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Mark Carney on the risks and opportunities of a low carbon economy transition

Bank of England governor Mark Carney – credited as kick starting the fast growing refocus of financial institutions towards decarbonisation – spoke at the Climate Alliance’s 10th annual national conference in Melbourne earlier this week. He appeared in a short, pre-recorded video: “a more carbon efficient way to communicate,” he said.

Mr Carney spoke to the importance of bringing climate risk and resilience “into the heart of financial decision making” in order to minimise the risks and maximise returns in the necessary transition to a low carbon economy.

“Changes in climate policies, new technologies and growing physical risks are going to prompt reassessment of the values of virtually every financial asset worldwide,” he explained. “Those that fail to adapt will cease to exist.”

He spoke of how this transition could be executed under a framework of three r’s: reporting, risk management and return.

Reporting as a virtuous circle

According to Mr Carney, the majority of major investors now consider a company’s Task Force on Climate-related Financial Disclosures (TCFD) disclosures when making investment decisions.

In the two and a half years since the recommendations were designed, the market demand for their adherence has become “enormous”, to the point where research such as conducted by Bank of England and PwC, has identified positive correlations “between a company’s stock prices and the number of TCFD disclosures that firms are making”.

Mr Carney pointed to jurisdictions such as the UK and the EU signalling intentions to make TCFD mandatory in the near future.

Within the Australian context, he highlighted that “ASIC has already issued two regulatory guidelines which formally include climate change as a risk that issuers should consider disclosing”.

The momentum behind voluntary reporting is starting to make “a virtuous circle”, Mr Carney said.

“As companies are applying the recommendations, investors are increasingly able to differentiate between firms based on this information.

“Adoption is spreading, and disclosure is becoming more decision-useful and efficient.”

From the static to the strategic

Mr Carney highlighted the growing trend for climate related risks to be treated as any other financial risk, rather than viewing them purely as issues of corporate social responsibility.

The biggest challenge he identified was in the assessment of a company’s strategic resilience during the transition to a lower carbon economy.

“For the market to understand where the risk and opportunities lie, these risks need to go beyond the static to the strategic,” he said. “Banks will need to establish how their borrowers are managing current and future climate related risks and opportunities.”

He gave the vulnerability of consumer loans secured on diesel vehicles as an example of an asset under threat with the transition.

“We expect those assessments will reveal which borrowers have strategies for the transition to a net-zero economy, which are gambling on new technologies or government inaction, and which haven’t yet thought through the risks and opportunities.”

To manage its own financial risk, Bank of England has started to stress test its financial systems against potential climate pathways, he said.

This includes “the catastrophic business-as-usual scenario” and the “ideal but still challenging” pathway to a net-zero economy by 2050.

Supporting the brown to go green

Mr Carney pointed to the International Energy Agency’s estimates of the low carbon transition requiring $3.5 trillion in energy investments every year for decades – “in other words, twice the rate at present”.

To mobilise this kind of mainstream capital, sustainable investment needs to do more than just exclude brown industries in favour of green technologies.

“Advances in reporting and risk analysis are paving the way for investors to realise opportunities in climate friendly investment,” Mr Carney said.

But for sustainable investment to “truly go mainstream”, it must “support and catalyse all companies that are working in the transition from brown to green”.

This necessarily includes companies that are in high carbon sectors such as mining and transportation that are adopting lower carbon strategies.

To do this Mr Carney suggested developing a unique index to capture these organisations and promote their transition.

“Consideration should also be given to the degree of warming,” he added, pointing to a number of large international companies with portfolios currently aligned to 3.5 degrees of warming or more.

This included the world’s largest pension fund, the Japan government pension fund GPIF, which calculates its portfolio is aligned to a 3.5 degree world. It also included the major German assurer Alliance, which has committed to transition its portfolio to promote a 1.5 degree world by 2050, despite preparing for a 3.7 degree path.

“We think these approaches could be taken more broadly,” Mr Carney concluded, highlighting though that financial policy makers cannot drive the transition to a low carbon economy alone.

“It is for governments to establish the climate policy frameworks,” he said, “and then if they do the private sector will make the necessary investments.

“But it can be most effective with a market in a transition to a 2 degree world, and that market is being built.”

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