Modern markets response to climate change and their likely response to a climate emergency
The central weakness in most assessments of how climate action will occur, and particularly on how it will impact the economy, is the idea of the ‘single big decision’. The questions often asked are: When will this happen? What will be the tipping point? Do we need a major climate catastrophe? When will the world agree on a treaty that then drives globally coordinated policy?
This is a flawed world view, not supported by the evidence of how modern markets work or how major change happens. The reality is much closer to one where millions of small decisions are made throughout a system, that ripple through it, and then, at some imprecise point, that system transitions into a new state. Historians may then refer to a tipping point to explain the shift, but in reality it’s not likely to be a ‘single big decision’.
While there may have been an intense focus in the past year on the climate emergency and the level of existential risk, markets have been analysing and adjusting for increasing climate and carbon risk for three decades, and at a rapidly increasing pace in the past decade.
However, the public debate and most people’s assumptions are still dominated by the now irrelevant framing of ‘action = cost’ and the follow-on assumption that action will only occur through policy intervention (e.g. a carbon price).
This is now totally flawed. Firstly, already today, action does not always equal extra cost, in fact it often lowers direct costs and even more often, indirect costs. Secondly, we live in a modern globalised and highly connected market economy - financial risk is managed based on constantly adjusting assumptions about changes in future policy, physical risks, public attitudes and the complex interplay and sometimes contagion [FN4] between these factors. Together these unleash powerful drivers that are already driving change, and will also soon accelerate it.
The totality of the change driven by the market economy in this way, while powerful, will not drive the emergency transition at the scale or speed required to face the climate crisis. That is why policy remains key. It is however, a critical contributor and influencer both on action but also on the decisions of policy makers. Policy makers will be more likely to act when they see major market players being ready to deliver.
As this all unfolds, there will be many more events and triggers across the system. These should be monitored and understood by anyone seeking to understand how change will occur and how to accelerate it. Examples may include physical climate events and the markets response to them, actions from corporations and regulators, the collapse or creation of industries, major losses or gains in the value of key sectors and disruptors, risk rating downgrades of incumbent corporations or entire countries, protests in the streets, legislative change or a solitary 16 year old sitting on the steps of parliament demanding action.
Economic and financial shifts towards change
We have created a time-line of what we think are an interesting selection of recent key economic and financial events that are incrementally shifting the market. This timeline includes actions from corporations and regulators, key findings from research and the opinions of influential experts. It is not intended to be an exhaustive list, but just provides examples of the system preparing for what is to come.
If you would like to suggest an addition, you can make you can give us your suggestion here.
2014: Ratings agency Standard & Poors releases report on climate change being global mega-trend for sovereign risk. “Climate change is likely to be one of the global mega-trends impacting sovereign creditworthiness, in most cases negatively. The impact on creditworthiness will probably be felt through various channels, including economic growth, external performance, and public finances.”
June 2017: The Task Force on Climate-related Financial Disclosures (TCFD) releases final recommendations for companies and other organizations to develop more effective climate-related financial disclosures. The intention being to promote more transparent pricing of climate change risk to support informed, efficient capital-allocation decisions.
2018: FTSE Russell announce that the green economy [FN4] has reached parity with the fossil fuel - “the green economy is now worth as much as the fossil fuel sector and offers more significant and safe investment opportunities”.
July 2018: Swiss Re (the world’s largest re insurer) announces it will not provide re/insurance to businesses with more than 30% thermal coal exposure. Noting that restrictions would apply to specific properties seeking coverage, not whole companies.
January 2019: The World Economic Forum’s 2019 Global Risk Report, reports survey respondents have identified ‘Extreme weather events’, ‘Failure of climate change mitigation and adaptation’ and ‘Natural disasters’ as the 3 most likely global risks from a total of 30 risks. ‘Failure of climate mitigation and adaptation’ and ‘Extreme weather events’, were identified in the top three risks, as having the highest global impact.
May 2019: 76 major companies ask congress for a price on carbon advising that “Climate is clearly the biggest issue that we have in front of us”. Majors include Royal Dutch Shell, DSM, Unilever, BP, BHP & Nestle
June 2019: Task force on climate related financial disclosures (TCFD) releases status report showing 340 investors with nearly $34 trillion in assets under management now require companies to report under TSFD.
