A veteran of Britain’s central bank, Paul Fisher says climate change will have a massive impact on the global financial sector. He talks about managing the risks.
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| British economist Paul Fisher. CHRIS RATCLIFFE / BLOOMBERG |
Paul
Fisher recently retired as deputy head of the Bank of England’s
Prudential Regulation Authority, after a long career in financial
markets, financial stability and monetary policy. In September 2015 the
bank released a report on the risks to the financial system of dealing
with climate change.
Mike Seccombe First, tell us why you’re here.
Paul Fisher I’m here at the request of the Climate Alliance, who approached me in the UK when I was still at the Bank of England. I retired my full-time role at the bank this [northern] summer. I’d been there 26 years. One of the jobs I had in my last couple of years there was co-ordinating the bank’s work on climate change. And in those couple of years, I saw this go from being an issue that was sociopolitical, ethical, moral if you like, to being front and centre as a hard commercial issue. It’s now about what are the risks to financial sector firms that need to be taken into account. So I come at this not from the point of view of a campaigner or a politician or anything like that but as a policymaker and regulator.
MS So what are the risks?
PF Anybody who is a long-term asset-holder potentially is exposed to climate risk. You can divide the risks two ways; there’s physical risk if the climate does change, or as it does change, and that’s fairly easy to think about – floods or whatever. But more interestingly you’ve got the transition risk, and two things are going to happen. [First] the economy will need to restructure in order to try to minimise climate change and that will present both new opportunities for new businesses to grow, and it will be a threat to some existing business models. So you’ve got that structural change. But perhaps even more importantly you’ve got the policy change. Governments have committed to reducing climate change to below 2 degrees Celsius [and] that will evolve a whole series of policies of which we don’t know the full details yet. As those policies come through you could see the repricing of financial assets. People investing in infrastructure will find that is vulnerable to policy [change] risks. We saw a big utility company in Germany, RWE [hit by a share price plunge after Germany changed its energy policy away from coal and nuclear to more renewables]. We see the coal industry in the United States, for various reasons, collapsing. Peabody, for example.
MS It seems to me that the insurance industry, because it has a long-time horizon and takes a very actuarial approach, would be well ahead of the game on this. Is that an accurate reading?
PF In the UK that’s certainly true. The UK is one of the world’s largest insurance markets. Lloyd’s of London writes a lot of catastrophe, risk insurance, so they’ve been on this case for some time. They are experts and certainly helped the Bank of England in doing its work. The other insurers and pension funds, and savings managers generally, are also picking up on it. You are starting to see more of the bigger firms announcing investment policies to reflect climate risk. Banking, I would say, is a bit further behind, but coming along. In some countries now – China for example – if you lend to a polluting company, then you as the lender can be held to account, not just the polluter. China is one of the major forces in the world trying to get this on the agenda, which is relevant to Australia, of course, as a big exporter. Here you have big superannuation companies looking at long-term asset issues.
MS This goes to a question of fiduciary duty then, doesn’t it?
PF Absolutely. Up to now people have said, “Oh, you can’t take account of these things.” Opinions on this are now changing in various ways. First, lawyers point out that what fiduciary duty means is a duty [of company managers and directors] to the corporate entity. That means you have a duty to future shareholders, not just existing shareholders. We’re coming to a point where people say actually it is legitimate to take account of climate risk in any sort of business strategy that is long term. Indeed, in most jurisdictions you have to take account of all material risks. Climate change is … becoming a material risk for more and more firms. If you could have taken it into account and you didn’t and the risks crystallise, you will be held to account for failing in your duties. This is the way the interpretation is going. The law is never static on this sort of thing and it will be interpreted by the courts as time goes on and more evidence mounts that if you didn’t take climate risk into account and it crystallises, you can’t expect the courts to be very sympathetic.
MS Is there sufficient transparency around these long-term risks?
PF What we were most interested in as central bankers was financial stability. And the risk is that you get a sudden repricing of financial assets. The way you mitigate that is disclosure. If we make these firms provide more information about what their exposures and risks are, then investors start to take account of that straight away, so you are less likely to get shocks. When you do get a shock there’s more information out there to reprice accurately. You’re less likely to have … overshooting. The move is to make disclosure more comprehensive and more standardised. This is being done at the moment through the G20’s Financial Stability Board where [Bank of England governor and current FSB chairman] Mark Carney set up this taskforce on climate disclosure, which is due to report by the end of the year. It’s chaired by Michael Bloomberg and is private sector-led, and will hopefully come up with a set of recommendations. You can’t insist on global legislation, but I will be surprised if some jurisdictions don’t take this and translate it into requirements rather than [it being] voluntary.
MS And to what extent has the Australian government been involved?
PF Well, they signed up to the Paris agreement and they are part of the G20. [When the] G20 and the FSB get together they can help put a bit of backbone into each other about what we need to do. Translating that into national actions is going to be interesting. But the Australian government is committed to the Paris agreement.
