Climate change a threat to financial stability – Bank of England governor

Intro

Mark Carney, the governor of the Bank of England, has become the latest person to deliver a blunt warning about the risks of climate change to global financial stability. Speaking at Lloyd’s of London, Carney warned that “the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations” and that “climate change will threaten financial resilience and longer-term prosperity.” His speech came as the Bank of England published a report on the impact of climate change on the British insurance industry, to be presented to the UK government, and sees the governor join a host of economic figureheads warning about the risk of continued reliance on dirty fossil fuels.

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Key Points

  • By acting now, the financial sector can limit its exposure to climate risks. Carney warned that time is running out and urged greater action to limit the risk, including stricter tests to identify the potential impacts of climate change on returns. He also called for greater transparency by carbon intensive industries on how much they are emitting today and how they are planning for a carbon-free world, and urged G20 nations to consider developing consistent and clear rules to aid this. Such measures would expose those companies continuing to bet on out-dated energy and leave them nowhere to hide as the rest of the world transitions to a low carbon economy.

Background

Mark Carney, the governor of the Bank of England has, this week, become the latest person to add his voice to the climate debate, delivering a blunt warning over the risks of climate change to global financial stability. Speaking at Lloyd’s of London, Carney warned that “the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations” and that “climate change will threaten financial resilience and longer-term prosperity.”

In his speech he laid out a host of ways in which climate change would impact financial stability: the physical risks that come through claims following extreme weather events; the transition risk caused by the re-assessment of fossil fuel assets as the world transitions towards a clean energy future; and liability risks that could rise if those suffering climate change losses sought compensation from those they held responsible.

Urging action, Carney warned that “the challenges currently posed by climate change pale in significance compared with what might come.” and that by the time climate “becomes a defining issue for financial stability, it may already be too late”. He called for greater stress testing to identify potential impacts of climate change on returns, while also calling for better disclosure of information about how much companies are emitting but also how they are planning for a transition to a fossil-free world. He recommended a voluntary ‘Climate Disclosure Task Force’ to help design and deliver a voluntary standard for disclosure by those companies that produce or emit carbon and said the Financial Stability Board, an international body monitoring the global financial system that Carney chairs, may recommend G20 countries make it easier for investors to compare the “carbon intensity” of different assets.

While this week’s speech may be Carney’s most outspoken analysis of climate change to date, it is not the first time the governor has used his position to speak on the issue. Speaking at the World Bank in October 2013, Carney warned that “the vast majority of reserves are unburnable” and urged companies and public institutions to consider climate change risk in their annual reporting. In late 2014, the Bank of England revealed that it was conducting the inquiry into stranded assets, just days after it wrote to insurers asking them to assess how extreme weather as a result of climate change  could affect the “the viability” of their business.

It joins a host of other economic institutions in warning about the dangers of continued investments in fossil fuels assets, including the International Energy Agency, the World Bank and the International Monetary Fund. In March 2015, HSBC, also warned of this potential, publishing a research note ‘Stranded Assets: what next’? warning of the increasing risk of “stranded assets” in the fossil fuel industry, while in June 2015 Mercer published a report ‘Investing in a Time of Climate Change, which stressed that climate-related risk factors should be standard considerations for investors because climate change “will inevitably have an impact on investment returns”.

Carney’s latest intervention comes as the Bank of England publishes a report – to be submitted to the UK’s Department for Environment, Food and Rural Affairs – setting out the impact of climate change on the British insurance industry. This report, alongside the others resulting from the second round of Adaptation Reporting, will inform the next UK Climate Change Risk Assessment, to be laid before Parliament in 2017.

