Midweek Climate Focus: Unlikely Climate Heroes, 'Bubble-wrap' Money, Human net-zero pledges, & more
Edition #6
Welcome to the latest edition of Climate Focus.
I said I’d be back with a post this Friday, but here I am, exceeding my own expectations.
The COP is still underway and the news emerging from Glasgow leaves even the optimists among us clutching at straws. But let’s all take a deep breath and wait until this Friday to take stock of the ‘make-or-break’ climate summit (a label I do not approve of).
I called the last edition a special one. This one is too. It is about a couple of bad boys from the world of finance and the promise they hold in our climate fight. They aren’t your usual suspects.
Let’s dive in.
Heroes can come from the unlikeliest of places.
I have a personal aversion to posts that have a hook at the start but keeps me guessing until the end. So, I am going to just go ahead and give it to you.
They are your Insurers and Auditors
When your ‘bubble wrap’ money saves the planet
It is a bold claim, but I am convinced insurers have the highest incentive to take climate action. Before I substantiate it, a quick glimpse at how insurance companies make money.
Insurance companies are in the business of managing risk.
They underwrite the risk (aka give it a $ value and calculate its likelihood to occur) and charge paying customers a recurring fee to cover it (aka insurance premiums).
Tens of thousands of customers pay these premiums. Insurance companies use this money (aka float) to invest and generate returns.
Here’s Warren Buffett talking about ‘the genius of float’
Insurers receive premiums upfront and pay claims later. ... This collect-now, pay-later model leaves us holding large sums -- money we call "float" -- that will eventually go to others. Meanwhile, we get to invest this float for Berkshire's benefit. ...
If premiums exceed the total of expenses and eventual losses, we register an underwriting profit that adds to the investment income produced from the float. This combination allows us to enjoy the use of free money -- and, better yet, get paid for holding it.
Naturally, when premiums collected fall short of expenses or claims, insurance companies book underwriting losses, i.e., if they underwrite risks and invest well, they hold on to a lot more money.
When fighting Climate Change is good for business
How can insurers who profit from underwriting risk offset it efficiently, especially with something that is as pervasive climate change? It’s tricky.
Swiss Re, one of the largest reinsurers in the world, conducted a stress-test and estimated that the global economy stood to lose 18% of GDP (eek!) from climate change if no action is taken. The International Monetary Fund pegged global GDP at ~$142 trillion for the year 2021.
Insurers are exposed to climate risk on both sides of the balance sheet: fossil-fuel assets they hold as investments that were long lucrative (and some still are), and claims that will be filed from climate disasters and extreme weather events.
Climate change is a significant material risk to the risk management industry
Insurers can predict $ value of climate costs reasonably well, but the variations in extreme weather events and commensurate losses are difficult to model with fidelity.
For an industry that makes money from how well it underwrites risk, that is not good for business.
Policy uncertainty throws an additional spanner. Countries might wake up one day and decide to phase out coal incrementally or suddenly.
For an industry that does not like surprises, that is very bad for business.
In effect, it is good for business to not underwrite new coal projects and/ or stop investing in fossil fuels.
And there are promising developments.
More than 30 insurance companies have announced restrictions on underwriting coal projects, making it difficult for major coal operators to line up bank financing and investment for mines, transportation and power plants. Without insurance, those investments could seen too risky.
What’s more? Climate stewardship from insurers will stifle further expansion of fossil fuels quickly.
It is nearly unheard of for a business to run without insurance. It is mandated by law in most jurisdictions to have adequate insurance coverage. So much so that it is a prerequisite for financing. I doubt any financial institution will be forthcoming with funding a fossil-fuel project without the ‘bubble-wrap’ to cushion climate risk.
I don’t see it happen everyday that incentives of a ‘whale’ in financial services aligns with climate action.