June 2019: Rostin Behnam, one of the 5 member US Commodity Futures Trading Commission warns “If climate change causes more volatile frequent and extreme weather events, you’re going to have a scenario where these large providers of financial products — mortgages, home insurance, pensions — cannot shift risk away from their portfolios,” “It’s abundantly clear that climate change poses financial risk to the stability of the financial system.”
June 2019: Moody’s Analytics release report warning that climate change could inflict $69 trillion in damage on the global economy by the year 2100, assuming that warming hits 2 degrees.
June 2019: Norway’s parliament votes into law for The Norwegian Pension Fund (the world’s largest sovereign wealth fund), to dump more than $13bn of investments in eight coal companies and an estimated 150 oil producers.
July 2019: Ratings agency Moody’s acquires majority stake in climate change data firm Four Twenty Seven, signalling a shift in how they will price climate risk into methodologies for assigning ratings.
August 2019: The Australian Securities and Investments Commission names climate change as a ‘systemic risk that could have a material impact on the future financial position, performance or prospects of entities’ in its rulebook.
August 2019: Bloomberg NEF reports that for 2/3 of the global population, it is already cheaper to get power by building new wind or solar farms (unsubsidised) than a fossil-fuel power plant. For the rest of the world, including countries like Japan and much of southeast Asia, where coal currently has the edge, renewable plants are likely to be cheaper within the next five years.
September 2019: An alliance of the the world’s largest pension funds and insurers (United Nations-convened Net-Zero Asset Owner Alliance - responsible for directing more than US$ 2.4 trillion in investments), commits to carbon-neutral investment portfolios by 2050.
September 2019: Bank BNP Paribas releases research comparing how and outlay of $100bn for oil and renewables converts to useful energy at the wheel for cars and light-duty vehicles. The report says, the long-term break-even oil price for gasoline to remain competitive as a source of mobility is $9 - $10 per barrel, and for diesel $17 - $19 a barrel.
September 2019: An IMF working paper examining macroeconomic and financial policies for climate change concludes “"There is growing agreement between economists and scientists that risk of catastrophic and irreversible disaster is rising, implying potentially infinite costs of unmitigated climate change, including, in the extreme, human extinction."
October 2019: IMF announces that they will examine the impact of climate on the world's financial markets and whether it is priced into market valuations.
October 2019: New York attorney general’s securities fraud lawsuit against Exxon Mobil goes to trial, accusing them of lying to investors about how profitable the company will remain as governments impose stricter regulations to combat global warming.
October 2019: Governor of the Bank of England Mark Carney warns that “Companies that don’t adapt [to zero carbon] will go bankrupt without question.”
October 2019: The state of Massachusetts files lawsuit against Exxon Mobil, accusing them of deceptive advertising to Massachusetts consumers and for misleading Massachusetts investors about the risks to Exxon’s business posed by fossil fuel-driven climate change—including systemic financial risk.
October 2019: Investment bank Morgan Stanley release report advising that global investment of US$50 trillion will be required to meet the Paris Agreement’s goals. The report list sectors where investments should be directed (Renewable power & storage US$14 trillion; electric vehicles US$11 trillion; carbon capture & storage US$2.5 trillion; hydrogen US$2.7 trillion, and biofuels US$2.7 trillion), as well as individual stocks that could benefit.
November 2019: The European Investment Bank, the largest public bank in the world, will phase out lending to fossil fuel projects by 2021.
November 2019: Sweden’s central bank Riksbank announces that to manage the economic consequences of climate change it will reject bonds that have a “large climate footprint”. Bonds issued by the Canadian province of Alberta and the Australian states of Queensland and Western Australia have recently been sold.
December 2019: Spanish oil and gas company Repsol pledges to achieve net zero emissions by 2050. Investors urge other oil majors to follow suit to demonstrate to shareholders that they are “looking forward, not back, when it comes to the energy transition.”
December 2019: A group of 285 companies including Microsoft, Coca-cola and Unilever commit to science based emission targets, a move that will see $18 billion in climate investment, an additional 90 TWh of renewable energy and emission reductions in the order of 265 million mt CO2e.
December 2019: More than 600 institutional investors managing $37 trillion in client assets call for an end to thermal coal power plants worldwide, the introduction of a “meaningful” price on carbon, an end to fossil fuel subsidies and for governments to cut emissions beyond Paris pledges.
