“Once climate change becomes a defining issue for financial stability, it may already be too late”
Mark Carney, Governor of the Bank of England (2015)
This year has been marked by extreme weather across the globe. Hurricanes Harvey, Irma, and Maria wreaked havoc in the Caribbean and southeast US. Europe also experienced turbulent conditions this summer with prolonged heatwaves in the south and unusually wet weather in the Nordic countries. If global warming continues at its current pace then such extreme weather may become increasingly common.
Aside from the environmental impact, climate change poses two serious threats to the stability of the financial system. In a world facing the growing prospect of droughts, floods and other extreme weather phenomena, insurance companies face massive potential losses with knock-on effects for the insurance industry and those who rely on it. Secondly, the fossil fuel sector continues to constitute a large proportion of institutional investor portfolios. In a post-carbon world the values of these companies could evaporate. So climate change will continue to have significant long-term implications for investors.
Fortunately, the world is waking up to the harsh reality of man-made climate change.
Fortunately, the world is waking up to the harsh reality of man-made climate change. Governments and companies worldwide have made limiting emissions of greenhouse gases a priority. The Paris agreement (COP21), which came into effect in late 2016, was a landmark moment in which nearly 200 countries agreed to a long-term goal of keeping the increase in global average temperature to well below 2°C above pre-industrial levels, ideally aiming to limit the increase to 1.5°C.
So progress is being made – but is it enough? The short answer is no. While the Paris agreement was a landmark moment, we must cut greenhouse gas emissions further. The United Nations Environment Programme estimates that on current country pledges, temperatures will rise by 2.9-3.4°C – far above the current Paris target, which itself may not be enough to avert catastrophic climate change.
The road to decarbonisation
Faced with such threats the need for solutions has never been greater. The immediate challenge is to reduce our reliance on fossil fuels. This won’t happen overnight. We have been using fossil fuels to drive economic growth and development for centuries.
The first step should be to reduce our use of coal, by far the dirtiest fossil fuel producing the most carbon dioxide emissions and smog. Change is already underway – since 2010, three of the top five US coal companies have filed for bankruptcy and many countries are reducing coal consumption.
Oil is less polluting while gas is the cleanest of the three fossil fuels, despite contributing to methane emissions. So governments and companies should prepare for a future where gas makes up a larger proportion of energy use. Indeed, this is already underway with the development of new liquefied natural gas pipelines.
Paradoxically, President Trump’s decision to withdraw the US – the world’s second largest greenhouse gas emitter – from the Paris accord has led to renewed efforts to combat climate change. More than 7,400 cities globally have vowed that Trump’s decision will spur greater local efforts to combat climate change. And the Under2 Coalition initiative – covering more than one third of global GDP and including 10 US states – is demonstrating increasing sub-national commitment to action on climate change.
In the absence of the US, China and India are leading the charge on decarbonisation.
In the absence of the US, China and India are leading the charge on decarbonisation. Despite historic challenges with environmental degradation, both have agreed to work with the European Union to control carbon emissions and are making large strides in moving away from coal and other fossil fuels towards alternative energy.
Another part of the solution is expanding the use of renewable energy. In recent years, we have seen large-scale investment in expanding the efficiency and availability of renewables including solar, wind and hydroelectric energy. Interestingly, Moody’s, the credit rating agency, predicts that emerging markets will overtake developed markets in 2018 in their capacity to generate wind and solar power. Equipment and installation costs are falling across regions from Mexico to India and energy storage is also becoming more efficient and affordable. Watch this space.
Companies taking the lead
Progress towards tackling climate change is being sped up by a global task force set up by the G20 nations (the Task Force on Climate-Related Financial Disclosures). It recently recommended that companies should assess and disclose their climate risk governance through strategic long-term scenarios, and banks are advised to reveal their lending to companies with carbon risks. If followed through, this should help investors identify key risks in their portfolios and determine those companies that stand out, either on emission reduction targets or exposure to the growing lower carbon economy.
Companies around the world are also agreeing on the need for action. Many have evolved their products and services to cater for an increasingly knowledgeable and environmentally conscious customer base, a phenomenon driven by the rising purchasing power of women and millennials (those born from around 1980 to the mid-1990s).
We have a societal duty to raise awareness about how we can support efforts to contain global warming.
Asset managers should be playing a major role in the energy transition. We have a societal duty to raise awareness about how we as an industry can support efforts to contain global warming. Our fiduciary duty to clients involves identifying companies that are managing the energy transition successfully. Responsible corporate stewardship and ongoing engagement with companies on environmental, social and governance issues is instrumental in identifying those high-quality companies best prepared for the transition to a low carbon world.
So, Mark Carney’s gloomy prediction can be averted – but it will take concerted action.