Certainty, climate, investors & risk

The catastrophic weather conditions globally in 2018, from extreme heat to typhoons and hurricanes to flooding and prolonged drought, have driven renewed concern around the impact of climate change across many countries.

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While climate change may still cause controversy, globally regulators and standard setters are intensifying their policies on climate change risk exposure. Powerful investor groups are demanding both transparency in reporting and action, and customers are – at the margin at least – supporting companies which have environment-friendly policies.

"More and more major investors are focussing on climate risk in their investments.”

It’s true not all these actions are pure: marketers have seized on the consumer sentiment driving ‘green washing’ and other spurious responses. But neither are the reactionary right and their vested interests correct to disparage the moves as ‘virtue signalling’ (an inherently self-defeating slogan given it acknowledges these policies are indeed virtuous).

Some governments, including the US, the Philippines and Australia, have ignored carbon emission reductions in developing energy policy, but this is not an approach the corporate and particularly financial services sector can follow. In financial services for example, the Financial Stability Board, a uber-supervisory body for banks, is pushing for much more explicit recognition of climate risk.

Weather is not climate but as climate change continues it is clear the incidence and intensity of destructive weather events and more chronic dangers such as rising sea levels will intensify, further increasing pressure for action.


In Australia, the Australian Securities and Investments Commission (ASIC) has warned Australian companies they have to “improve consistency in disclosure practices” in regard to climate risk.

According to ASIC commissioner John Price, “climate change is a foreseeable risk facing many listed companies in the Australian market in a range of different industries”.

“Directors and officers of listed companies need to understand and continually reassess existing and emerging risks (including climate risk) that may affect the company’s business – for better or for worse,” he said.

“Climate risk disclosure practices are still evolving, not only in Australia but also globally. We intend to monitor market practice as it continues to evolve and develop in this area.”

The Australian financial services regulator, the Australian Prudential Supervision Agency (APRA), has also warned its charges to monitor their exposures closely and factor them in to long-term planning.

In other developed markets, particularly Europe but also China and Japan, governments are being much more pro-active in demanding action from the corporate sector to address carbon emissions. (It is true such action remains primarily a developed market phenomenon but given the role of funding from these markets in the developing world, flow on affects are assured.)

In an editorial published in The Financial Times, Japanese prime minister Shinzo Abe noted Japan had set carmakers a goal to cut greenhouse gas emissions per vehicle by 80 per cent by 2050 to realise a “Well-to-Wheel Zero Emission” policy.

“We must simultaneously boost economic growth and reduce the use of fossil fuels,” he wrote. “That means cutting the costs and improving the reliability of renewable energy.”

“Manufacturers with large-scale greenhouse gas emissions should be encouraged to update their production methods.”

In Japan, cost, reliability and emissions are in the frame.

While regulators and policymakers carry big sticks, corporates are particularly sensitive to the demands of capital markets – their owners and funders.

More and more major investors are focussing on climate risk in their investments and so-called ESG (environmental, social and governance) measures are growing in importance.

Abe noted as much.

“Momentum is already growing in the private sector,” he said. “The number of companies engaging in environment, social and governance-focused investment or issuing green bonds is rising dramatically”.

“Japan’s Government Pension Investment Fund [the world’s biggest] is one of them. Investors now require businesses to analyse environmental challenges and disclose potential risks as well as opportunities.”


In the vanguard of pressure from investors is the Investor Group on Climate Change which said in the wake of the ASIC report “investors need companies to report investable data which delivers a complete picture of climate-related risks”.

“Investors are demanding better, more meaningful information and collaborating in unprecedented numbers through initiatives such as the Climate Action 100+ to push for it,” IGCC chief executive Emma Herd said.

“With ASIC, APRA and the market calling for better reporting on climate change, it’s time for Australia companies to step up.”

The IGCC is also part of a broader front, investor signatories to Climate Action 100+ which have scaled up engagement with systemically important greenhouse gas emitters. These emitters, known as the + list, have significant opportunities to drive the clean energy transition.

Launched in December 2017 with 225 investors and $US26 trillion in assets under management, Climate Action 100+ is now backed by 289 investors with nearly $US30 trillion in assets under management, mobilising across 29 countries.

For investors climate change initiatives must have a financial and not just a moral imperative. The financial case does exist. For example, a new report from Moody’s Investors Service finds environmentally friendly infrastructure loans have lower default risk than non-green projects.

Moody’s’ research revealed a 10 year cumulative default rate of 5.7 per cent for green projects compared with 8.5 per cent for non-green projects.

“Our analysis of thousands of project finance bank loans examined various industry sectors that align with our definition of infrastructure,” said Kathrin Heitmann, vice president and senior analyst at Moody’s.

“We further split the data into green and non-green projects and found significant distinctions related to default and recovery rates.”

Meanwhile, the Bloomberg Barclays MSCI Green Bond index outperformed the Barclays Global Aggregate from December 2013 to October 2017, in terms of equivalent bond returns.

An HSBC survey of 1,731 companies and institutional investors worldwide, carried out in May and June, found financial returns - as well as tax incentives - were the main drivers of green investment.

“Investors are now making their decisions on whether to invest in a green bond based on commercial returns,” Daniel Klier, HSBC’s group head of strategy and global head of sustainable finance said.

“This is a good indicator that investors are not purely making such investments for charity but they are really believing such investment can make money,”

Critical moment

This is of course a critical moment as history tells us financial incentives are powerful drivers of human endeavour.

Olli Rehn, governor of the Bank of Finland laid out the economic and regulatory template at a recent conference on climate change.

“Private money, and more importantly private investment decisions made by private companies, need to be aligned with the sustainability targets,” he said.

“Economic theory suggests that the first consideration of policy should be to remove wrong incentives and replace them with better ones, which would take into account the environmental externalities of different economic activities.”

“No longer should the polluting companies freeride on the backs of others - we need to move towards the principle of 'the polluter pays'.”

“The International Energy Agency has estimated global fossil-fuel subsidies exceeded €250 billion in 2016. This is a direct subsidy for fossil fuel consumption at a time when we have problems in finding out how to pay for the transition to sustainable energy. This balance must be changed.”

Rehn argued the costs of emissions needed to be incorporated into the decision-making processes of every company - introducing a global carbon tax should help solve this externality problem, he said.

“The third step is to increase transparency in companies' business models by requiring them to disclose their emissions,” he said. “The European Commission and the Financial Stability Board have been working on such reporting. Many large institutional investors have already embraced their recommendations.”

Companies ignore such forecasts at their peril.

Andrew Cornell is bluenotes Managing Editor

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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