IEA and IPCC Reports: Are Governments & Business in Denial? Pt 3
Part 3: The Implications for Finance
In the first blog of a three-part series, we looked at the ways in which the recent publication of two reports, from the IEA and the IPCC, has fundamentally changed the ground rules for fossil fuel investment.
In the second blog in the series, we looked at the initial response to these reports from governments.
In this third blog, we look at some of the wider implications for the finance industry.
Implications for finance
For banks, pension funds, asset managers and insurers, publication of the IEA and IPCC reports together underline with new urgency the challenge put to them by Mark Carney, former Governor of the Bank of England and UK and UN Climate Envoy -
“A question for every company, every financial institution, every asset manager, pension fund or insurer – what’s your plan?”
Climate change and the current state of the science, law and politics gives these institutions quite a lot to plan for.
Stranded assets?
Financial institutions have been warned in very clear terms by Mark Carney and others, including the IMF and ECB, that up to 80% of coal assets and up to half of the developed oil reserves will become “stranded assets” if Paris Agreement targets are met. If the boards of financial institutions nevertheless opt to ignore that evidence and those warnings and continue to make investments in fossil fuel exploration and production, it must raise questions about their own fiduciary duties to their own investors and the way in which they intend to approach those risks of investing in what may become stranded assets.
Even the boards of fossil fuel companies themselves face new questions as to the extent to which they ought now to be taking into account and reflecting Paris Agreement targets in their operations. In the landmark case of Milieudefensie et al v Royal Dutch Shell plc on 26 May 2021, Shell was ordered by a Dutch Court to reduce its worldwide emissions by 45%. It will appeal the judgement, but notably on the same day activist investors from the hedge fund Engine No 1 won a shareholder resolution voting new members onto the board of Exxon Mobil, and other investors passed a resolution requiring Chevron to take more account of Scope 3 emissions from its customers’ use of its products. Directors may no longer be able to rely upon ‘fiduciary duties’ simply amounting to an obligation to produce as much fossil fuel as possible, maximising profit and taking no account of the world outside.
Regulatory expectations
The Task Force on Climate-related Financial Disclosure (TCFD), and similar initiatives elsewhere, are increasingly placing regulatory rules and investment pressure on firms to provide accurate and full information on climate impacts and climate risks, under the headings of:
GOVERNANCE
STRATEGY
RISK MANAGEMENT
& METRICS AND TARGETS
The TCFD is really aimed at ensuring that climate risk is reflected in every financial decision. As governments worldwide and especially in significant financial markets give legal effect to its provisions, these regulatory expectations will become the norm for most large companies.
Already in 2021 there have been major moves by the Biden Administration in the USA to replace Trump Administration rulings affecting major pension funds under the US ERISA legislation. Basically the Trump Administration ruled that pension fund trustees could only take very limited account of ‘Environmental, Social and Governance’ (ESG) considerations, whereas the Biden Administration’s Executive Order says the opposite – with the result that the trillions of dollars of US pension funds are becoming subject to wholly new regulatory expectations which will affect whole investment markets. Comparable moves are expected through US Securities and Exchange Commission (SEC) rules.
Investor expectations
Meanwhile UN and UK Climate Envoy Mark Carney launched the Glasgow Financial Alliance for Net Zero (GFANZ) on 21 April 2021. Some 160 firms together responsible for assets in excess of $70 trillion have become accredited to the UN Race to Zero campaign. They have signed up to science-based guidelines to reach net zero emissions, to cover all emission scopes, to include 2030 interim target setting, to commit to transparent reporting and accounting in line with the UN Race to Zero. Mark Carney was joined at the launch of GFANZ by US Climate Envoy John Kerrey, US Treasury Secretary Janet Yellen, UK Chancellor of the Exchequer Rishi Sunak.
This movement has been joined by 43 banks from 23 countries, with assets of $28.5 trillion at the Net Zero Banking Alliance, complemented by the Net Zero Insurers Alliance.
Boards of financial institutions wishing to make or maintain investments in new fossil fuel exploration and development will need to take account of the investor expectations reflected in GFANZ and the governments that support it, and of the expectations of other investor groups with similar aims.
Climate litigation
The annual meeting of the UK Environmental Law Association was told in the summer of 2021 that climate litigation was “surging”, and the Grantham Institute reports that it has grown “exponentially”. The IEA and IPCC reports should ensure that this trend continues and gathers pace.
Financial institutions have dodged the litigation bullet on climate change for a while, but there are several factors which contribute to the view that this will now change.
First, there is now no serious doubt at all about the science of climate change and the urgency with which it must be addressed. The IPCC report uses terms such as “unequivocal”: there is less room to hide.
Secondly, the IPCC report makes it clear that all regions of the world are directly affected by climate change, so all countries and all investments will be affected directly or indirectly.
Thirdly, the IPCC report reflect great advances in the last 10 years in “attribution science”, enabling scientists to attribute the contribution of human induced global warming to individual extreme weather events with much greater certainty than before.
Fourthly, the work of attributing the published contribution of individual major companies to global warming and climate change has continued and progressed significantly.