Context

The lives and livelihoods of people worldwide are threatened by food and water shortages, extreme weather events, and displacement induced by climate change. The average annual economic losses from climate-related disasters are hundreds of billions of dollars.

Currently, efforts to eradicate poverty are mitigated by the potential increase in temperatures resulting in a severe effect on ecosystems and agriculture, affecting human societies thanks to the imminent change in the scenarios of economic activities and human health itself.

Climate change

The economy globalization involves broadening and deepening interdependence among societies and states to foster economic growth. Nevertheless, this growth has had a negative impact, resulting in overconsumption of natural resources and climate change. According to the United Nations Framework Convention on Climate Change (UNFCCC), climate change is “a change of climate attributed directly or indirectly to human activity that alters the composition of the global atmosphere and which is in addition to natural climate variability observed over comparable periods.”

It is widely recognized that continued emission of greenhouse gases will cause further warming of the Earth and that warming above 2° Celsius (2°C), relative to the pre-industrial period, could lead to catastrophic economic and social consequences. In recognition of these potential consequences, in December 2015, nearly 200 governments agreed to strengthen the global response to the threat of climate change by not only holding the increase in the global average temperature to well below 2°C above pre-industrial levels but to pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels. This effort is referred to as the Paris Agreement.

The Global Green New Deal

In his book The Climate Crisis and the Global Green New Deal, Noam Chomsky recognized the monumental challenges in implementing reforms and overcoming the political muscle of the fossil fuel industry and entrenched government officials. In it, he calls for reductions in carbon emissions and subsidies (with strict compliance), along with public and private subsidies for full employment, renewable energy production, efficient energy modernization, as well as comprehensive job retraining, guarantees pension and land reclamation for transition regions now dependent on fossil fuels.

The contributions of progressive economist Robert Pollin focus on how Green New Deal programs would operate and be funded, and they are more elegant and friendly. However, it also offers passionate analyzes of how a coordinated international effort should unfold, transforming the “current interregnum between neoliberalism and neo-fascism” into a more humane and environmentally conscious world.

Both encouraged by the rise of youth activism and climate change politics among a large group of local governments, businesses, and unions, Chomsky and Pollin are hopeful that their book is the essential plan to lead the movement to the hard work, sustained monitoring, and consensus-building.

Financial implications of climate change[1]

While many efforts are being developed, the current comprehension of the potential financial risks entailed in climate change is at an early stage. Climate-related risks are usually divided into two major categories: The first one is the Transition risks; transitioning to a lower-carbon economy may entail extensive policy, legal, technology, and market changes to address mitigation and adaptation requirements related to climate change. On the other side, the Physical risks resulting from climate change can be event-driven (acute) or longer-term shifts (chronic) in climate patterns.

In this context, there is a growing demand for decision-useful, climate-related information by a range of participants in the financial markets. Creditors and investors are increasingly demanding access to consistent, comparable, reliable, and straightforward access to risk information. This has resulted in several climate-related disclosure standards, but still, there is a lack of a single, comprehensive, and comparable set of standards.

To make more informed financial decisions, investors, lenders, and insurance underwriters need to understand how climate-related risks and opportunities are likely to impact an organization’s future financial position. While climate change affects nearly all economic sectors, the level and type of exposure and the impact of climate-related risks differ by sector, industry, geography, and organization. These are some reasons why financial authorities across jurisdictions need to play an active role in addressing climate-related financial and non-financial disclosures.

Risks of the climatic environment

Currently, the risks related to climate change are not exclusively associated with companies that produce or consume intensive CO₂, but also affect companies that, due to the characteristics of their operation, are much more exposed to extreme weather events, an example of the materialization of this type of risk is offered by the case of the electric company Pacific Gas & Electric (PG&E), the largest utility company in the U.S., whose bankruptcy, originated as a result of a series of forest fires caused by the extreme drought lived in the Western United States, at the beginning of 2019, was called by The Wall Street Journal as the “First Bankruptcy of Climate Change”, where the materialization of the risk associated with an adverse climate event, catalyzed the materialization of operational risks related to security and risk on physical assets (poles, undisturbed areas, etc.), which in turn led to the materialization of business risks, such as business interruption and reputational risk, finally materializing the financial risk of total loss of liquidity, ultimately resulting in the bankruptcy of the company.

Possible scenarios for financial stability in the face of transition risks

As in macroeconomic models, the timing of the transition is vital when it comes to the financial stability aspects of the transition. The literature suggests that a “smooth and early” transition minimizes risks to financial stability, while a “late and sudden” transition significantly increases risks to financial stability. Effective mitigation of the physical risks of climate change requires a long-term structural change in the economy, which is likely to affect all sectors, including the financial sector.

According to the Bank of England’s NGFS Macro-Financial Task Force, “Most models of macroeconomic and financial stability rely heavily on a few common assumptions and share many of the same uncertainties. These assumptions usually refer to factors such as the future evolution of climate policies, the pace of advance of carbon-neutral technologies, the effects of feedback mechanisms, the level of adaptation, and the capacity to adapt. Adaptation and non-linearities or uncertainties related to the nature of climate risks”.

