The record breaking heat and wildfires in Europe this year should prompt European securitization investors to think hard about the physical climate risks in their portfolios.
It might not feel like an immediate problem. The actual damage to securitized property from wildfires this year will be minimal. Much of what damage there is will be insured.
But there are two imperatives that make it a pressing issue — one economic and one moral.
Lending into areas affected by climate danger is risky, even if the physical damage is covered by insurance. If the same damage keeps occurring year after year, premiums will rise and insurance may become unaffordable, or at best squeeze the borrower's mortgage affordability.
There are also knock-on effects from climate-related damage. The local economy will suffer and tourists will be put off, likely resulting in lost income and lost jobs. If that becomes severe enough, it could lead to delinquencies in deals and losses for investors.
The second thing investors need to consider is whether their investments are making the problem worse. It is a complex matter because simply withdrawing financing from communities in risky areas won’t make things better. Indeed, local communities are often best placed to manage areas of land and help mitigate risk.
Development is different. Part of preparing for the impact of climate change is better land use and planning — avoiding new developments on marginal land or near wild areas, for instance. From a financing perspective, that should be part of the underwriting consideration.
Work will be needed to understand and underwrite these risks. This year's wildfires prove it can't wait.