October 1, 2016

Governor Carney On Climate Change: Why Pension People Should Pay Attention

“A classic problem in environment economics is ‘the tragedy of the commons’.  The solution to it lies in property rights and supply management…. Climate change is ‘the tragedy of the horizon’…. its impacts will be felt beyond the traditional horizon of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix…..”.

From a speech by Mark Carney, Governor of the Bank of EnglandGiven at Lloyd’s of London, 29 September, 2015

“The Paris Agreement provides detailed climate policies and creates the prospect of a future ratcheting up of efforts to control carbon emissions. In doing so, it greatly increases transition risks as well as opportunities. By bringing forward the horizon, it puts a premium on the ability of private markets to adjust….. This is crucial because these transition risks could turn success into failure…..”.    

 From a speech by Mark Carney, Governor of the Bank of EnglandThe Arthur Burns Memorial Lecture, Berlin, 22 September 2016


A Different Kind of Central Banker

In a recent visit home to Canada, Mark Carney jokingly observed that the job of central bankers is to repeat the same few messages over and over again, but to do so a profound and very serious manner. He went on from there to offer thoughts on what he called the “climate paradox” in a way that belied his earlier “repeat the same few messages” comment. His remarks ranged well beyond the usual central banker boiler plate about fostering stable economic environments and prosperity. His dissertation on the realities of climate change and its profound implications for financial markets and investors effectively combined deep integrative thinking with an ability to ‘keep things as simple as possible, but no simpler.i

As the Governor of the Bank of Canada during the Global Financial Crisis (GFC), Mr. Carney gained international prominence as he and his colleagues played important leadership roles in stabilizing the global financial system. Arguably, this led to two outcomes for him. First, he was the first foreigner to be offered the Governor position at the Bank of England. And second, he was appointed Chair of the newly created Financial Stability Board (FSB) at the 2009 G20 London Summit. The mandate of FSB is to play a pro-active role in fostering international financial stability and thus prevent the kind of GFC that almost brought the global financial system to its knees in 2008/9.

In Mr. Carney’s view, the FSB’s mandate includes assessing how climate change, and measures to mitigate its current and future impacts, could lead to financial instability in the years/decades ahead. This assessment should in turn inform the FSB on what measures it, and other financial markets participants, should be taking now to mitigate climate change-related risks.ii This Letter sets out his views on these matters, and my interpretation of their implications for pension people.         

Is Climate Change Real?

In his Lloyd’s of London speech last year, Mr. Carney took on the climate change deniers:

  •  In the Northern Hemisphere the last 30 years have been the warmest since Anglo-Saxon times. Indeed, eight of the ten warmest years on record in the UK have occurred since 2002.
  • Atmospheric concentrations of greenhouse gases are at levels not seen in 800,000 years.
  • The rate of sea level rise is quicker now than at any time over the last two millennia.
  • Since the 1980s, the number of registered weather-related insurance loss events has tripled. Losses from these events have increased from an annual average of around $10B in the 1980s to $50B over the past decade.
  • Without mitigation, these impacts will continue to increase in size and scope in the years/decades ahead.

With mounting evidence that human drivers have, are, and will continue to play a major role in these outcomes, why has so little been done to date? The answer lies in ‘the tragedy of the horizon’. Solutions to the climate change problem require unconventional thinking beyond the typical lengths of the business cycle, the political cycle, and the time horizons of technocratic authorities like central banks.

In his Berlin speech last month, Mr. Carney characterized last December’s COP-21 Paris Agreement on climate change as a serious international attempt to address the ‘tragedy of the horizon’ challenge. The goal is to curb carbon emissions consistent with limiting the rise in global average temperatures relative to those in the pre-industrial world to 2◦C, and to pursue efforts to limit the temperature increase to 1.5◦C. Countries have agreed to submit their Nationally Determined Contributions (NDCs) to these goals, to be updated regularly with each update a progression on the last. Of course saying is one thing, doing another….

Climate Change and Financial Stability

How does climate change impact the stability of the globe’s financial system? Through three channels:

  •  Physical risks: arising from the increased frequency and severity of climate- and weather-related events that damage property and disrupt trade. The insurance industry is the front line of these risks, but there are limits to its ability to cover them.
  • Liability risks: stemming from parties with climate change-related losses seeking compensation from those they hold responsible. Some actions of this nature are already occurring, but they could accelerate as the science and evidence of climate change hardens.
  • Transition risks: resulting from adjustments towards a lower-carbon economy. The triggers could be changes in policy, technology, or reassessments of physical risks. The result could be a reassessment of the value of a large range of assets as costs and opportunities become apparent. The speed of these price adjustments is uncertain, possibly taking place rapidly enough to destabilize financial markets (e.g., the U.S. coal sector is a ‘canary in the coal mine’ micro example).

These realities lead Mr. Carney to encourage us to think through how building new markets in climate-change transition and green finance can help mitigate these risks. This thinking leads to clear policy frameworks that encourage the mobilization of private capital to finance the transition to low-carbon economies. Green finance offers major opportunities here by allocating capital to green technologies and increasing the prospects for an environmentally sustainable recovery in global growth.iii

The Information Imperative

Mitigation strategies to effectively deal with these three climate change-related risks cannot be executed without a requisite information base. To that end, Mr. Carney proudly points to the FSB’s Taskforce on Climate-Related Financial Disclosures (TCFD) chaired by Michael Bloomberg. The TCFD’s mandate is to develop recommendations for voluntary, consistent, comparable, reliable, and clear disclosures around climate-related financial risks for companies to lenders, insurers, investors, and other stakeholders.

