07 Oct 2015
Not least because implicit in the speech was a recognition of the limits of economics and hence the necessity for everyone – public and private and institutional – to accept what might be called the moral and ethical dimensions of the response.
"Even where governments accept their responsibility to address climate change, and use their regulators as agents, there are limits."
Andrew Cornell, Managing Editor
What then is the role of corporate responsibility and indeed the idea now of corporations having a “purpose" as well as a profit motive?
The headline points of Mark Carney's recent speech to Lloyds of London, around the direct costs of climate change and the bleak implications for owners of potentially stranded energy assets, were well covered.
Speaking to a room of insurance experts, he simply drew attention to the growing costs of insurable incidents like bigger storms while the assets insurers (and others) hold against liabilities – assets like coal investments – might suddenly plunge in value.
Carney's point was the financial system will play a central role in the response to human-induced climate change via capital allocation and risk pricing.
“The right information allows sceptics and evangelists alike to back their convictions with their capital," he said. “(That information, around carbon intensity and mitigation strategies) will reveal how the valuations of companies that produce and use fossil fuels might change over time."
But less dramatically, Carney also drew attention to the limits of financial policy.
Even where governments accept their responsibility to address climate change, and use their regulators as agents, there are limits.
“The horizon for monetary policy extends out two to three years," Carney said. “For financial stability it is a bit longer, but typically only to the outer boundaries of the credit cycle – about a decade.
“In other words, once climate change becomes a defining issue for financial stability, it may already be too late."
Even today, financial systems can prove inadequate. Carney pointed to the Caribbean where emerging storm patterns are preventing citizens from obtaining private insurance cover “prompting mortgage lending to dry up, values to collapse and neighbourhoods to become abandoned".
Moreover, even with the best intentions, policy can be inadequate or inappropriate: “Some have suggested we ought to accelerate the financing of a low carbon economy by adjusting the capital regime for banks and insurers.
“That is flawed. History shows the danger of attempting to use such changes in prudential rules – designed to protect financial stability – for other ends."
What that means though is the long term solutions needed to address climate change lie outside the realm of financial policy or regulation. Carney called it the “tragedy of the horizon". We all have a responsibility but how do we determine it?
Carney is hopeful the financial system, especially insurers, banks and other providers of capital, will address the issue as far as they can by directing capital.
The challenge however is that while pricing risk is the proper role of such institutions, with climate change, while the risk is clear, measuring it isn't. As Carney and indeed the vast body of experts accept, underlying global temperatures are rising; human activity is causing it; but the range of possible outcomes, while negative, is enormous depending on the modelling.
The ratings agency Standard & Poor's has been devoting considerable research to the financial risks of climate change and in particular, given the firm's role, the impact on credit quality.
“Altogether, in our review of all 38 corporate subsectors, we identified 299 cases in which (Environmental and Climate) risks have either resulted in or contributed to a corporate rating revision or have been a significant factor in our rating analysis," S&P says in a body of work under the title “Climate Change: Assessing the potential long term effects".
“In 56 of these cases, E&C risks have had a direct and material impact on credit quality, resulting in a rating, outlook, or CreditWatch action or notching of the rating - nearly 80 per cent of which were negative in direction. The lion's share of these ratings were in the oil refining and marketing, regulated utilities, and unregulated power and gas subsectors. As the severity and frequency of E&C risks continue to rise, we believe related rating actions could also accelerate in coming years."
This sort of work by scrutineers will affect capital allocation but again the horizon, even when forward looking, is not sufficient to encompass the potential risk. And there is obviously resistance from a significant array of vested interests.
Recent research by the non-profit group InfluenceMap found 45 per cent of the 100 largest global industrial companies are obstructing climate change legislation, while 95 per cent of these companies are members of trade associations demonstrating the same behaviour. InfluenceMap used a research methodology developed with the Union of Concerned Scientists.
Governments obviously are making decisions, recognising they have a role beyond their own terms in power, just as they do in managing for ageing societies.
Cities too: around the world, in developing and developed countries, more cities are driving change associated with "clean energy". Vancouver, for example, has pledged to go 100 per cent renewable.
So what about banks? Obviously they have to make risk and pricing decisions around concepts like stranded assets and the potential impact of regulation. Their decisions too have to be explicable to shareholders and defensible in terms of the impact on returns.
But at a certain point, as Carney notes, the challenge of climate change goes over the horizon.
This bank, ANZ, has recently made a formal statement regarding its role in addressing the reality of climate change, including a $A10 billion lending pledge to help companies reduce emissions, the introduction of new rules on coal and a public commitment to playing a role in the transition.
This bank isn't alone. Others have made formal and informal commitments.
In a speech last week, Commonwealth Bank of Australia's institutional bank head Kelly Bayer Rosmarin said the bank had an unlimited appetite for financing renewable energy projects as long as “they are good, viable, commercially-backable projects, and they are bankable".
She also flagged the need for clearer price signals, perhaps in the form of a carbon price, so implicitly recognising the challenge of the “horizon". According to S&P, 55 jurisdictions, including 35 national and 20 subnational jurisdictions, have implemented an Emissions Trading Scheme (some, like Australia, have also abandoned them) as a way to put a price on carbon. By early 2015, jurisdictions accounting for 40 per cent of global GDP had introduced an ETS, S&P said.
That doesn't mean such investment is gambling. Carney argued “financing the de-carbonisation of our economy is a major opportunity for insurers as long-term investors".
But “for this to happen, 'green' finance cannot conceivably remain a niche interest over the medium term".
In its World Energy Outlook, the International Energy Agency estimates investment of $US13.5 trillion in low-carbon technologies and efficiency is required to 2030 just to meet the COP21 pledges to keep below 2.7 degrees of warming.
The deeper implication in this debate is banks and other institutions are recognising the challenge of climate change is of a different order to the usual risk assessments they make. Both because it is more complex and because the “pay off" is well beyond any regular time frame.
But that doesn't mean a decision can be avoided. What it means is it will be an ethical and moral decision, consequent with being a good corporate citizen with a more profound “purpose" to support society, not simply an economic decision.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
07 Oct 2015
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