Assessing the Climate Change Exposure of Foreign Direct Investment

Physical climate risks, defined as risks arising from the physical effects of climate change, increasingly affect facilities worldwide across industries including foreign assets, or foreign direct investment (FDI). Despite the increasing impact of physical climate risks on firms and facilities globally, little is known about how multinational companies incorporate such risks into their overseas investment decisions.

In a new journal article published by Nature Communications, Xia Li and Kevin P. Gallagher deploy newly available data to examine the exposure of multinational companies’ overseas investments to physical climate risks. They found that, globally, foreign investments are significantly exposed to lower physical climate risks, compared with local firms across countries. Within countries however, the differences in physical climate risks between foreign and local facilities are small.

Li and Gallagher examine China in particular, as it is fast becoming one of the largest sources of outward foreign investment across the globe. They find Chinese FDI is significantly more exposed to water stress, floods, hurricanes and typhoon risks across countries, compared with other foreign facilities. Within host countries, however, once again the physical climate risks of Chinese overseas facilities are comparable to those of non-Chinese foreign investments.

Main findings:

• Foreign firms tend to shy away from countries with the higher levels of physical climate risks than local firms, which by their nature have less choice regarding where they can locate their facilities.
  • Firms’ decisions to locate facilities abroad involves considerations of the characteristics of the host country.
• Compared with local firms, foreign firms investing abroad are at disadvantage in a local market, as they lack information about local conditions, face discrimination by host country stakeholders and have difficulty responding to some local conditions.
• Foreign investments have substantially and significantly lower climate risks—particularly flood, sea-level and hurricane/typhoon risks—compared with all facilities across host countries. Furthermore, the differences of climate risks of foreign facilities are small within host countries.
• Li and Gallagher’s focus on China revealed Chinese FDI has higher water, floods and hurricane/typhoons risks across countries, compared to all overseas facilities.
  • Within host countries, however, the climate risks of Chinese overseas facilities are comparable with those of non-Chinese counterparts.
• Why do Chinese facilities have higher climate risks?
  • First, it may be that some Chinese companies are willing to invest in countries for political or strategic reasons, regardless of climate risks. For instance, the Belt and Road Initiative (BRI) was launched in China in 2013 to improve regional and transcontinental cooperation and connectivity through investments and trade. Facilities in BRI countries throughout Africa, Southeast Asia and Latin America face higher climate risks than countries elsewhere in the world.
  • Second, Chinese companies started to invest heavily overseas in the early 2000s and may therefore have had to invest in locations with higher climate risks, as less-risky locations had already been taken.
  • Third, the climate risks of a firm’s headquarters country are positively associated with those of its overseas facilities. As facilities in China have relatively high climate risks, Chinese firms are likely to take above-average climate risks when investing overseas. This is consistent with previous research suggesting that firms with local experience of high risks (e.g., natural disasters or political risks) are more likely to expand into other countries posing such risks.

Given the growing awareness of climate risks, governments, investors and communities are becoming more active in taking preventative measures. For instance, organizations like the Task Force on Climate-related Financial Disclosures and the Network for Greening the Financial System tackle these risks head-on and encourage cooperation between stakeholders. The 2020 version of the Equator Principles incorporated climate risk assessment into its guidelines and called for climate-resilient infrastructure. In all, Li and Gallagher argue understanding the climate risk baseline of firms’ global assets can help policymakers and international organizations craft climate-related policies and guidelines.