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The big challenge for the G20: aligning financial markets to 1.5°C global warming

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Currency and money

By Santiago Lorenzo

There is no doubt that the ambitious long term goal of keeping global warming to 1.5°C requires large amounts of financial resources be used radically differently from how investments are directed today. The call for shifting the trillions in the UNFCCC Paris Agreement (PA) text required a strong move by those who actually can influence financial markets.

We may be witnessing a first step. The Task Force on Climate-Related Financial Disclosures (TFCFD) just published its first report last week.

In December last year, 195 countries agreed the landmark climate deal which aims to tackle the challenge of climate change globally. It came at time in which when 15 of the 16 warmest years on earth were recorded since 2001 – the last two were consecutive years – and unabated growth of greenhouse gas (GHG) emissions.

Notwithstanding, we need to remember that in 1948 the Universal Declaration of Human Rights was signed and unfortunately, we can witness daily how a global agreement by itself doesn’t solve humanity’s larger challenges. Multilateral legal frameworks are useful only if complemented by strong political will and solid institutional architecture.

In this regard, the PA needs to be further strengthened so have a global architecture that could deliver the Paris aspiration. The international community increased its ambition by highlighting the need for a more ambitious long term goal looking to approach towards 1.5°C, but remained shy on its means of implementation. In Paris, governments expected to get more from less effort. This is a challenge for delivery!

On finance, the USD 100 bn per year promised in Copenhagen will probably only be achieved until 2020, despite increasing literature showing that around USD 1 tr annually is required for just the energy sector to meet the PA targets.

As a less committed way forward, the PA mentioned the need to “shift the trillions”, with no critical route to follow. In this regard, what could be considered a keystone to start moving in the right direction happened during COP 21  when Bank of England Governor Mark Carney established a global task force under the coordination of former New York Mayor Michael Bloomberg.  This followed a mandate by the G20 given earlier in the year to Carney as chairperson of the Financial Stability Board (FSB).

The objective of the Task Force on Climate-related Financial Disclosures (TCFD) is to set climate related disclosure guidelines that could help on reducing the potential of large, abrupt, corrections in asset values that can destabilise financial markets, in the light of potential climate related impacts to assets. The aim is to make investors, creditors and underwriters aware of new risks on their decisions.

What does this work has to do with ‘shifting the trillions’ for the transition to a low carbon resilient economy? Properly assessing climate related risks in investments will change the way financial institutions invest, particularly institutional investors holding large amounts of assets with a longer term horizon. It can start ‘shifting the trillions’.

This TCFD first report sets its scope and objectives and puts forward a set of fundamental disclosure principles. WWF appreciates the openness of the process and acknowledges the good quality of the content. The comprehensive literature review was informed by active participants in climate related disclosure; the methodological approach is wise, going step by step, starting with reviewing the state of the art, assessing system needs and making public consultation on progress, shaping the terms of reference for the final report.

Some financial institutions have already started reporting their climate related risks, opportunities and strategies, but these efforts are spread out and uncoordinated, making it difficult to give informed recommendations to investors. If the TCFD achieves its objective of establishing a solid and harmonized set of guidelines on climate related disclosure, it will be an important first step to driving the ‘shift the trillions’ for low carbon resilient societies, and contribute to make financial markets more stable.

In fact, it is not only the Paris outcome that needs this work, financial markets face big challenges and the financial community has the right to know the materiality of climate risks to their investments. Climate related risks are not only potential stranded assets and liability risks, it is also about a wider portfolio risks due to climate impact in a varied array of asset classes.

Simultaneous to the CDTF report issuing, an article was published in Nature Climate Change setting global assets loss due to climate impacts at US 2.5 tr (or 1.8 per cent of global asset value). Investors, lenders and underwriters benefit from good quality information presented in a simple and harmonised way.

The report contains a lot of valuable material, and it is good to cheer the sensitive way this group is developing the research. For instance:

  • Looking to the future: “…assessing climate related issues requires forward-looking dynamic disclosures”, the best way to be capable to include new evidence in disclosure criteria and keep open the possibility to address the need for a transition to a 2° / 1.5°C scenario.
  • What is next? The TCFD recognises “…our current understanding of the potential financial risks posed by climate change – to companies, investors, and the financial system as a whole – is still at an early stage.” The larger gap relies in the need to develop wider portfolio risks methodologies.
  • It is clear the need that the framework to be provided must be market driven. However, it would be good to bear in mind that for climate (maybe not financial stability) purposes this is a limited approach.
  • A well stated key issue is the active role in spreading the demand of carbon related risks disclosure that the CDTF is thinking about. There is a need to expand the demand of such information to investors even in markets where this demand still doesn’t develop.
  • Another positive point raised by the TCFD was the differentiation issue among G20 countries. It is not only about the usual differentiation argument on climate negotiations (on responsibility and vulnerability), but also on financial system maturity.
  • The task forward faces complexity, uncertainty and ignorance on many climate risks and this is well recognized by the TCFD. There is a clear need to set up some specific institutional arrangement worldwide that can continue this work in a permanent base.

Beyond drafting a reliable final report, the work of the TCFD and the FSB face some important challenges:

  • One is on how to speed the adoption of these guidelines that can shape a new financial -ecosystem aligned with the aspirations of all countries reflected in the PA and a 1.5°C scenario. Starting for the G20 adopting and – avoiding the lack of action as in the case of the fossil fuels subsidies reform – implementing the report and asking for this CDTF to continue their excellent work.
  • Another will be on how to generate a cascade effect to reach all those firms and economic activities that fall out of the scope of the report. Shifting the trillions also entails to change investment patterns outside of listed firms.

Santiago Lorenzo is WWF’s head of Green Finance, based in Mexico City, Mexico.

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To limit global warming to 1.5 degrees, we need a more ambitious investment shift. Are we seeing the first steps?

Financial stability needs to properly assess climate risks, giving more chances to limit global warming at 1.5°C:

Climate risks and challenges: aligning financial markets to a 1.5 degree world

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