TL: CLIMATE CHANGE AND THE PRIVATE FINANCIAL INSTITUTIONS: SO: Greenpeace International DT: November 1994 CLIMATE CHANGE AND THE PRIVATE FINANCIAL INSTITUTIONS: A case of unappreciated risks and unrecognized opportunities Jeremy Leggett, Greenpeace International, November 1994 CLIMATE CHANGE THREATENS THE CAPITAL MARKETS Insurance, banking and pension funds at risk Global warming, and the climatic destablization it would result in, threatens insurance companies with unmanageable catastrophe losses. It threatens banks with significant physical risks to the projects for which they provide loans. A destabilizing climate would cause untold general economic disruption, and hence global warming threatens the interests of pension funds on many fronts. Of particular immediate concern is the prospect of a global insurance crash. Leading insurers speak in growing numbers of their fears that global warming could bankrupt the $1.4 trillion insurance industry. A collapse of global property- catastrophe insurance reserves in the face of escalating windstorm, flood, and drought-related wildfire losses would pose dire knock-on economic problems. These would apply to insurers, bankers, and pension funds alike. Investments at risk The private financial institutions control a vast and growing share of equity markets. For example, insurance companies, banks and pension funds own more than half the equity in the top 1,000 US corporations. Global warming threatens the security of energy-sector investments - whether by the private financial institutions, or other institutions, or by individuals - in a way which is as yet little appreciated by investors. Investing in carbon- fuel industries - coal or gas-fired power plants, or oil exploration projects, for instance - may seem like safe bets in 1994. But they are not. Coal, oil and gas (the carbon fuels) are by far the largest source of the greenhouse gases which cause global warming. In November 1994, Greenpeace released a report commissioned from the Delphi Group of financial consultants and written by a former Director and Securities Analyst with Chase Investment Bank [1]."Climate change presents major long term risks to the carbon fuel industry," this report concludes. "These risks have not yet been adequately discounted by financial markets." An international panel involving several hundred top climate scientists has advised governments that they are "certain" that continuing to emit greenhouse-gas at present day levels will cause global warming [2]. Though the rate and regional distribution of the warming are uncertain, estimates by NASA and similar institutions around the world strongly suggest that the atmosphere will heat up rapidly and dangerously in the years ahead. A growing number of studies point to the scope for abrupt disruptions of climate relating to changes in oceanic circulation in a warming world. Some authoritative bodies advising governments have concluded that the first signs of a human-enhanced greenhouse effect are already becoming apparent [3]. Governments will almost certainly have to act as the evidence of global warming becomes more clear. Yet investors in the carbon-fuel industries rely, for example, on coal-fired power stations constructed today still being profitable thirty years from now. They rely on oil coming to market twenty years from now being as profitable as it is today. They rely on gas markets in power and transportation growing in the future in the same way they are today. These are no longer safe assumptions. The Delphi Report: an authoritative wake-up call for investors The Delphi Report argues that the worrying advice being given to governments by their own scientists is on the massive balance of probabilities likely to be a correct assessment, or even an underestimation, of global warming in the years to come. The report argues that it is only a matter of time before international concern about global warming will swell, and governments be compelled to launch robust policy responses: for example, carbon taxes and active measures to promote solar energy at the expense of carbon fuels. No less than 167 governments have already signed a convention committing to fight the climate-change threat by stabilizing atmospheric greenhouse-gas concentrations at levels which pose no danger [4], and are involved in ongoing negotiations aimed at cutting greenhouse-gas emissions sufficiently to reach this ultimate target. The report makes clear that the gravity of the risk to equities will increase the longer serious decisions by climate policymakers are delayed. "Investors should avoid long term overweight positions in the carbon fuel industry until such risks are adequately discounted," the report concludes. Especially at risk are coal and oil exploration companies, but given the potential gravity of the climate crisis, the integrated oil companies (the oil "majors") and gas companies are also at risk. The risk to investors is significant The Delphi Report explains that "the flexibility of the major energy companies to adapt by reallocating their investment streams would be severely limited by the impact on profitability and decommissioning costs. Overall the high