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Key Quotes

  • “Climate change is the tragedy of the horizon. We don’t need an army of actuaries to tell us that the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix… The horizon for monetary policy extends out to two to three years. 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.” – Governor of the Bank of England, Mark Carney
  • “Cases like Arch Coal and Peabody Energy – where it is alleged that the directors of corporate pension schemes failed in their fiduciary duties by not considering financial risks driven at least in part by climate change 21 – illustrate the potential for long-tail risks to be significant, uncertain and non-linear. And ‘Loss and Damage’ from climate change – and what to do about it – is now formally on the agenda of the United Nations Framework Convention on Climate Change, with some talking openly about the case for compensation. These risks will only increase as the science and evidence of climate change hardens.” – Governor of the Bank of England, Mark Carney
  • “If that estimate is even approximately correct it would render the vast majority of reserves “stranded” – oil, gas and coal that will be literally unburnable without expensive carbon capture technology, which itself alters fossil fuel economics… On the other hand, financing the de-carbonisation of our economy is a major opportunity for insurers as long-term investors.  It implies a sweeping reallocation of resources and a technological revolution, with investment in long-term infrastructure assets at roughly quadruple the present rate. For this to happen, “green” finance cannot conceivably remain a niche interest over the medium term.” – Governor of the Bank of England, Mark Carney
  • “The more we invest with foresight; the less we will regret in hindsight.” – Governor of the Bank of England, Mark Carney
  • “Mark Carney spoke under the Lutine Bell, the way Lloyds has signalled great events that will affect the market. He chose his setting perfectly. We welcome his focus on more consistent and reliable carbon disclosure that will allow investors to make a more informed assessment of the climate risks in their portfolios.” – Stephanie Pfeifer, CEO of the Institutional Investors Group on Climate Change
  • “Carbon Tracker welcomes this important milestone, a major international microprudential regulator clearly setting out  for the first time how climate risk is a material financial risk. The PRA [Prudential Regulation Authority] and ourselves share a common acknowledgement that a declining ‘carbon budget’ to 2 degrees will mean that fossil fuels will need to stay in the ground. For investors, including insurance companies, this creates the risks of ‘stranded assets’ in an investment portfolio. Carbon Tracker agrees that the best way to address this risk is by relevant disclosure that allows policymakers, firms and investors the ability to make informed choices. Carbon Tracker’s analysis of the world’s top 200 publicly traded fossil fuel companies discovered that they are developing  or are proposing to develop enough fossil fuels to take us beyond 4 degrees of warming. This report highlights the risks facing these companies and the potential for litigation related to climate damage. With this report, investors will sit up and take notice of the potential risks and liabilities these companies face and begin to re-price this material risk. Fossil fuel investors face the combined risk of their business models being out-competed by price competitiveness of the renewables energy sector, while also potentially picking up the costs of climate damage.” – Mark Campanale, Founder and Executive Director of the Carbon Tracker Initiative
  • “Today’s report from the Bank of England should sound warning bells for anyone working in the financial sector. It confirms climate change is an immediate, material business risk. The case for litigation brought against those ignoring climate change risk grows ever stronger. If directors fail to manage the risks and opportunities presented by climate change, they could be found personally liable for losses incurred by the company in the future. Investors such as pension fund trustees and their advisors also have legal duties to manage the risks affecting their portfolios. ClientEarth is examining these duties and we may bring legal challenges if we find that funds are failing to meet their obligations. Investors across the board cannot afford to treat climate change as a distant possibility. Increased regulation, changing market dynamics and heightened risk to physical assets must shape their investment decisions from today.” – Alice Garton, Lawyer at ClientEarth
  • “The lessons of the sub-prime crisis were quickly forgotten by most banks itching to return to their short term ways, but Mark Carney has laid out their next crisis in black and white – “Sub-Clime” is coming and we need to act fast. Investors should be taking action now, not panicking once the crash hits and it is too late.” – Julian Poulter, Founder and CEO of the Asset Owner Disclosure Project (AODP)
  • “Mark Carney has offered a worthwhile challenge to institutional investors: Become part of the solution to climate change by acting as fiduciary capitalists. Preventable Surprises applauds this call to action, and will support the financial industry with actionable ideas to help investors engage with the companies whose shares and debt they own.” – John Rogers, former CEO and President of the CFA Institute 
  • “Ceres welcomes the leadership of the Bank of England in its call for greater transparency and consistency of climate risk disclosure by insurers. Climate change has the potential to affect insurance companies’ financial stability through both higher losses and declining asset values. Greater transparency by all insurance companies will allow investors and regulators to more accurately assess companies’ management of their exposures and enable appropriate action. Over the past decade, Ceres has worked with U.S. insurance regulators to require stronger climate risk disclosure by all U.S. insurers through the implementation of the “Climate Risk Disclosure Survey.” Ceres will be releasing its next report benchmarking insurers responses in mid-2016.” – Cynthia McHale, Director Insurance Program at Ceres
  • “The Bank of England’s public statement that climate risk is a material financial risk speaks to the challenge of so-called stranded assets, and makes planning for declining carbon intensity an absolutely mainstream investment requirement. CCLA agrees that the best immediate means of illuminating the risk are through relevant disclosure that supports informed decision taking. As investors we recognise that the investment risks associated with companies with high carbon intensity are now significant, and CCLA will now work to build coalitions of investors driving change through engagement and co-filing such as with ‘Aiming for A’.” – James Bevan, Chief Investment Officer at CCLA
  • “Mark Carney has offered a worthwhile challenge to institutional investors: Become part of the solution to climate change by acting as fiduciary capitalists. Preventable Surprises applauds this call to action, and will support the financial industry with actionable ideas to help investors engage with the companies whose shares and debt they own.” – John Rogers, former CEO and President of the CFA Institute

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