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Banking on climate change

Leaving aside that the energy debate in Australia is almost entirely a political one, there is another front, beyond politics and the economics of risk, for would-be financiers.

Global regulators of and investors in the financial services sector, the first port of call for funding or organising the funding of energy generation and distribution, have very clear views on the carbon economy.

And they are not malleable to particular national sensibilities. Nor do they support subsidies of existing, higher carbon intensity generation.

" Global regulators of and investors in the financial services sector… have very clear views on the carbon economy.” - Andrew Cornell

Last week a group of 100 global investors with nearly $US2 trillion under management demanded the world’s top 60 banks take action to protect the world from catastrophic climate change.

Investors included pension funds, asset owners and asset managers including Candriam Investors Group and Hermes EOS. They’ve written to the CEOs of the world’s largest banks, including Bank of America, Deutsche Bank, HSBC Holdings, JP Morgan Chase, Mitsubishi UFJ Financial Group and Australia’s majors.

Such investors are owners of both bank equity and debt.

The letter, coordinated by responsible investment non-profit ShareAction and Boston Common Asset Management, calls for more robust and relevant climate-related disclosure to be supplied to investors on four key areas:

  • climate-relevant strategy and implementation;
  • climate-related risk assessments and management;
  • low-carbon banking products and services; and
  • public policy engagements and collaboration with other actors on climate change.

The letter comes on top of demands from global banking regulators for greater transparency from banks with respect to how they are managing the financial risks associated with climate change.

Vulnerability

Mark Carney, governor of the Bank of England and chairman of the Financial Stability Board has been one of the most prominent figures warning banks to be aware of their role in and vulnerability to a more carbon constrained world.

In a recent presentation at a forum organised by the BIS, OMFIF, the Deutsche Bundesbank and the World Bank Group, Green finance: can it help combat climate change?, Luiz Awazu Pereira da Silva outlined key elements of how regulators were thinking.

“Any good policy to combat climate change requires a ‘price’ to act as an incentive to reduce a negative externality such as greenhouse gases (GHGs), in line with basic welfare economics,” he said.

While couching his discussion in the even-handedness of official economists, da Silva argued a "shadow price", incorporating the social cost of carbon (SCC), would be enough to reduce emissions in a perfect world.

“In particular, in the cost-benefit analysis of investment projects, (we should) to take into account these negative externalities (eg congestion, pollution, toxic emissions),” he said.

It’s not easy – even without partisan politics: “the ‘right price of carbon’ is a tricky issue; we need to be pragmatic and use various metrics to reach emission targets, calculating abatement costs while incorporating all the available information on new technologies that reduce them.”

However, for the financial services and investment sector, to argue a price is difficult to determine is not to argue it doesn’t exist.

Both regulators and major investors recognise this price is not negligible – hence the increasing pressure for banks to be fully cognisant of the longer term costs of funding emissions intensive industries, particularly coal-fired energy generation.

The ShareAction letter asked for details from major banks of their plans to support the transition to a low-carbon economy – entailing investment of up to $US93 trillion by 2030.

According to Isabelle Cabie, Global Head of Responsible Development at Candriam Investors Group, “banks now face risks and opportunities that are real, wide-ranging, and material to investors.”

“As long-term investors, better disclosure of climate risk allows us to judge how specific banks are performing compared to their peers, and so we ask that banks pay heed to this important call from the investor community.”

ShareAction’s chief executive Catherine Howarth says “millions of people have an interest in how these banks respond to climate change, whether as citizens affected by the frightening physical impacts we hear about almost daily now in the news, as pension savers whose funds invest in these banks, or indeed as customers of these banks”.

Compensation

Some banks – ShareAction names Barclays – have already linked compensation to senior executives with the meeting of climate strategy goals.

The investment community is already acting itself, not just demanding action. In a recent survey by HSBC, 68 per cent of global investors said they intend to increase their low-carbon related investments to accelerate the transition to cleaner energy generation.

“Growing investor appetite for low carbon investments is strongest in Europe (97 per cent), the Americas (85 per cent) and Asia (68 per cent),” the survey of a thousand companies found.

The survey did find one factor inhibiting companies from increasing disclosure on their carbon strategies is the lack of any clear competitive advantage from doing so, specifically with regard to the cost of funding.

The main drivers of increased transparency were investor pressure (83 per cent) and international regulation (77 per cent).

What we are now seeing is these two factors, already driving the shift, are becoming increasingly prominent. Regardless of what national governments say or do, globally regulated banks and investors will have to respond to these demands.

That, and their own sustainability and environmental policies, coupled with community expectations, will push them further towards more “green” investments.

The BoE’s Carney and the FSB have warned of “potentially huge” losses for the banking sector stemming from climate change.

A withdrawal of funding by investors for banks seen to be opaque in reporting their climate change exposures or remiss in where they are directing investment funding add another layer of supra-national pressure.

Implications

In Australia, where the climate change debate has become particularly polarised and truculent, the local financial system supervisor is no climate denialist.

Speaking at the Insurance Council of Australia Annual Forum earlier this year, Australian Prudential Regulation Authority executive board member Geoff Summerhayes discussed climate change and its implications for prudential supervision and the financial sector.

The speech,  “Australia's new horizon: Climate change challenges and prudential risk”, outlined APRA’s thinking following the 2015 Paris Climate Agreement and the Financial Stability Board's draft recommendation on climate-related risk disclosure released in December 2016.

“While climate risks have been broadly recognised, they have often been seen as a future problem or a non-financial problem,” he said.

“The key point I want to make today, and that APRA wants to be explicit about, is that this is no longer the case. Some climate risks are distinctly 'financial' in nature. Many of these risks are foreseeable, material and actionable now. Climate risks also have potential system-wide implications that APRA and other regulators here and abroad are paying much closer attention to.”

‘Green finance’, whether via particular bonds or more direct investment in projects, is becoming more and more attractive to investors. They see in it an opportunity for potentially higher returns as more sectors and even governments recognise what combating climate change means.

The corollary is also true: the attraction of investing in conventional, carbon-intensive generation, which runs the risk of being ‘stranded’ by newer technologies and renewables, is less and less attractive.

Andrew Cornell is manging editor at bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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