Brian Fallow: When climate fight gets real

The oil industry is just one which is at risk of seeing its assets plunge in value because of efforts to combat climate change. Photo / 123RF

COMMENT:

Mandatory disclosure of climate-related risks is becoming a thing.

At least it is for listed companies, or other enterprises of that scale, which might in the future want to raise equity capital, or debt, or carry insurance.

The Government put out a discussion document on this last October, the responses to which were strongly supportive. Policy decisions can be expected, hopefully, later this year, Climate Change Minister James Shaw told the more than 1000 people in the virtual audience of a webinar on the issue held last Thursday.

Its star attraction was Mark Carney, former governor of the Bank of England and before that the Bank of Canada, and now UN special envoy for climate action and finance. In a celebrated speech to Lloyd's of London four years ago, Carney laid out the case for the disclosure of climate risks.

They include not only the physical risk from climate change itself, but also "transition" risks arising from emissions pricing and other policies governments may undertake to get us to a zero-carbon world and from disruptive technologies arising as the corresponding opportunities are seized.

Until companies routinely report those risks in a consistent, comprehensive and "decision-useful" way, they will not be managed and mitigated.

Carney argues that only if they have the relevant information will financial markets be able to play their role in smoothing the transition to a low-carbon future, and avoid the financial stability risks of an abrupt repricing to reflect stranded assets (like two-thirds of known reserves of fossil fuels).

Comprehensive disclosure would also improve policymakers' ability to understand corporate readiness when drawing up carbon budgets.

The World Bank in 2018 valued future profits from oil, gas and coal at US$39 trillion ($60.6t), but a report released yesterday by CarbonTracker concluded that if global demand falls by 2 per cent a year in line with the Paris Agreement, and discount rates rise in line with increased risk, those future profits would collapse by nearly two-thirds to US$14t.

And the International Monetary Fund's latest global financial stability report warns that the physical risks from climate change do not appear to be reflected in equity market valuations, and calls for mandatory disclosures on material climate change risk.

The Covid crisis teaches us that we can't wish away systemic risks, including climate change, Carney told the webinar.

Reserve Bank governor Adrian Orr quoted The Economist: "Following the pandemic is like watching the climate crisis with your finger on the fast forward button."

Climate change and its associated risks provided a direct challenge to financial stability, he said. "The risks are material but extremely difficult to identify, price, allocate and manage with accuracy. In the jargon, market failure is rife."

A Reserve Bank survey last year of insurers and banks found scant evidence climate risk concerns were influencing their daily business decisions. Only 60 per cent of banks and a third of insurers disclosed climate-related information. The others should hurry up and do so, said Orr (their regulator). The bank supports mandatory disclosure.

The framework for disclosure would be the principles-based standards and approaches developed by the Taskforce on Climate-related Financial Disclosures (TCFD) set up at the behest of the G20 in late 2015, widely regarded as best practice.

The TCFD framework is in some ways still a work in progress. Shaw said the External Reporting Board (XRB), which had a long history of developing reporting standards across a wide variety of matters, was keen to take a lead in developing climate-related reporting standards in New Zealand. The intention was that climate risk reporting would be part of normal financial reporting.

Carney said four-fifths of the top 1100 companies across the G20 provided material TCFD disclosures. "But it is not yet quite comprehensive, which is why we think it is now time for mandatory disclosure."

Matt Whineray of the NZ Superannuation Fund asked him what companies said got in the way of using the TCFD framework properly.

Carney said it was the forward-looking, scenario analysis aspect, when companies were used to static reporting of their liabilities and assets today.

It is akin to the stress testing approach banking regulators employ.

"There's the one we all wish for, which would be a relatively smooth transition from where we are to net zero [emissions]. So gradual adjustment to climate policy which brings investment responses and stable macro-economic outcomes.

"Then there's the Minsky scenario, which is where we leave it too late and have to make a sharp adjustment. That's when you really see trillions of dollars of stranded assets, in that second scenario.

"The third scenario is the business-as-usual, do-nothing approach, when the physical risks of climate change really ramp up, with the many problems associated with that."

Reserve Bank governor Adrian Orr. Photo / Mark Mitchell

Shaw said 84 per cent of respondents to the Government's discussion document agreed the TCFD framework was appropriate for New Zealand — "an astonishingly high number" — and 77 per cent supported requiring large investors and listed companies to disclose on the basis of TCFD.

The document proposed that the disclosure regime would apply, on a comply or explain why not basis, to all entities with public equity or debt, to banks, to general insurers including reinsurers, and to institutional investors and investment managers.

Some argued that private companies and government agencies should be included, given that the stock exchange intercepts relatively little of the economic life of the country.

The NZX argued that if private companies were not included, it could discourage listing and weaken New Zealand's capital markets. It said there were about 1200 larger private companies with revenues exceeding $30 million, compared with just 70 listed companies of the same size. Five of the top eight emitters of greenhouse gases in New Zealand were not listed, it said.

Shaw has some sympathy for that view. "It makes sense from an investment perspective and a governance perspective for it to go broader. That will be one of the considerations when we get around to policy decisions later in the year."

Carney said the United Kingdom's Financial Conduct Authority was also consulting on comply-or-explain disclosure and the European Union was taking TCFD as the basis for a mandatory climate disclosure requirement working its way through the European legislative process.

"The Canadian Government is making TCFD mandatory for companies getting assistance on Covid recovery. There is going to be a lot more of that," he said. Shaw said the Cabinet had not considered any similar provisions here, but he would be supportive of it.