Measures taken about sustainable finance

To address the problem of climate change from the point of the day, the following measures have been taken:

Environmental, Social, and Governance Standards (ESG)

It refers to standards on environmental, social, and governance management in organizations. Investors are increasingly applying these non-financial factors to identify material risks and growth opportunities as part of their analysis process. ESG metrics are not typically part of mandatory financial reporting, although companies increasingly make disclosures in their annual reports or independent sustainability reports. ESG cases are often interrelated, and it can be a challenge to classify an ESG topic into a single category.

ESG integration is the practice of considering environmental, social, and governance factors in the investment process. Several terms have evolved concerning ESG integration: sustainable investment, responsible investment, socially responsible investment, and impact investing.

Sustainable Scenario Analysis

In finance, the Task Force on Climate-Related Financial Disclosures (TCFD) recommended using scenario analysis to disclose better the financial impacts of climate change-related risks and opportunities on organizations.

Scenario analysis is a process for identifying and evaluating the potential effects of many possible future states under uncertain conditions. Scenarios are hypothetical constructs and are not designed to provide accurate results or forecasts; they can be quantitative and qualitative.

Taxonomy

The taxonomy on sustainable finance is a classification tool to help financial actors and businesses determine which activities qualify as sustainable. Investments in projects and activities that pursue environmental objectives contribute to the transition to a low-carbon economy.

Setting performance thresholds helps companies’ project developers and issuers access green financing to improve their environmental performance and help identify which activities are already environmentally friendly. Doing so will help to develop low-carbon sectors and decarbonize high-carbon ones.

Non-financial disclosure rules

The disclosure framework, parameterized by accounting and verification standards and transparency standards, ensures that investors and society have an accurate and fair picture of financial circumstances.

The current accounting system has significant value and limitations to incorporate human and natural capital management into allocating resources.

2020-2030 the most consequential decade in human history

This decade requires attention to the issue of climate change from the following three perspectives:

1. Science points out that the climate crisis is worse than the one resulting from the pandemic. However, since climate change has a much slower pace, its negative impacts are not as visible and seem far from the daily work of decision-makers, entrepreneurs, and citizens. However, this issue represents an immediate urgency to be addressed.
2. Government actors, mainly national regulators of the financial sector, are taking increasingly ambitious actions to channel financial resources towards climate change mitigation and adaptation and recognize, report, and manage the risks and opportunities associated with climate change through ESG report.
3. It is necessary to mobilize public and private funding for climate change and sustainable development goals. Transparency of the source and destination of resources is critical. Proactive and transparent ESG reporting and data help companies raise capital, and investors weigh climate risk in their investment decisions.

Conclusion

Addressing climate change is critical to a sustainable future; the impact of the transition is related to the adjustment to a low carbon economy. We must halve emissions by 2030 and transition to carbon-neutral economies by 2050 to avoid irreversible uncontrolled climate change. Government actors, mainly national regulators in the financial sector, are taking increasingly ambitious actions to channel financial resources into climate change mitigation and adaptation and recognize, report, and manage the risks and opportunities associated with climate change.

Emissions should eventually reach “net zero” to avoid further climate change. The scale of economic and financial change required for this transition is considerable. Since the macroeconomic consequences of climate change can be significant, central banks, supervisors, and macroeconomic policymakers should consider quantitatively assessing the physical and socio-economic effects of climate change. 

References:

IPCC, 2012, Glossary of terms. In: Managing the Risks of Extreme Events and Disasters to Advance Climate Change Adaptation [Field, C.B., V. Barros, T.F. Stocker, D. Qin, D.J. Dokken, K.L. Ebi, M.D. Mastrandrea, K.J. Mach, G.-K. Plattner, S.K. Allen, M. Tignor, and P.M. Midgley (eds.)]. A Special Report of Working Groups I and II of the Intergovernmental Panel on Climate Change (IPCC). Cambridge University Press, Cambridge, UK, and New York, NY, USA, pp. 555-564.

TCFD, June 2017, Recommendations of the Task Force on Climate-related Financial Disclosures, Task Force on Climate-Related Financial Disclosures, Final Report.

Rachel Jagareski, September/October 2020, The climate crisis and the global green new deal the political economy of saving the planet book review, Foreword Reviews.

Adriana Cárdenas Uribe, José Luis Ruiz, octubre 2019, Repercusiones del Cambio Climático en las Finanzas, Tesis para optar al grado de Magister en Finanzas, Postgrado Economía y Negocios, Santiago de Chile, Universidad de Chile.

María José Andreu, Alessandra Mensi Teixidó, Impacto Financiero del Cambio Climático, Oportunidades de Inversión, IDEC, Universidad Pompeu Fabra.

NGFS Macro-Financial Task Force, Sarah Breeden, Bank of England, Julio de 2019, Estabilidad macroeconómica y Financiera Consecuencias del cambio climático, Red para Enverdecer el Sistema Financiero Suplemento Técnico del Primer informe integral, Central Bank and Supervisors, Network for Greening the Financial System.

[1] TCFD, June 2017, Recommendations of the Task Force on Climate-related Financial Disclosures.

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