The UK watchdog addresses the perils posed by human-induced climate change in its Financial Risk Outloook (FRO) for 2007. It marks the first time that the annual FRO has identified the "considerable risks and challenges that climate change poses to the financial sector". These include greater costs to firms through extreme events and possible equity market volatility arising from these costs.

The FSA notes that the financial centres of London, New York, Tokyo and Hong Kong are all located in coastal areas, and are likely to be particularly affected by global warming as flooding increases and changes in soil composition weaken buildings’ foundations.

Increasing use of offshore centres for outsourced financial services also exposes the global financial system to climate change, notes the watchdog, as extreme weather events and a rise in sea levels destroy infrastructure around the world.

Insurance companies will be worst hit in the immediate term, but rising costs of capital and unforeseen changes to the value of collateral holdings will be an issue for all market participants warns the FSA.

The regulator predicts an upsurge in new financial products that either allow hedging against climate-change impacts or improve firms’ reputations as they are seen to be ‘green’. Those firms that don't seek to minimise their carbon footprint may also suffer from increased reputational risk and subsequent loss of business as consumers search for environmentally-friendly investments or more swiched on money managers.

The publication of the FSA report coincides with the release by UBS Wealth Management of an investment guide to the risks and opportunities arising from global warming. The report identifies products and processes that deliver improved energy efficiency, and development of renewable/low-carbon energy sources as the investment sectors best positioned to benefit from the changing climatic and regulatory environment.

Klaus Wellershoff, global head of UBS Wealth Management Research comments: "Whether or not you agree with the view that human activity is influencing the climate system is largely irrelevant to the investment thesis. What is important is that numerous policies to combat the threat of global warming are converging to influence people's behavior, alter the risk profile of various businesses, and improve the investment outlook for others."

Lehman Brothers has also weighed in with a 150-page analysis of the impact of global warming on the investment climate, warning: "The pace of a firm's adaptation to climate change is likely to prove to be another of the forces that will influence whether, over the next several years, any given firm survives and prospers; or withers and, quite possibly, dies."

Read the full FSA report: