Investors fear next financial crisis will be climate-related

A rushed transition to clean energy triggered by extreme weather events linked to global warming “will be very expensive” to swallow for the economy, investors warned policymakers at an event in Bratislava last week.

“Does climate change pose a systemic risk? ― I think the answer is yes,” said Annie Bersagel, responsible investment advisor at KLP, a Norwegian pension fund which is also the country’s largest life insurance company.

“But I would add that we don’t know yet what those risks will be,” Bersagel told a panel of policymakers at the Transition to the Green Economy (T2gE) conference in Bratislava last week (6 September).

KLP, she said, has chosen a prudent approach by divesting entirely from coal and launching an investment fund to develop renewable energy infrastructure in developing countries.

“I don’t think we have a choice” of moving towards a green economy, said Frido Kraanen, director of corporate responsibility at PGGM, a Dutch service provider in the field of pension administration, executive advice and asset management.

“There will be a transition. But if it is an unmanaged transition, it will be very, very expensive,” he warned delegates at the conference.

Fossil fuel divestment

Exposure to climate-related disasters such as floods, storms, or sea-level rise can have a huge impact on property and infrastructure, destroying value and raising insurance rates overnight.

Rintaro Tamaki, deputy secretary general of the Organisation for Economic Co-operation and Development (OECD), warned there would be no second chance when it comes to climate change.

“Unlike the financial crisis, we do not have any climate bailout option,” Tamaki told the audience in Bratislava.

Things are evolving however and fund managers are increasingly looking for companies that offer safe returns on a long-term perspective, he said.

“The decarbonisation of portfolios and divestment from fossil fuel assets is happening,” Tamaki remarked. “544 institutions with a combined valuation of 3.4 trillion US dollars have committed to divest” from fossil fuels entirely or partially, he pointed out, citing figures that were updated before the summer.

Disclosure

However, investors still lack reliable information to make decisions about the best companies on which to hedge their bets in the long run. Currently, there is indeed no obligation for corporations to report on their green strategies or exposure to climate risk.

15 OECD countries have already adopted “some climate-related financial disclosure” obligations on companies, Tamaki said, adding he hoped the practice will soon become mainstream. But those schemes vary widely, leading to “a multiplicity of reporting requirements” leading to “inconsistencies” and lack of comparability, he said.

This could change towards year end. An industry-led Task Force on Climate-related Financial Disclosures (TCFD), chaired by Michael Bloomberg, was set up by the G20 last December to develop voluntary climate-related financial risk disclosure for use by companies in their communication to lenders, insurers, investors and other stakeholders.

The task force is expected to issue its final report in December and make it available to the public in February 2017, adding fuel to calls for regulators to make the standard mandatory one day.

Winners and losers

As companies gradually move towards disclosing their exposure to climate risk, the most heavily-polluting industries are expected to come under growing pressure from investors.

And some are already feeling the heat. Just after global leaders signed the landmark Paris Agreement on climate change in December, the coal industry’s European lobbying association expressed worries that the sector “will be hated and vilified, in the same way that slave traders were once hated and vilified”.

Kraanen echoed this sentiment, saying investors were already perceiving these signals.

“Investing is very easy, it’s about avoiding the losers and backing the winners. And if we have companies with expiry dates, we don’t see the need of investing in them.”

But for other sectors, the picture is less simple.

Take the aluminium industry. Although carbon pricing is widely accepted as the best tool for steering the transition to greener production, aluminium makers feel unfairly penalised by CO2 prices that focus only on the industrial production process, without taking into account the environmental benefits of aluminium later in the life- cycle of products.

“Yes, it takes a lot of energy to produce aluminium first time,” admitted Arvid Moss, Executive Vice-President of Norsk Hydro, a Norwegian aluminium and renewable energy company.

“But after the first time, the accounting is purely positive from a climate perspective,” he pointed out, citing lighter cars that save fuel and buildings that are more energy efficient. “And you can recycle the metal forever, without losing its properties,” Moss underlined, saying the recycling process absorbs twenty times less energy than production from virgin raw materials.

Regulators are broadly unfazed by pleas from the aluminium sector and seem to accept that the transition to a green economy will be costly for the heaviest polluters. CO2 pricing schemes for instance may “eliminate some industries” and represent “costs for consumers,” admitted the OECD’s Tamaki.

Still, he said carbon pricing was “the right way to select the future structure of the industry”.

Exclusive focus on carbon intensity ‘misguided’

Investors, for their part, are not sure that carbon pricing alone can do the trick.

“Focusing exclusively on carbon intensity as a measure of [the green economy] I think is misguided,” said Annie Bersagel, from the Norwegian pension fund KLP.

“It’s an indicator, a proxy. But the data that we have on carbon emissions is still not of sufficient quality to make a sound basis for informed decision-making,” she said.

Without naming aluminium, Bersagel said an example of this are industries which do emit high levels of carbon dioxide in the production process but whose products enable emission cuts further down the line elsewhere in the economy.

“We feel it would not be prudent to use [carbon intensity] data as sole basis for investment criteria,” she said.

Frido Kraanen, for his part, said regulators can help redefine “business as usual” by steering companies away from fossil fuels as the default option. “Regulators are still subsidising the linear economy,” he said, citing taxation schemes that are heavy on labour and easy on raw materials.

“The circular economy is more labour-intensive” while throwing away is still cheaper than recycling, Kraanen said, calling for a tax shift to hit materials use rather than human resources.

To make things worse, regulators are not helped by fluctuations in commodity prices, with continued cheap oil easing the pressure on manufacturers to recycle.

“At times, it’s much cheaper to buy virgin plastic rather than recycled granules for example,” admitted Karmenu Vella, the EU’s Environment Commissioner. But prices will eventually swing back up, he said, adding: “I don’t believe this is a long-term thing”.

Moss recognised the inherent benefits of recycling, saying it is “always less capital intensive” than producing aluminium from virgin raw materials. More investment was now going into the circular economy than ever before, he pointed out, with around 70-90% of aluminium in Europe currently being recycled, he said.

Still, he complained that pressure from environmental regulations such as the EU’s Emissions Trading Scheme (ETS) for carbon dioxide, was driving aluminium producers to the brink.

“Here is the dilemma: on the one hand, politicians want to enhance industry development with R&D, financial measures and innovation. And on the other hand, ‘older’ climate tools like the ETS can knock industries out as profitable businesses,” he said, claiming the ETS was pushing companies to look outside of Europe to locate their factories.

Changing mood

Taking a more long-term view, Vella said the mood in the investment community had changed however, and that fund managers were now looking at environmental challenges as an economic opportunity.

“There was a time when the environmental community and the investment community couldn’t collaborate. Today, I think it’s safe to say they need each other,” Vella said.

Kraanen agreed. In the early days of green finance, “there was a trade-off between financial returns and ecological benefits,” he said. “But this is no longer the case.”

Bersagel even suggested politicians were now trailing behind the investment community in embracing an environmentally-friendly transformation. “For us, it’s like ‘welcome to the party’,” she said referring to policymakers’ hesitations to embrace green policies. “Implementing the Paris Agreement and bringing a carbon price that bites – these are the key factors that can contribute to a more efficient transformation to a green economy,” Bersagel said.