Physical risk: China’s canary in the transition mine?
Extreme weather events in recent years have brought physical risk to the investment forefront
Flood season is underway in China as are efforts to launch a response. Since the season began in April, 146 rivers across the country have witnessed water levels beyond alert thresholds. A 50% increase over a five-year average.
Beijing even dispatched seven work teams to guide flood control in provinces. A move that follows its pledge to launch a satellite to better monitor extreme weather.
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China’s physical climate risks – of which such efforts are a visible acknowledgment – has implications for investors looking to deepen their Chinese footprint.
Physical risks
For investors, China’s energy transition has quickly become a cornerstone of its appeal. Asset managers – notably Schroders Capital Infrastructure, BlackRock, BNP Paribas and DWS – all offer strategies tapping into China’s transition.
When China’s water resources ministry issued flood warnings earlier this month, it brought into focus the physical risks surrounding transition opportunities. The ministry even defined the situation as ‘grim and complex’.
The warnings speak to wider trends in physical risks across China and evoke memories of 2020 – when the country experienced some 21 large scale floods.
“Physical climate risk is certainly becoming an increasingly relevant consideration for investors in China, particularly given the country's exposure to extreme weather events such as flooding, heat stress, drought and typhoons”, says Donald Lee, associate director for ESG at FountainCap Research & Investment.
MSCI is one of the data providers tracking the numbers. “Pluvial flooding is the most prevalent type, accounting for over 85% of flood events and broadly distributed across eastern China”, says Siyao He, a researcher at MSCI’s APAC sustainability & climate research and development team.
MSCI’s analysis of 9353 assets from its China index constituents shows coastal flooding to hold a higher degree of business disruption risk under the IPCC’s SSP5-8.5 scenario. Asset density mixed with coastal exposure contribute to heightened risks.
“Flood risk tells only part of the story though. Extreme heat is the dominant physical hazard across listed Chinese companies, driving over half of estimated average annual losses through business interruption, with extreme precipitation ranking second”, she adds.
Investment implications
Investment implications from China’s physical risk often have a geographical component. Some regions and industries are more exposed than others, courtesy of asset density around areas under risk.
MSCI’s He says this determines the industries most at risk. “For MSCI China index constituents, real estate and utilities carry the highest absolute average annual losses at median estimates of $338m and $333m per company, respectively”, she explains.
Assessing physical risk management within large listed companies has been a point of focus for investors. “Our focus is usually on understanding how companies identify, assess and manage material climate-related risks, including governance, risk management processes, business continuity planning and relevant disclosure”, says FountainCap’s Lee.
Lee warns data visibility is becoming a concern. “From an investment perspective, assessing physical climate risk remains challenging. Company-level disclosure remains uneven, and comparable metrics are often limited”, he notes.
Implications run beyond listed equities. MSCI’s analysis recommends keeping a close eye on infrastructure assets – particularly those relocations and retrofits are not feasible. Renewable energy generation and storage projects fit the description, as do grids.
For their part, Chinese officials have acknowledged the need to step up efforts. “By 2030, we aim to achieve major breakthroughs in key meteorological technologies”, said Chen Zhenlin – the State Council Information Office's CMA head – back in April.
Making weather monitoring more precise, upgrading radar systems, integrating AI into forecasting and pledging to launch the world’s first geostationary microwave atmospheric sounding satellite are all part of China's plans.
All else equal, Beijing’s efforts will bring visibility into a hitherto silent corner of investor risk radars. In an investment thesis predominantly centred around transition opportunities, physical risks are floating in the background.
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