The greening of the financial sector: a climate ‘tipping point’
11 Jun 2019|

It’s not surprising that climate change featured so prominently in the Australian federal election given the recent record-setting extreme weather that has buffeted the country and warnings from scientists that these events will become more frequent and destructive as the planet continues to warm.

Ultimately, the public’s alarm did not lead to victory for Bill Shorten and Labor. Indeed, Queenslanders, worried about preserving jobs in the coal sector, contributed to his defeat. There is, nevertheless, reason for cautious optimism that we can meet this global challenge faster than either of the major parties may realise.

We may be close to reaching three ‘tipping points’ that will help turn the tide of climate change. Two of them—the renewable energy revolution and the unprecedented level of global public concern about climate change—have received considerable media attention. But a third, the greening of the global financial sector, is greatly underappreciated, although it will ultimately unlock unprecedented investment in low-carbon development and climate resilience.

Influential institutions and actors across the global financial sector are increasingly moving from treating climate change as a public relations matter to seeing it as a core business risk (and opportunity). The work of the Task Force on Climate-related Financial Disclosures is rapidly gaining traction. The voluntary disclosure of material climate-related risks promoted by the task force is now supported by three-quarters of the world’s globally systemic banks, eight of the top 10 global asset managers, the world’s leading pension funds and insurers, major credit-rating agencies, and the big four accounting and consulting firms. Together these institutions manage almost US$110 trillion in assets.

The voluntary reporting addresses two categories of climate risk: physical and transitional. The former concerns financial losses resulting from the sudden-onset hazards that climate change is amplifying (such as wildfires, drought, floods, storms and heatwaves) and from progressively intensifying hazards (such as sea-level rise, changes in rainfall patterns and increasing temperatures). The latter concerns the risks to the financial system, and to specific sectors and investments, associated with the transition to a low-carbon economy.

A vivid demonstration of physical risk unfolded earlier this year when the utility giant Pacific Gas & Electric was forced to declare bankruptcy in the wake of the devastating bushfires that struck Northern California. Mark Carney, the governor of the Bank of England, described this as ‘the first major corporate casualty of climate change’.

Ultimately, the voluntary reporting is likely to become mandatory and the methodology underpinning it more rigorous. As it does, it will unlock enormous amounts of capital that can be redirected from high-carbon to low-carbon assets and shifted away from assets that are exposed to financial losses from extreme weather.

Sophisticated analysis by the world’s largest asset manager, Blackrock, is already detecting major climate-change impacts on the value of investments, including evidence that the most climate-resilient utilities trade at a premium. The company is advising its investors that this premium will increase over time as climate-change risks and dangers compound.

Tools are being developed to help markets and managers make climate-smart investments. Global Infrastructure Basel, for example, is developing a standard for sustainable and resilient infrastructure which will support the development of a resilient asset class that demonstrates higher performance relative to other portfolios. Credit-rating agencies, such as Moody’s, are factoring climate shocks into their analysis of municipal bond issuers’ economies, fiscal position and capital infrastructure, as well as managers’ ability to marshal resources and implement strategies to drive recovery. They are also developing a carbon transition assessment, which measures how well companies will be able to operate in a low-carbon economy.

Australia is a part of many of these global initiatives and is initiating homegrown ones. Guy Debelle, the deputy governor of the Reserve Bank of Australia, warned earlier this year that climate change is increasing the likelihood of non-linear impacts on the economy, with implications for financial stability. The RBA is now working through the challenge of incorporating climate change in the economic models and frameworks that inform Australia’s monetary policy.

Australian insurers, such as IAG, are moving equities holdings away from companies with the highest exposure to, and poor strategies to manage, climate-related risks. The Australian Business Roundtable for Disaster Resilience and Safer Communities, which includes leaders representing a cross-section of the Australian economy, is this year launching a new strategy focusing on partnering with government to build the private sector’s, and the broader community’s, resilience to climate and disaster risk.

The greening of the financial sector, together with the rapidly diminishing cost of renewable energy and growing public demand for climate action, will increasingly have a transformative impact. But it will still not be enough to meet the climate challenge without a fourth tipping point: ambitious government action. As Carney recently observed: ‘Financial policymakers [alone] will not drive the transition to a low-carbon economy. Governments will establish the climate policy frameworks, and the private sector will make the necessary investments.’

This is now a pivotal challenge for the Morrison government. Australia is hugely exposed to both physical and transitional risks. Climate-change-amplified natural disasters are already exacting an enormous social and economic toll and our economy is heavily invested in fossil fuels (we are the world’s largest exporter of coal, valued at $67 billion).

Addressing these risks will require strong leadership and a sustained commitment not just by this government, but also by future governments. The longer it takes to lift the policy ambition, the more costly it will be—both in the narrow economic sense and in terms of lost lives and livelihoods.