Dec. 11, 2007 The financial services industry is uniquely positioned to capitalize on new business opportunities created by climate change but its greatest short-term strengths are also its greatest long-term weaknesses according to a new report, which outlines five recommendations to help financial institutions outperform their competitors in a carbon-constrained market.

The report by strategy consulting firm Oliver Wyman identifies risk expertise and capital mobility as the finance industry's secret weapons for capitalizing on climate opportunities. For example, successful financial institutions must continually hedge business risks for themselves and customers, develop new products quickly, and invest in new markets. Institutional banking and asset management in particular will likely see the biggest upsides, thanks to emerging carbon markets, growing demand for hedging innovation to manage energy prices, and increasing investment in clean tech, according to the report.

Yet the very factors that make the financial sector resilient to climate change , its global nature and its mobile capital , also leave it more exposed to climate risk over the long term, the report cautions. The economic impact of temperature rises and tough emissions regulations will gradually outweigh the market opportunities. Insurance faces the greatest threat, primarily from rising premiums and risk-pricing adjustments.

Wildcards such as customer perception and public policy decisions also pose risks to financial firms that fail to move quickly on a climate agenda. While the green banking market is currently "tiny," environmental considerations could increasingly influence consumer choice of retail bank over time, according to the report.

The report identifies five key strategies to help financial institutions get ahead and stay ahead of the competition:

1. Re-appraise the firm s portfolio, stress-testing its geographic and business exposure to climate risk. Firms may need to re-prioritise regional markets and business lines according to their likelihood of being net beneficiaries or casualties, while monitoring regulation, emerging liability issues, technological change, and increasing public activism.


2. Innovate to capture the increased appetite for climate change related financial products, and exploit arbitrage opportunities between different markets. The consumer market is largely untapped, and there is considerable scope for insurance innovation in emerging markets. The unpredictable implications of climate change necessitate rapid innovation which is highly responsive to changing market conditions.


3. Develop the brand. Consumers and new recruits will be attracted by a sense of shared values in markets where financial institutions are virtually indistinguishable, loyalty is low, and climate change concern is high. In many regions there is still scope for firms to seize the role of the green financial institution. But while firms may suffer by being slow to market their eco awareness, they must also be alert for climate change fatigue and green wash accusations, recognizing that green branding will soon become a hygiene factor.


4. Deliver effective climate change governance. Financial institutions must instill a coherent stance at firm level, ensuring that a growing capability is both utilised across the organisation and matched by internal performance. Firms need structures whereby climate risk and opportunities are reported on and used to inform strategy and products, and measures are taken to reduce emissions from infrastructure and travel.


5. Collaborate with governments, NGOs, customers and competitors. The complexity of climate change means that the biggest financial firms should work collaboratively in ways that strengthen not only their individual reputations, but also that of the industry as a whole. Industry leaders should actively work to influence policy solutions to climate change that best leverage the power of capital markets for the common good, helping advise governments to steer away from unilateral policies that could create significant moral hazard and thereby latent costs for taxpayers.
   

Many financial firms still have much to do on climate change," says David Knipe, co-author of the report. "They should be focusing as much on the opportunities now opening up as on protecting themselves against the erosion of value. [T]heir ability...to create value from the opportunities and threats will depend on how they deftly they respond to the changing business environment."