Climate solutions best found in financial risk management

We need to speak a language that echoes and resonates within the existing financial paradigm. Photograph: Lydia Khmer/Connect4Climate

 

We need to speak a language that echoes and resonates within the existing financial paradigm. Photograph: Lydia Khmer/Connect4Climate
We need to speak a language that echoes and resonates within the existing financial paradigm. Photograph: Lydia Khmer/Connect4Climate

As climate change drives an ever-expanding list of risks and uncertainties, momentum is building to frame the problem and its solutions through the lens of financial risk management. This is an undeniably positive development, and one we at Asset Owners Disclosure Project (AODP) Carbon Tracker and others in the finance/climate space (even someforward-looking politicians and philanthropies) wholly support.

The recent global risk index compiled by the World Economic Forum (a who’s who of sustainability leaders) declared climate change as a major threat to world economic security. Recognition of this peril was a heartening development, as was hearing U.N. climate chief Christiana Figueres recently describe climate change as one of the biggest long-term threats to investments and the wealth of the global economy.

This isn’t an exaggeration. Our 2013-14 Global Index and other reports illustrate that the world’s largest asset owners (which we define as pension and superannuation funds, insurance companies, endowments and sovereign wealth funds) aren’t adequately assessing and responding to climate change risks.

These risks will play out in familiar ways, such as extreme weather ruining uninsurable property, but also through product obsolescence and asset devaluation as the world inevitably moves through various pathways toward a low-carbon economy. Without action to correct the imbalance between high and low carbon investments, climate-related risks could cripple the global financial system just as the sub-prime housing crisis did in 2008.

Chastising the laggards and making demands on moral ground, however, isn’t going to generate the amount of change this problem demands.

We need to speak a language that echoes and resonates within the existing financial paradigm. One-hundred percent divestment from high-carbon assets is a noble end goal, and one path that civil society is busy promoting. But more importantly, we encourage asset owners to actively manage and progressively divest from this systemic risk — not because it’s the right thing to do for the planet but because it’s their fiduciary responsibility as managers of individuals’ retirement and pension funds.

What does active management look like? The first step is recognising that climate change will crash head-on with our current investment framework, which biases short-term performance and return. This pits the interests of fund managers (many of whom are pressured by asset consultants addicted to out-dated models that should have been thrown away after the sub-prime crash) against the long-term interests of investors in these funds. Active management works to identify forward-looking risk analysis and methodologies that can, over time, identify climate-related vulnerabilities. You can’t manage a risk you can’t define.

This transition goes hand in hand with greater transparency. There is currently a dearth of publicly available data about the amount of high-carbon assets in a portfolio as well as how they are managed. Disclosure is a critical step toward empowering fund investors and other stakeholders to hold asset owners accountable.

Perhaps the most important component of active risk management, however, is hedging — investing in two competing industries, so that if one becomes obsolete, the other will most likely increase in value. This means investing in low-carbon assets so that when carbon is re-priced, the destruction of value in their high-carbon investments is offset by an increase in their low-carbon ones, be they in renewable energy, energy efficiency, clean tech, mitigation and adaption assets, climate bonds — or even new financial derivatives dreamed up by our great Wall Street entrepreneurs.

This won’t be easy or quick, by any means. Yet there is already movement from industry leaders, and research indicates low carbon does not mean low performance. None of the AODP AAA-rated funds has suffered poor financial performance as a result of their climate efforts.

Now is the time for civil society to move beyond campaign slogans and play the finance industry on its own turf — a game that can certainly be won. Divestment calls have got us in the door, and there is now an opportunity for us to display a complete toolbox to help asset owners face their most complex change they have faced. If we do this, they will be on our side. If we don’t, we willfully ignore climate change for what it is: the paramount market risk facing the world today.

Julian Poulter is the founder and executive director of the Asset Owners Disclosure Project. He is also business director of research and advocacy group The Climate Institute, based in Australia. Julian is an experienced business executive with his primary experience in strategy and change consulting combined with several CEO and director roles.

This piece was first published in The Guardian. Reproduced with permission of the author.

 

 

 

 

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