Accounting for climate change: The business and economic risks of a warming planet

There can be no more denial that climate change is happening. Nor can there be any more doubt that climate change is the biggest existential threat to human survival.

The existential threat

Warming temperatures are destroying our health and environments through extreme weather events like heatwaves, fires, floods and cyclones. And it is going to get a lot worse, a lot quicker than you might think. If you are not yet incentivised to do something about the existential threat posed by climate change, I would strongly recommend reading David Wallace-Wells’ uncompromising assessment of the trajectory of our current situation: The Uninhabitable Earth.

The current situation we are in would see a 2-3% rise by 2050 with horrendous consequences for people, planet and prosperity.

And, as Lord Hain sets out in IC Intelligence Insight_05, the consequences for Africa will be particularly severe. 2019 was among the three warmest years on record for the continent, and this trend is continuing, according to the State of the Climate in Africa 2019, a multi-agency report led by the World Meteorological Office.

“This report shows increasing climate change threats for human health, food and water security and socio-economic development in Africa. Because of this, we need accurate and current data for adaptation planning,” said Ovais Sarmad, deputy executive secretary, UN Climate Change, at the time of its release.

Rising sea levels seen in West Africa and extreme weather events such as Cyclone Idai in Mozambique have been of particular concern. The agricultural sector is particularly vulnerable to increasing drought and locust plagues. This, in turn, threatens food security.

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The economic threat

Aside from the immediate existential threat to our livelihood, there is also increasingly consensus that climate change is also the most serious long-term economic risk should countries fail to achieve the targets set out in the Paris Agreement (see below). Governments globally are therefore committing to move to net-zero carbon emissions by 2050 in order to mitigate a worst-case scenario.

As our case study on the recent Royal Dutch Shell ruling (see below) shows, it is not only countries that are responsible for reaching net-zero. Companies with high emissions are increasingly also being held accountable for adhering to the Paris targets.

Modelling done in research by the Swiss Re Institute shows that rich and poor countries alike have much to gain economically from co-operating to mitigate climate change, and much to lose by not addressing climate risks immediately. Insurers and reinsurers are particularly exposed to climate risk, and as such, have contributed to the most ground-breaking research on the economic risks of climate change.

According to Swiss Re, the world stands to lose close to 10% of total economic value by mid-century if climate change stays on the currently-anticipated trajectory, and the Paris Agreement and 2050 net-zero emissions targets are not met.

The potential impact of climate on economies is much larger than the risk presented by the pandemic. For low-income African countries, this is particularly so. The African Climate Policy Centre projected that the GDP in Africa would suffer significant decrease as a result of a global temperature increase. For scenarios ranging from a 1°C to a 4°C increase in global temperatures, the continent’s overall GDP is expected to decrease by 2.25% to 12.12%.

However, on the other hand, action today to get on track with mitigating the Paris temperature rise scenario would mean economies – particularly in emerging markets – could prevent around a quarter of the gross domestic product (GDP) loss by 2050 (see chart below).

The global policy opportunity

The scale of losses from the systemic risk posed by climate change depends on the speed at global policy action can be co-ordinated to implement measures such as carbon taxes, increased reporting and disclosure requirements on climate exposures, technological adoption, shifting long-term investment into renewables and other economic greening activity through a combination of private and public actions.

There has been particular leadership from the financial sector as the transition to a net-zero, carbon neutral world will require significant capital commitments.

A key turning point was clearly the work on quantifying climate exposures in the wider financial sector by Mark Carney and Michael Bloomberg and the establishment of the Task Force on Climate-related Financial Disclosure at the Financial Stability Board in 2016. The task force has also been a key protagonist in the development of the UN Principles for Responsible Investing initiative, which requires all signatories to declare climate risks in their portfolio, and recent efforts by the EU to develop a sustainable taxonomy for investors.

These efforts also inspired the Network for Greening the Financial System (NGFS). The NGFS, launched at the Paris One Planet Summit on 12 December 2017, is a group of central banks and supervisors, which on a voluntary basis are willing to share best practices and contribute to the development of environment and climate risk management in the financial sector, and to mobilise mainstream finance to support the transition toward a sustainable economy.

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The NGFS brings together 91 central banks and supervisors and 14 observers. Together, they represent five continents and around 85% of global greenhouse gas emissions, and are responsible for the supervision of all of the global systemically important banks and two thirds of global systemically important insurers.

Earlier initiatives include the UK’s Companies Act, making it compulsory in 2013 for all companies to report on their greenhouse gas emissions, which has been consolidated by the Bank of England requiring banks and insurers to disclose their climate exposures. Moody’s has also since 2016 been including climate risk as a factor in its analysis.

But it is not just the balance sheets of banks and companies that are vulnerable to exposures, their investors too are susceptible to the political and legal pressures leading to mass divestment from fossil fuels and other extractive industries such as mining. Such assets are fast becoming likely to be stranded.

In light of these investment risks, activist investors are beginning to be more vocal in holding the boards of Big Oil to account to speed up transition. For example, at Exxon the hedge fund Engine No. 1 managed to get the majority of investors to back the appointment of a more progressive board.

Africa must lean in to the global debate

Despite the challenges, the UN Climate Change secretariat contends Africa has made great efforts in driving the global climate agenda. “This is demonstrated by the very high levels of ratification of the Paris Agreement – over 90%. Many African nations have committed to transitioning to green energy within a relatively short time frame. Clean energy and agriculture are, for example, prioritized in over 70% of African NDCs. This ambition needs to be an integral part of setting the economic development priorities of the continent,” it says.

The UK will host the 26th UN Climate Change Conference of the Parties (COP26) in Glasgow on 1-12 November 2021. This is just a few months away, and it is important to ensure that all countries can participate equally given the disparities in emissions and effects on economies and societies between more developed and less developed countries. Especially so because the pandemic presents new inequalities in participation.

The Swedish climate campaigner Greta Thunberg has said she will not attend Cop26 because the uneven distribution of Covid-19 vaccines would mean countries could not participate on even terms. This is especially crucial for African countries as Lee White, Minister of Water, Forests, Sea, the Environment charged with Climate Change and Land‐use planning, Gabonese Republic, argues in IC Intelligence Insight_05.

African countries and companies also should exercise their policy muscles as norm-makers in global policy collaboration as shown through successful insurance initiatives such as the African Risk Capacity sovereign insurance pool alongside continent wide investment programmes supported by the Africa Finance Corporation and African Development Bank into renewables and other sustainable investment programmes.

This article originally appeared in IC Intelligence Insight_05.