Bank of England warning suggests need to upgrade carbon risk disclosure Opinion Article

Oct 01, 2015 - 1:43pm

This article first appeared in Climate Spectator on 1 October 2015. This is a joint op-ed by Emma Herd, CEO of the Investor Group of Climate Change, and Kate Mackenzie, Manager of Investment & Governance of The Climate Institute.

“Past performance is not a reliable indicator of future results”. We’ve all read and heard this countless times, usually in advertisements or documents for investment funds or superannuation.

Given the familiarity of the phrase, you might think that few in finance world would downplay an emerging, pervasive risk that could lead to huge losses and disruption.

Yet amounts of capital are still being directed into assets which are vulnerable to climate change, or will lose value -- becoming “stranded” -- as the world moves to avoid dangerous climate change.

The problem, as Bank of England governor Mark Carney describes it, is “the tragedy of the horizons”. That’s a riff on the “tragedy of the commons” -- a publicly-owned good (such as a park, or a stable climate) which everyone needs, but no-one is incentivised to protect. Horizons for many in the financial sector are measured in months - for financial authorities like the Bank of England and its Australian counterparts can only look two or three years ahead, or perhaps a decade at most for big-picture risks. Climate change’s worst effects will come later than this, but they will be the result of actions taken today.

“In other words, once climate change becomes a defining issue for financial stability, it may already be too late,” he told the audience.

Mr Carney also pointed out that financial policymakers and central bankers like himself can’t drive the transition to a low-carbon economy. It is well outside of their mandate. They do, however, “have a clear interest in ensuring the financial system is resilient to any transition hastened by those decisions, and that it can finance the transition efficiently”.

It is investors themselves, as the intermediary that turns savings into investments, who will play a critical role in getting to a safe, low carbon and ultimately, a net-zero carbon economy. Investors wear the risks and realise the opportunities depending on how well they manage the transition.

And a growing number of financial participants do understand that climate change poses a risk to their returns. The Investor Group on Climate Change was established a decade ago, and today has a membership encompassing most of the biggest super funds and asset managers, responsible for over $1tn in funds under management.

Many investors recognise that carbon risk can be regulatory or physical, market or technological. These play out across asset classes and industry sectors in different ways, and all have the ability to affect returns. Once identified, these risks need to be managed. Investors do this in different ways of doing this, as you’d expect with any broad, complex risk. New tools are emerging as the financial industry grapples with how best to deal with the complexity of climate change.

They face a common problem, however: figuring out exactly how they can be sure that their investments aren’t going to suffer from climate change or climate policies. With company stocks it is relatively straightforward, but what about government bonds, for example? Or derivatives?

Climate risk, particularly through carbon emissions, is embedded so widely in our economy it can be hard to detect. In our stock markets, in our banks, and even in our housing and infrastructure. Australia has a particularly carbon-intensive economy, which is also reflected in our financial sector, as pointed out in The Climate Institute report, “Australia’s Financial System and Climate Risk”.

Most of us have also heard of “black swans” - as an overused term for unexpected and unforeseen events. Climate change isn’t necessarily a “black swan” event. It’s unprecedented and the specifics are difficult to predict, but the direction of travel is already clear. No-one can say they weren’t warned. But what we need now is a common language for talking about these risks in financial terms.

That’s why having an agreed approach to disclosure is so important.

Mr Carney and other international regulators participating in a closed-door meeting last week at the behest of the Financial Stability Board have attempted to address exactly that. “What gets measured gets managed,” Mr Carney said last night. However, he added, there are now some 400 different frameworks, voluntary standards and proprietary methodologies that can be used to measure and disclosed carbon risk. Some make for nice marketing material and others even help to make better decisions, but it is not easy to compare one set of disclosure to another.

The FSB, which represents financial authorities from the world’s biggest countries, discussed establishing a “Climate Disclosure Task Force” - modelled on a similar project to develop relatively simple and comparable ways to compare increasingly complicated risk profiles of banks. A joint approach from industry and financial policy makers for talking about climate risk makes sense and is supported by the investment community.

Kate Mackenzie

Kate is Investment & Governance Manager at The Climate Institute. Prior to joining the Institute in 2014, she worked primarily as a financial journalist, winning awards for her work at the Financial Times and the Australian. Earlier, she was a technology and business reporter for the Australian, and online editor of Australian IT. Kate is a veteran of new media, and was one of the first online journalists to be hired by the ABC in the late 1990s.

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