Working Group II: Impacts, Adaptation and Vulnerability

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8.4.2. Adaptation Issues

To date, the literature does not explicitly address financial services firms outside the insurance sector. There is emerging evidence that some investors or businesses as a group are modifying their risk perception to incorporate the potential for climate change. Partly this is driven by pension funds that are filing shareholder resolutions against polluting companies or banks that finance such practices (Behn, 2000). Similarly, there also is emerging evidence that financial services firms are including consideration of potential climate change as a risk factor in evaluating investments or developing new products (World Bank, 1999; Jeucken and Bouma, 2000). However, history has shown that the ability of banks and asset management firms to respond and adapt to external shocks is strongly tied to the ability of those institutions to diversify risk, both for themselves and for their customers. Over the past 25 years or so, financial services firms have changed significantly in response to a variety of circumstances, including macroeconomic disturbances of local and global proportions, advances in communications and information technologies, and changing regulatory regimes (Kaufman, 1992; Downing et al., 1999). Several types of tools can be identified for managing risk: improved information and research, diversification, building up reserves, and new product development.

The Role of New Product Development

Over the years, banks as a whole have demonstrated their ability to continuously develop new products and services to respond to changes in their own business environment as well as the changing needs of their customers (Folkerts-Landau and Mathieson, 1988; Haraf and Kushmeider, 1988; Jeucken and Bouma, 2000). The ability of those firms to respond and adapt to any impacts of potential climate change will be determined largely by their ability to identify any changes in their customers' views of asset risk and to develop new products to hedge and diversify that risk. Again, the literature does not discuss explicitly which specific existing products might be useful in responding to changes in risk stemming from potential climate change or what types of new products might be developed to respond to such potential changes in risk. However, the industry continues to apply basic concepts—including options, swaps, and futures contracts—in new and different ways to create new products that provide investors and businesses with useful tools for reducing well-known and understood risks (Mills, 1999, Vine et al., 1999). These products can range from environmentally and socially screened investment funds to very sophisticated derivatives that hedge against weather risks.

In the past few years, such weather derivatives have seen rapidly growing use to hedge the risks of businesses whose sales and revenues are strongly affected by the weather. Securitization is becoming more and more widely used as a means of spreading risk and obtaining resources for investment banking with a secure flow of income in the future. Financial institutions other than insurance companies have been developing and offering such instruments in the form of catastrophe bonds, for example (see Box 8-3).

In summary, the banking industry is more likely to see climate change and the possible response more as an opportunity than as a threat. In the new global competition, banks and asset managers are likely to be less concerned about any possible threat posed to their existing portfolios by weather extremes induced by climate change and more preoccupied with adjusting to a rapidly changing and increasingly competitive global market in which failure to adjust leads rapidly to loss of market share and net revenue and a decline in share price and shareholder value. They have little incentive to try to change the rules, but they are highly motivated to respond once changes are imminent or implemented.

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