Climate Crisis and the Finance Sector

Climate Crisis and the Finance Sector

Mark Carney, Governor of the Bank of England, argued that the financial sector must be at the heart of tackling climate change. He is one of the leaders of 34 central banks and supervisors that joined forces in 2017 to create the Network for Greening the Financial System (NGFS). In an open letter, Carney discusses the recent NGFS report that calls for action by the finance sector to support the market and regulators in adequately assessing the risks and opportunities from climate change.  He argues this is necessary to avoid a “Minsky moment” – a sudden collapse in asset prices.

Together with François Villeroy de Galhau, the governor of the Banque de France, Carney also suggested that companies that don’t adapt will go bankrupt. US coal companies had already lost 90% of their value. Banks were also at risk –“ those banks overexposed to the sunset sectors will suffer accordingly”.

The Bank of England has said up to $20tn (£16tn) of assets could be wiped out if the climate emergency is not addressed effectively. As long ago as 2014, Carney was arguing that the “vast majority of reserves are unburnable”.

Guy Debelle, Deputy Governor of the Reserve Bank of Australia, discussed how climate change affects the objectives of monetary policy.  Short-term climate related shocks to the economy – droughts etc – can be safely excluded from policy consideration, but we are now seeing a trend in weather events whose impact is ongoing. For businesses and financial markets, the challenge is understanding the climate modelling and conducting the scenario analysis to determine the potential impact on their business and investments.

The IMF also discussed how central banks are taking action in a range of areas within their mandates. The key points they identified were:

  • the adjustment needed for the transition to low carbon sources will have a substantial impact on prices, and carbon-intensive industries;
  • developing a coherent set of global standards is priority, requiring international cooperation on issues such as developing more harmonized disclosure standards and regulatory policies;
  • there could be a role for “green quantitative easing” programmes, through the purchase of bonds funding energy-efficient/renewable projects.

In Singapore, the regulator (the Monetary Authority of Singapore – MAS) put out guidelines on environmental risk management for the financial sector. MAS is concerned that climate change threatens to leave some assets stranded and catch financial institutions off-guard.

MAS also sees opportunities for the financial sector to “nudge” the real economy towards becoming more green,.

The insurance industry is also becoming increasingly concerned as climate related risks grow.  Wildfire risk in particular is causing concern. The fires of 2017 and 2018 cost the sector more than $15 billion each year, forcing reinsurers to reconsider their view of wildfire losses as moderate and predictable, and to develop new wildfire models, and innovative risk transfer solutions.

Munich Re even suggested that large numbers of homes could become uninsurable.  The 2018 Californian wildfires caused losses of $24bn (£18bn) leading Munich Re to view the only sustainable option being  to adjust risk prices– “some people on low and average incomes in some regions will no longer be able to buy insurance.”  Increasing premiums in high wildfire risk areas, or lowering them for fire-resistant construction could be effective signals to reduce fire costs.

The Lloyd’s Market Association even runs masterclasses that provide “a better understanding of climate change in the context of insurance, which will be useful in anticipating and mitigating emerging exposures, improving wordings, and developing new products”.

Power companies are also vulnerable. The Californian power utility PG&E filed for Chapter 11 protection in the “first climate change bankruptcy” caused by $30bn of liabilities due to a series of wildfires linked to its equipment.  Hundreds of billions of dollars have been wiped off the value of power utilities by the rise of renewable energy, which has disrupted electricity generating market economics and turned the incumbent business model on its head.

Banks and asset managers will need data that allows them to evaluate the transition and physical risks to which corporations in their portfolios are exposed. So, they will demand it. Companies will increasingly find themselves having to make climate-related disclosures.

The FSB’s Task Force on Climate-Related Financial Disclosures, set up in 2018, is a multinational group pushing for greater transparency of the risks companies face.  It is developing voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders.

The Task Force will consider the physical, liability and transition risks associated with climate change and what constitutes effective financial disclosures across industries

There are calls for companies to consider the issue of climate change on their balance sheets. Richard Murphy of City University argues for “sustainable cost accounting” requiring that every company provide in full, and upfront, its cost of transition to being a net zero-carbon emitter.

However, not everyone is taking this on board. The world’s top three asset managers oversee $300bn fossil fuel investments. The two largest asset managers, BlackRock and Vanguard, have also routinely opposed motions at fossil fuel companies that would have forced directors to take more action on climate change.

So what will be the effects of climate risks on asset values?  Are the top asset managers taking too short-term a view? Will political pressure build sufficiently to turn voluntary codes into compulsory ones? Boards will be expected to address climate change risk, with all its uncertainties, taking different future scenarios into account in their financial planning.  Just the sort of thing that SAMI, with its Board governance and scenario planning capabilities, can help do.  As COP 25 begins, is it not time to begin work on this now?

Written by Huw Williams, SAMI Principal

The views expressed are those of the author(s) and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

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