($130 trillion) reasons why we need Auditors in the good fight
Mark Carney, head of the Global Financial Alliance for Net Zero (aka GFANZ. Yeah, I don't get it either), made a headline statement last week at COP26. He claimed that $130 trillion in private assets was now aligned to achieve net-zero goals.
That's a sh*t ton of money.
As with most things at said levels, there are serious issues with that claim.
$130 trillion equals all assets held by the signatories. It represents ~40% of the entire global financial system. It is also money that is already locked and cannot be reallocated. Like, mortgages and other assets it is invested into, including ... fossil fuel assets.
There are asset owners (pension funds, insurers, family offices etc.) and asset managers, those paid by asset owners to manage money. The signatories include both. Is it double counted, you ask? Absolutely yes, is my answer.
Signatories that pledged net-zero also continue to fund new fossil fuel projects. One could argue that it is a bank's job to make money and money finances energy transition. Yes, but a coal plant's average lifespan is between 30 and 50 years. That comes really close to the 2050 cut-off date. You can’t help but question intent here.
One could also argue that regulations don't prohibit it. Yes, but I fail to see the point of signing a voluntary pledge and wait for somebody else to tell you what to do.
And I am just scratching the surface.
In my view, Mark Carney’s $130 trillion announcement is a grand gesture in a highly political platform. Unfortunately, it will have repercussions on the climate finance narrative. It is very easy to say there are trillions at our disposal, when it is far less. *Deep breath*
A 3-question Story
Why do investors struggle with climate action? It is natural that they have a hard time cutting emissions because they are -
a. not the emitters, and
b. good at making money, but not so much at climate stewardship
Question 1: Would it be easier for investors to be better climate stewards if companies were held to higher accountability standards?
SBTi (Science-based Targets initiative) announced a net-zero corporate standard that qualifies whether individual corporate targets are aligned with current climate science and if the scale of emission cuts proposed meets the 1.5-degree target. It takes into account both direct, as well as (the contentious) indirect emissions.
Near-term targets cover immediate emissions reductions for the next 5-10 years, while long-term science-based targets determine the total level of decarbonization by 2050 or before.
[…]
Through the standard, the SBTi clarifies that science-based net-zero requires companies to achieve deep decarbonization of 90-95% before 2050. At that point, a company must neutralize any limited residual emissions that are not yet possible to cut.
It is a brilliant initiative, and SBTi has assisted nearly 1,000 companies with science-based targets so far, with a similar number engaged with them currently.
However, it only solves a part of the problem.
a. SBTi assists companies while setting climate targets, which is voluntary, and does not track performance against these climate targets
b. There is room for companies to ‘creatively’ report their sustainability achievements to signal progress that may or may not exist
Question 2: Would companies be more transparent about their climate performance if there was standardised reporting for sustainability performance?
The International Financial Reporting Standards (IFRS) Foundation announced that they are developing a sustainability framework to standardise corporate reporting on climate action and ensure comparability across industries and countries.
IFRS defines the accounting standards for reporting financial information in every country, except the US (also the only country that writes dates in MMDD format; another thing I don’t understand).
However, reporting standards are merely a guidance to companies and go hand-in-hand with regulations.
(I am beginning to realise I have some issues with most things)
Such reporting standards offer investors information in a format that allows for comparability, reasonable interpretation, and a basis for their investment choices. Regulators protect the interests of investors, ensuring compliance, albeit with the ‘stick’ of punitive action.
Question 3: Would regulatory intervention in climate disclosures hold companies accountable to their climate pledges and subsequent performance?
I am sure it will. But it is going to heck of a lot difficult to prove that poor climate performance is financially damaging to investors, and make a case for regulatory intervention. There are some promising developments, but it is going to be a long wait until it is the norm.
That is the final piece of the puzzle that needs solving.
But one thing is certain. Auditors have a crucial role to play in our endeavour to protect the planet. That is quite a pivot from their alleged role in protecting bottom lines.
Banter
Net-Zero Pledges … By Humans
(This one had me in splits, until I realised how real the inspiration was)