In a Phase I Report in April, the TCFD confirmed that existing disclosure frameworks vary in their legal status, and are generally incomplete and fragmented. Mr. Carney lists three imperatives for the TCFD’s Final Report, due by the end of this year:

  •  Disclosures must be strategic rather than static: they must be forward-looking, and sufficiently granular to offer real insight into how climate-related risks and opportunities may impact a firm’s existing and future businesses.
  • Scenario analysis may be needed for investors to price financial risks and opportunities correctly against plausible public policy developments, technological advances, and evolving physical risks.
  • Materiality judgements will help scale the granularity necessary for effective disclosure. This will help investors sort out the information they need to understand the prospective risks and rewards across such varied sectors as agriculture, automobiles, consumer goods, and electric power utilities.

There is in fact a fourth imperative. The TCFD is not the globe’s first initiative to attempt to set out a standard protocol for corporate disclosure of climate change–related risks and opportunities at a micro level, or of broader disclosure of what a corporation is doing to be a sustainable wealth-producing entity in the long term. It is going to be important to align the TCFD’s recommendations with already-developed broad approaches such as those of the IIRC, SASB, FASB, IASB, and SEC, and more climate-specific efforts such as CDP, CERES, and CDSB. 

In the end, lenders, insurers, investors, and other stakeholders want a stream of material corporate information that is consistent, comparable, reliable, and clear. The TCFD is well-placed to play an integrative role of bringing this about.

Climate Change and Security Analysis

How could/should this framing of the risks and opportunities attached to climate change impact assessing the long-term investment prospects of publicly-traded corporations? A recent study titled German Utilities: Scoping the ‘Tragedy of the Horizon’ shows the way.iv The study focuses on the strategic restructuring of German electric utilities E.ON and RWE. Both companies are splitting themselves into separate ‘new’ (i.e., renewables and networks) and ‘old’ (i.e., fossil fuels [FF]) entities.

The study’s risks/opportunities assessments are based on following through the implications of (likely) tighter Paris Agreement-driven carbon emission targets than the current EU targets for 2030. Tighter targets mean a higher CO2 price, higher power prices, and a radical shift in FF merit order towards gas and away from coal and lignite. Such shifts would have materially different valuation implications for the ‘old’ E.ON and RWE businesses. In contrast, the ‘new’ renewables/networks businesses offer “appealing defensive growth” prospects. All this supports the view that over the next decade and beyond “we will see a further acceleration away from the more carbon-intensive forms of fossil fuel generation”.

And what does all this have to do with Governor Carney’s quest for greater understanding of, and more decisive actions to address the consequences of climate change? Here is how the Barclays researchers put it in the context of their study:

“This is precisely why Governor Carney set out the need for greater disclosure from companies around their climate-related financial risks….. It is also why we think power utilities should be disclosing more information about how they are thinking about the risks of tighter climate policy in the future, and what they are doing to prepare for and/or pre-empt these risks. In this way, as Governor Carney puts it, a ‘market’ in the transition to a 2-degree world can be built.”

Implications for Pension People

This Letter is a sequel to our July 2015 Letter titled “From an ‘Unknown’ to a ‘Known’: Managing Climate Change Risk’.v It placed managing climate-related risks in the broader context of the roles of boards and managements of pension organizations in understanding the financial risks they need to oversee and manage on behalf of plan participants, and how to actually do that. Using the Mercer study “Investing in a Time of Climate Change” as a guide, that Letter also pointed to the value of scenario analysis in assessing exposures to the three types of climate change risks set out by Mr. Carney:  1. physical, 2. litigation-related, and 3. transition-related.

Importantly, Mr. Carney pointed to the likely dominance of transition-related risks and opportunities over the next few years, flowing out of the myriad national policy decisions triggered by the Paris Agreement. The cited Barclays study confirms the view that these decisions will have major impacts on how markets will assess the present value of future corporate cash-flows, depending on whether their sensitivity to these policy decisions is negative or positive.

The July 2015 Letter used the fractured Donald Rumsfeld ‘known unknown’ taxonomy as a metaphor for the state of knowledge of the global pension community about climate change and its financial implications. This Letter signals that pension people can no longer use the ‘unknown’ excuse for inaction on the climate change file. We must all play constructive roles in successfully managing the needed market transition to a 2-degree world.

Keith Ambachtsheer


  1. A dictum attributed to Albert Einstein.
  2. As well as identify and exploit climate change-related opportunities.
  3. See the cited Berlin speech for more detail about these ideas. All speeches are available at www.bankofengland.co.uk .
  4. The September 2016 study was produced by the European Utilities team of Barclays, led by Mark Lewis. He is a member of the FSB’s Taskforce on Climate-Related Financial Disclosures.
  5. It was reprinted as Chapter 27 in my new book THE FUTURE OF PENSION MANAGEMENT.

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