The battle to halt climate change is reshaping business.
Sales of electric cars and solar panels are rising fast, while coal is falling out of favour. Entire industries are facing obsolescence, and new ones are springing up.
Yet the revolution is not unfolding quickly enough. That's the view of Dr Paul Fisher, a former member of the Bank of England’s Monetary Policy Committee and now fellow of the Cambridge Institute for Sustainability Leadership (CISL).
To him, the low carbon economy won't become a reality unless companies account properly for the climate-related risks they face.
“A lot of people treat climate change as if it’s an ethical, social, moral and political issue. And it is. But that gets in the way. It stops people dealing with it rationally. My take on it is that this is a business issue,” he says.
“The demand for goods and services is going to change as we move to a lower carbon economy and/or as temperature continues to warm.”
Whether it's businesses considering the viability of their plans or investors deciding where to put their money, environmental risk should be the top priority.
The problem is that the financial models currently in use aren’t set up to cope with the unpredictable and multi-faceted nature of the climate threat. They fail to account for the physical, policy and legal challenges that come with global warming, or the potential changes in consumer behaviour.
“Traditional risk management looks at data on the basis that risks which happened in the past might crystallise again in the future. Climate change being on an upward trend, most of the potential climate-related risks haven’t crystallised yet – they are not in the data,” says Fisher. “So what you have to do is more like scenario analysis, where one has to work out the “what ifs” around how your business model might be affected. It’s a lot harder.”
Power of regulation
For a start, there are a lot of unknowns. Nobody can say for sure how quickly global temperatures will rise, or what action governments and regulators might take.
“Governments have promised they will act to combat global warming, but we don’t know entirely what they are going to do. Every time a government makes a policy decision, that has the potential to shift financial markets – it will benefit some industries and companies, and be negative for others,” Fisher says. “We have already seen examples of companies that have lost their [stock market] value because of government policy decisions.”
The world’s largest private coal company, Peabody Energy, for example, was hit by a shift towards gas use in the US, while German utility firm RWE was impacted by the Berlin government’s drive to phase out nuclear energy.
And governments are bound to do more. The UK may have taken the lead by committing to reduce carbon emissions to zero by 2050, but in order to effectively stop global warming it will need to find a way to reduce the stock of greenhouse gases already in the atmosphere – and the technology to do that is still in its infancy.
The physical impacts of climate change, meanwhile, are likely to alter the price of land and of real estate, which will have a knock on effect on the value of the collateral held by banks as security for loans.
“A climate-related event has the potential to destroy a borrower’s ability to repay its debt and to take away the security at the same time,” Fisher warns.
Insurance risks
The rising frequency of catastrophic weather events – such as major floods, droughts or wildfires – has a particularly pronounced effect on insurance companies. According to a Bank of England report, the number of weather-related events which have led to insurance losses has tripled since the 1980s, while insurance losses have increased five-fold to around USD55 billion per year, when adjusted for inflation.
“There is some evidence that climate events are becoming more correlated – you get droughts simultaneously all over the world, where you didn’t before,” says Fisher. The whole insurance business model could be under threat, leading to rising premiums and reduced coverage. That, in turn, will have repercussions for financial markets and overall financial stability.
“Our financial system currently attaches a high valuation to fossil fuel producers and users. There could be a simultaneous repricing of a lot of those assets. That would threaten financial stability. It’s a tail risk – so not very likely, but would have a big impact if it happens,” says Fisher.
Governments and regulators can help bring about the repricing of climate risk in a more orderly way. They can force disclosure of climate exposures, and encourage capital to flow into green sectors. On clean energy alone, United Nations-commissioned research estimates that the world must invest USD2.4 trillion each year through to 2035 to avoid catastrophic climate change.
“Green finance is about enabling the financial sector to deliver the required financial support to the green economy, and create sustainable markets.” Fisher concludes. “It is the real economy that’s going to be in the lead on fighting climate change, but it is the job of the financial sector to fund it.”
