27 February 2020
In this guest blog, Ed Baker, Senior Specialist, Climate Change and Energy Transition at the Principles for Responsible Investment (PRI) explains that in the current climate reporting environment, investors need to act now to manage risk and protect value.
On February 27, the finance track of COP 26, the pivotal UN climate summit that will be hosted by the UK this November, is formally launched. The role of finance is a key theme of the summit and personally overseen by the outgoing Bank of England Governor Mark Carney, who has made it clear that companies and investors need to have a plan for the energy transition.
Momentum around the recommendations from the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (TCFD), which the Governor was instrumental in setting up in 2015, is continuing to build. The UK government, which had already indicated it was considering making reporting against the TCFD mandatory by 2022, backed an amendment in the House of Lords last week to which would in effect make reporting on it mandatory for UK asset owners. The Bank of England for its part, has introduced supervisory requirements on climate change, consistent with the TCFD, and published a discussion paper on a biannual climate stress test for UK regulated insurers and banks in 2021.
Thus, in the short term, COP 26 is likely to accelerate the march towards formal regulation on climate reporting for IFoA’s UK members’ (and possibly some international) clients. Yet, climate change is not a one-dimensional issue. As past IFoA risk alerts have noted it has profound and far reaching implications for financial risk management. It is up ending the economics of energy, where established companies in the energy, utility and automotive sectors are facing unprecedented levels of technological competition. BP’s announcement of a net zero 2050 target last week, whilst short on specifics, was an illustration of how market forces as well as investor pressure are starting to bite. In addition, the physical impacts of climate change also have major implications for the insurance underwriting business and may in the future make residential property in increasing larger areas of the UK uninsurable against flood risk.
At PRI, we are concerned that mandatory climate reporting is an example of comparatively “friendly” government intervention compared to what could follow unless investors act now to manage risk and protect value. This is because governments have left it so late to address a problem that has been well documented by the scientific community for decades and as such there are growing risks of an abrupt and dis-orderly transition. PRI has sought to model this particular scenario and commissioned Vivid Economic and the Energy Transition Advisor to develop a forecast across a wide range of asset classes of how the Inevitable Policy Response could play out and impact investment portfolios. The equity results are available here and further asset classes will follow in the coming months for sovereign & corporate bonds, private equity, real estate and infrastructure.
For a leading number of asset owners, 2020 will also be about moving from measuring to target setting. In partnership, with UNEP-FI, PRI has convened the UN supported Net Zero Asset Owner Alliance. A leading group of 20 large insurers and pension funds who have publicly committed at a CEO level to net zero emissions in their portfolios, with a nearer term targets to be published in advance of COP 26.
Independent of whether this summit in November exceeds or fails to meet expectations, climate change will have growing implications for pension funds and insurers. Thus an important question for actuaries, a recognised authority and source of knowledge on investment advice, in 2020 is how well prepared are your clients to meet these market and regulatory changes?