Facts

Recommended Watch: Netflix – Breaking Boundaries: The Science of Our Planet

Land use and forestry

Agriculture, Forestry and Other Land Use (AFOLU) have a major impact on natural resources. According to the IPCC, the AFOLU sector is responsible for 23% of total net emissions that humans generate, and the IPBES estimates that deforestation and forest degradation account for 10 -15% of global GHG emissions. This is a significant issue to say the least.^8,9

In a 2019 report, the IPCC predicted a decrease in the stability of food supplies as an increase in the magnitude and frequency of weather events disrupts food chains.

Companies with deforestation practices anywhere in their supply chains face a multitude of risks, including:

Supply disruption
Cost volatility
Reputational damage

Marine resources

The ocean produces over half the world’s oxygen and absorbs 50 times more carbon dioxide than the atmosphere. This makes it one of the planet’s largest carbon sinks, as well as being a major transport network and a hugely valuable natural resource providing food and livelihoods to millions of people globally.

The use of the ocean’s resources as a source of economic growth is known as the blue economy. It is defined by the World Bank as: “sustainable use of ocean resources for economic growth, improved livelihoods, and jobs while preserving the health of ocean ecosystem.”

3. Pollution and waste

Air pollution

Air pollution is the largest environmental cause of disease and premature death in the world today. Evidence from the World Health Organisation (WHO) shows that more than 90% of the world’s population live in areas with levels of pollution that exceed their guidelines, with the situation only set to get worse as migration and demographic change see cities expanding.¹¹

In addition to being harmful to human health, increased air pollution:

Adversely affects the environment
Destroys ecosystems
Reduces biodiversity
Reduces crop harvests due to soil acidification

Water pollution

Water is essential to all living organisms, and water pollution is a serious threat to the environment and human health.

Water pollution happens when toxic substances enter water bodies such as lakes, rivers and oceans. These substances could be anything from human sewage to nuclear materials to microplastic – and they are all harmful. In fact, we are only just beginning to understand the extent to which global water sources are contaminated with man-made substances, and the knock-on effects that this has on biodiversity and the health of ecosystems.

Waste and waste management

Waste and waste management has become a larger priority for policymakers globally. Concerns have increased about the growing pressure on natural resources and level of pollution generated from ‘traditional’ waste disposal methods.

Increasing levels of consumption and changes in living and working patterns are generating ever greater quantities of waste. At the same time there is greater pressure on space for landfill.

In many developed economies financial mechanisms are being introduced to discourage waste and promote recycling – for example hypothecated taxes such as the charge for plastic bags.

The circular economy

The circular economy is an economic model based on the principles of designing out waste and pollution, keeping products and materials in use, and regenerating natural systems.

Watch: Ellen MacArthur’s TedTalk from March 2015 from 6:30