The Financial Sector Is Waking Up to Climate Change

Wall Street Bull - Credit: htmvalerio

In December 2019, Bank of England Governor Mark Carney warned of the “catastrophic impact” climate change could have for the global financial sector unless firms do more to disclose their vulnerabilities and develop plans to curb the negative impacts of climate change. Just one month later, in January 2020, BlackRock, the world’s largest investor, joined Climate Action 100+, a group of investors managing assets worth more than $35 trillion that pressures the companies responsible for two-thirds of annual global industrial emissions to show how they will reduce carbon dioxide emissions. Climate Action 100+ notes that climate change is a systemic risk—one which investors cannot diversify away from. Responsible investors must therefore address climate risks and ensure that the most systemically significant emitters are disclosing climate change risks and opportunities to the market.

Many investors are taking note of these developments. Some, previously attracted to the well-subsidized and profitable fossil fuel industry, are beginning to recognize the precariousness of their investments and are now focusing more on climate change impacts as critical factors in long-term decision-making. Massive public subsidies to the fossil fuel industry have helped obscure its negative impacts (see box).

According to the World Resources Institute (WRI), until recently, financial markets had “been neutral in their influence on sustainable investment decisions, and often downright negative due to their conservatism and short-term focus.” Financial markets are now starting to change as they recognize the serious risks associated with climate change and the perceived opportunities from climate action. The risks include both physical risks and stranded assets (i.e., assets like coal and other fossil fuels that may be phased out before the end of their economic lives).

The physical risks, in addition to health and climate disasters, include wars over dwindling resources (like water and arable land) and the increased number of climate migrants (sometimes called “climagees,” a mash-up of climate refugees) fleeing from crop failures, droughts, wildfires, flooding, and superstorms. According to the U.N. Internal Displacement Monitoring Centre, there were 18.8 million new disaster-related internal displacements recorded in 2017. This number does not include people displaced across borders.

Risk managers, including regulators, have started to take a serious look at the ongoing physical risks and costs of climate change. The Morgan Stanley Institute for Sustainable Investing has documented $650 billion in economic damage resulting from climate disasters between 2016 and 2018, including $415 billion (0.66 percent of GDP) in North America alone.

The Network for Greening the Financial System (NGFS)’s call for action in April 2019 discussed the role of the financial sector in achieving the objectives of the 2015 Paris Agreement. NGFS recognized climate change as a source of structural change in the global economy, recommended actions central banks and supervisors can take, and identified how policymakers can facilitate their work. The NGFS was established at the Paris “One Planet Summit” in December 2017. It has grown from eight Central Banks and Supervisors for Greening the Financial System to 42 members and 8 observers, representing 5 continents. The Network works to enhance the role of the financial system to manage risks and to mobilize capital for green and low-carbon investments.

In October 2019, the U.S. Federal Reserve published Strategies to Address Climate Change Risk in Low- and Moderate-income Communities, highlighting financial dangers to businesses and communities in the United States and possible strategies to deal with them, including:

• Encourage banks to subsidize adaptation projects, which include any investments meant to reduce future costs due to climate change, when doing so provides a net benefit to the community.
• Consider a community’s adaptation capacity and anticipated business continuity to enable investors to better assess risk.
• Recognize climate-induced relocation, or “climigration,” impacts on the private sector as millions of people relocate away from hazards.
• Deal with underlying structural concerns, such as political disenfranchisement, economic inequality, racism, and unrestrained growth which disproportionately impact the most marginalized, including minority and low-income residents, and invest in the virtuous cycle.
• Engage diverse audiences in understanding the climate crisis and scalable solutions.
• Promote healthy local communities that consider unique consequences for individuals aged 65 and over, and recognize the critical role that young people and schools can play.
• Use the Community Reinvestment Act (CRA) to pioneer strategies to increase private investment in underserved communities and to make low- and moderate-income communities whole in the face of disinvestment, economic downturn, and lack of access to opportunity.

The business sector is also paying closer attention to the long-term sustainability of its operations. The Business Roundtable, a group of 181 major U.S. corporation CEOs, has begun to consider the possibility that a corporation’s purpose is not just to benefit shareholders, but all stakeholders—customers, employees, suppliers, communities and shareholders. While short on detail, the Roundtable’s Statement on the Purpose of a Corporation signaled an important step away from simply maximizing profits to “supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.”

Author: Jonathan Herz