December 2019: Goldman Sachs pledges to decline financing that directly supports new thermal coal mines and upstream Arctic oil exploration and development. $750 billion will also be directed to “climate transition and inclusive growth finance” over the next decade.
December 2019: The Bank of England announces that lenders and insurers will be tested on their preparedness to manage risks posed by frequent severe weather and the sudden sale of “brown” assets — those considered detrimental to the environment. In the most severe scenario, lenders and insurers would be tested against temperature rises of as much as 4 degrees by 2080. Lenders and insurers have been notified that they will also soon need to nominate a senior manager responsible for climate risk who will be liable for fines or bans if risks are not adequately managed.
December 2019: The Supreme Court of the Netherlands ordered the government to cut the nation’s greenhouse gas emissions by 25 percent from 1990 levels by the end of 2020. It was the first time a nation has been required by its courts to take action against climate change. In the decision, the Chief Justice said because of climate change||” the lives, well being and living circumstances of many people around the world, including in the Netherlands, are being threatened…Those consequences are happening already.”
January 2020: BlackRock, the worlds largest asset manager with nearly $7 trillion in investments announces that it will make investment decisions with environmental sustainability as a core goal and exit investments that "present a high sustainability-related risk”. CEO Larry Fink wrote ““Awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance… The evidence on climate risk is compelling investors to reassess core assumptions about modern finance.”
January 2020: Chairman of UK Oil and Gas Authority (OGA), Tim Eggar, warns that the oil and gas industry must “act much, much faster and go farther in reducing the carbon footprint” “Climate change is happening now. The debate is over. The framework, the licence to operate for the industry, has changed fundamentally and -unlike the oil price - forever…If the industry wants to survive and contribute to the energy transition it has to adapt”.
January 2020: TCI Fund Management (worlds most profitable hedge fund) Manager Sir Christopher Hohn announces that he will leverage his $30 billion in assets to reduce fossil fuels and greenhouse emissions or “he’ll oust their boards or dump their shares”. Hohn explained that “[Investors] can use their voting power to force change on companies who refuse to take their environmental emissions seriously…Investors have the power, and they have to use it.”
January 2020: Reserve Bank of Australia Governor Philip Lowe warns that while “Addressing climate change isn't something that is any responsibility of the Reserve Bank of Australia, but what we do have a responsibility to do is to understand the economic and the financial implication of climate change… The economic implications are profound”.
January 2020: Leaked report from JP Morgan economists warns that business as usual climate policy “would likely push the earth to a place that we haven’t seen for many millions of years” and “Although precise predictions are not possible, it is clear that the Earth is on an unsustainable trajectory. Something will have to change at some point if the human race is going to survive”.
March 2020: UBS Group announces it will no longer finance offshore-oil projects in the Arctic or greenfield thermal coal mines and oil sands projects. Assets tied to the energy and utility sector have also been reduced by 40% in the last year and core sustainable investments have doubled since 2017 to $488 billion.
May 2020: Total SA joins BP and Shell in announcing it will reach net-zero emissions (associated with it’s own operations) by 2050. The French company has however also taken the additional step by vowing that all if it’s energy products used in Europe will also be carbon neutral by 2050, and cut the emissions of products used world-wide by 60%.
FOOTNOTES
FN4 A contagion is the spread of an economic crisis from one sector, market or region to another and can occur at a regional, domestic or global level. Consider this description of climate risk contagion from Rostin Behnam, US Commodity Futures Trading Commission: “Thinking about the flooding in the Midwest and the tornadoes that we experienced this past spring, you have farmland, homes, businesses that are still literally underwater and recovering from the floods. Tied to all of these are personal mortgages, commercial mortgage, or farm loans for purchasing truck equipment, or seed, or any number of farmer needs. When this land is not able to be used there’s going to be an asset impairment which could affect the lender. In that case, you could have a regional bank or a national bank that has a series of loans that are not being paid back. And if they’re not being paid back, I think it’s important that regulators start to think about what risk and what risk exposure those financial institutions have”.
FN5 The green economy is defined as an economy that aims at reducing environmental risks and ecological scarcities, and that aims for sustainable development without degrading the environment.