MS However, Australia’s economy is particularly tied to the fossil fuel industry.
PF This isn’t about stopping the economy from growing. It’s about how we get the maximum sustainable growth rate. It’s about making people more fuel efficient. It’s about making sure energy prices properly reflect the costs that are imposed on society, not just whatever the market price would otherwise be. This isn’t anti-Australia or anti-Australian industry, it’s about what you have to do to get Australian business working on a sustainable basis … given what’s happening to the planet. A lot of people are working behind the scenes quietly with firms to try to get the right position.
MS Nonetheless, we will see a lot of stranded assets here, won’t we?
PF Possibly, but the longer it’s left and the less is done, the more of those stranded assets you get. Even the Saudi Arabians are waking up to the fact that they need to do something else, to diversify their economy, otherwise they’re going to be a bit sunk.
MS Other countries… You mentioned China and the UK…
PF I wouldn’t hold the UK as the gold standard. We are leading in the analysis, more than we are the action. Earlier this year I was part of a study group, co-chaired by the Bank of England and Bank of China, on green finance. China needs something like $600 billion a year to finance their green investment program, for quite some years ahead. They know they’ve got a huge pollution problem, and it goes beyond climate change [to] air and especially water. Green finance was the only thing the Chinese added to the G20 agenda. That shows you how seriously they are taking this. Their potential for expansion of living standards is massive, but if they don’t get a lot better on carbon emissions and [energy] intensity, it’s just not going to be reachable. You will destroy the planet.
MS How long do you think we have to address the financial risk?
PF There is not a fixed interval. It would be much better to be ahead of the curve. The thing about risk is, you can often see the risk is there, but you just don’t know when. That’s what happened with the global financial crisis. People saw the risk, but it didn’t happen and didn’t happen and didn’t happen and when it did, the impact was much bigger. The longer we leave it without doing anything, the bigger it’s likely to be.
MS How did a scientific and economic issue become an ideological one?
PF Once it moves to the financial sector, as it has now, ideology’s out the window. This is a financial risk if you’ve got a long-term asset portfolio. Forget the ideology, do the risk analysis, otherwise you’re not meeting your responsibilities. We need to sweep the politics to one side and say this is just a commercial business risk, like any other, that we need to take into account. It’s coming, and ignoring it or pretending it isn’t there is not going to help.
Links
Mike Seccombe First, tell us why you’re here.
Paul Fisher I’m here at the request of the Climate Alliance, who approached me in the UK when I was still at the Bank of England. I retired my full-time role at the bank this [northern] summer. I’d been there 26 years. One of the jobs I had in my last couple of years there was co-ordinating the bank’s work on climate change. And in those couple of years, I saw this go from being an issue that was sociopolitical, ethical, moral if you like, to being front and centre as a hard commercial issue. It’s now about what are the risks to financial sector firms that need to be taken into account. So I come at this not from the point of view of a campaigner or a politician or anything like that but as a policymaker and regulator.
MS So what are the risks?
PF Anybody who is a long-term asset-holder potentially is exposed to climate risk. You can divide the risks two ways; there’s physical risk if the climate does change, or as it does change, and that’s fairly easy to think about – floods or whatever. But more interestingly you’ve got the transition risk, and two things are going to happen. [First] the economy will need to restructure in order to try to minimise climate change and that will present both new opportunities for new businesses to grow, and it will be a threat to some existing business models. So you’ve got that structural change. But perhaps even more importantly you’ve got the policy change. Governments have committed to reducing climate change to below 2 degrees Celsius [and] that will evolve a whole series of policies of which we don’t know the full details yet. As those policies come through you could see the repricing of financial assets. People investing in infrastructure will find that is vulnerable to policy [change] risks. We saw a big utility company in Germany, RWE [hit by a share price plunge after Germany changed its energy policy away from coal and nuclear to more renewables]. We see the coal industry in the United States, for various reasons, collapsing. Peabody, for example.
MS It seems to me that the insurance industry, because it has a long-time horizon and takes a very actuarial approach, would be well ahead of the game on this. Is that an accurate reading?
PF In the UK that’s certainly true. The UK is one of the world’s largest insurance markets. Lloyd’s of London writes a lot of catastrophe, risk insurance, so they’ve been on this case for some time. They are experts and certainly helped the Bank of England in doing its work. The other insurers and pension funds, and savings managers generally, are also picking up on it. You are starting to see more of the bigger firms announcing investment policies to reflect climate risk. Banking, I would say, is a bit further behind, but coming along. In some countries now – China for example – if you lend to a polluting company, then you as the lender can be held to account, not just the polluter. China is one of the major forces in the world trying to get this on the agenda, which is relevant to Australia, of course, as a big exporter. Here you have big superannuation companies looking at long-term asset issues.
MS This goes to a question of fiduciary duty then, doesn’t it?
PF Absolutely. Up to now people have said, “Oh, you can’t take account of these things.” Opinions on this are now changing in various ways. First, lawyers point out that what fiduciary duty means is a duty [of company managers and directors] to the corporate entity. That means you have a duty to future shareholders, not just existing shareholders. We’re coming to a point where people say actually it is legitimate to take account of climate risk in any sort of business strategy that is long term. Indeed, in most jurisdictions you have to take account of all material risks. Climate change is … becoming a material risk for more and more firms. If you could have taken it into account and you didn’t and the risks crystallise, you will be held to account for failing in your duties. This is the way the interpretation is going. The law is never static on this sort of thing and it will be interpreted by the courts as time goes on and more evidence mounts that if you didn’t take climate risk into account and it crystallises, you can’t expect the courts to be very sympathetic.
MS Is there sufficient transparency around these long-term risks?
PF What we were most interested in as central bankers was financial stability. And the risk is that you get a sudden repricing of financial assets. The way you mitigate that is disclosure. If we make these firms provide more information about what their exposures and risks are, then investors start to take account of that straight away, so you are less likely to get shocks. When you do get a shock there’s more information out there to reprice accurately. You’re less likely to have … overshooting. The move is to make disclosure more comprehensive and more standardised. This is being done at the moment through the G20’s Financial Stability Board where [Bank of England governor and current FSB chairman] Mark Carney set up this taskforce on climate disclosure, which is due to report by the end of the year. It’s chaired by Michael Bloomberg and is private sector-led, and will hopefully come up with a set of recommendations. You can’t insist on global legislation, but I will be surprised if some jurisdictions don’t take this and translate it into requirements rather than [it being] voluntary.
MS And to what extent has the Australian government been involved?
PF Well, they signed up to the Paris agreement and they are part of the G20. [When the] G20 and the FSB get together they can help put a bit of backbone into each other about what we need to do. Translating that into national actions is going to be interesting. But the Australian government is committed to the Paris agreement.
MS However, Australia’s economy is particularly tied to the fossil fuel industry.
PF This isn’t about stopping the economy from growing. It’s about how we get the maximum sustainable growth rate. It’s about making people more fuel efficient. It’s about making sure energy prices properly reflect the costs that are imposed on society, not just whatever the market price would otherwise be. This isn’t anti-Australia or anti-Australian industry, it’s about what you have to do to get Australian business working on a sustainable basis … given what’s happening to the planet. A lot of people are working behind the scenes quietly with firms to try to get the right position.
MS Nonetheless, we will see a lot of stranded assets here, won’t we?
PF Possibly, but the longer it’s left and the less is done, the more of those stranded assets you get. Even the Saudi Arabians are waking up to the fact that they need to do something else, to diversify their economy, otherwise they’re going to be a bit sunk.
MS Other countries… You mentioned China and the UK…
PF I wouldn’t hold the UK as the gold standard. We are leading in the analysis, more than we are the action. Earlier this year I was part of a study group, co-chaired by the Bank of England and Bank of China, on green finance. China needs something like $600 billion a year to finance their green investment program, for quite some years ahead. They know they’ve got a huge pollution problem, and it goes beyond climate change [to] air and especially water. Green finance was the only thing the Chinese added to the G20 agenda. That shows you how seriously they are taking this. Their potential for expansion of living standards is massive, but if they don’t get a lot better on carbon emissions and [energy] intensity, it’s just not going to be reachable. You will destroy the planet.
MS How long do you think we have to address the financial risk?
PF There is not a fixed interval. It would be much better to be ahead of the curve. The thing about risk is, you can often see the risk is there, but you just don’t know when. That’s what happened with the global financial crisis. People saw the risk, but it didn’t happen and didn’t happen and didn’t happen and when it did, the impact was much bigger. The longer we leave it without doing anything, the bigger it’s likely to be.
MS How did a scientific and economic issue become an ideological one?
PF Once it moves to the financial sector, as it has now, ideology’s out the window. This is a financial risk if you’ve got a long-term asset portfolio. Forget the ideology, do the risk analysis, otherwise you’re not meeting your responsibilities. We need to sweep the politics to one side and say this is just a commercial business risk, like any other, that we need to take into account. It’s coming, and ignoring it or pretending it isn’t there is not going to help.
Links
- Why Turnbull's COP21 Paris talks won’t save renewable sector
- Gadfly: Staff play the waiting game
- Aust emissions pressure builds ahead of Paris climate pact
- Abbott's smoke and mirrors before Paris climate summit
- Global markets prepared for Trump, another GFC? Not sure: Bank of England veteran
- It's time for financial institutions to get serious on climate risk
- World set to hit ‘dangerous’ global warming by 2050, scientists warn
- Donald Trump vows to stop climate change funding and sanctuary cities
- Rich doing ‘nowhere near enough’ to help poorest on climate change
- MPs accuse Government of preferring ‘dirty diesel’ to renewables
- UK must not abandon climate change fight after Brexit, experts say
- Inside the split at the Climate Change Authority
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