impact' scenario (of policy response by governments) could result in several years of very lean profits, or even losses, with carbon fuel businesses struggling to survive." The report makes clear that there are also non-business risks which investors must take into consideration. As things stand, burgeoning toxic liability costs are not incorporated on the balance sheets of carbon-fuel companies, even though the evidence of their potential enormity has been there for all to see in recent years. But furthermore, the report warns, "in the next century there is a risk that new and even greater sources of liability may emerge to affect the carbon fuel industry." Future liability for damaging climate? The Delphi Report raises the prospect that as climate-related damage bills clock up, and the evidence that greenhouse gases are altering the climate becomes more clear, the world may start looking back in anger. In such a climate, class actions by victims may be launched against those who facilitated acts of greenhouse-gas profligacy in the years after the warning to governments issued in the 1990 First Scientific Assessment of the Intergovernmental Panel on Climate Change. The report likens this prospect to the experience of the tobacco industry, currently facing the largest class actions in legal history. "The structure of these cases is not dissimilar to the potential cases the oil and gas industry could face. Allegations of anti-trust activity and consumer fraud in the case of the tobacco industry could find a parallel in the lobbying and campaigning activities of the carbon fuel industry. The consequences of being held liable for some of the damage arising from climate change could be devastating for the carbon fuel industry. If climate change costs are as large as forecast, having to pay for even a small fraction of this would severely affect the viability of carbon fuel participants." In this regard, it is interesting to note that the chief executive of Austria's largest electric utility took a Greenpeace Austria campaigner to court for defamation after the campaigner charged that to build a new coal-fired power station, rather than invest in energy efficiency or renewables, was tantamount to willfully killing people. In the first case of its kind anywhere in the world, the court ruled in September 1994 against the electric utility chief. THE FINANCIAL SECTOR IS AWAKENING TO THE THREATS Insurers The President of the Reinsurance Association of America told Time magazine in 1993 that "the insurance business is first in line to be affected by climate change... it could bankrupt the industry" [5]. Greenpeace has now heard such sentiments expressed, by very senior figures in the industry, in London, Zurich, Munich, New York, and Tokyo [6]. Eugene Lecomte, President of the US Insurance Institute for Property Loss Reduction, explained the worst-case analysis in 1993 at a conference on climate change organised by Greenpeace, the US College of Insurance, and insurance consultants ET&T. "Despite the fact that the industry is financially healthy," Lecomte said, "and has some $160 billion in surplus, in two events you could take 70 billion, or maybe 80 billion of that surplus away and you'd cripple the industry. It wouldn't be able to take on new risks. It wouldn't have the capacity to underwrite the business of the future. We'd have massive, massive availability problems." In 1993, Munich Re, the world's largest reinsurer, called on governments, businesses, and insurers alike to "take immediate action" to address the "dramatic development of natural catastrophes. ...The threatened climatic changes demand urgent and drastic measures," the company stressed [7]. In the UK, the Chartered Insurance Institute Society of Fellows set up a Study Group on climate change and insurance. It concluded in a 1994 report that "the industry has a limited breathing space in which to gather its wits, and plan in a truly longterm timeframe." It recommended many options, one of which was that "all investment managers should modify their investment policies to take account of the potential direct and indirect effects of global warming" [8]. Swiss Re, the world's second biggest reinsurer, wrote in a 1994 report that "human intervention in the natural climatic system could accelerate global climatic change to such an extent that society may no longer be able to adapt quickly enough." It noted that society had a duty to respond, and that "there is no shortage of practical suggestions, especially with regard to a drastic reduction of greenhouse gases" [9]. Bankers In May 1992, just before the Earth Summit, many banks signed a Statement by Banks on the Environment and Sustainable Development. It stated that "ecological protection and sustainable development are collective responsibilities and must rank among the highest priorities of banking." In the next two years, there were few signs that the banks were undertaking substantive action in translating these encouraging words into changes in practice. But a recent United Nations Environment Programme seminar on banks and the environment was attended by senior bankers from 45 banks around the world. UNEP had to relocate the meeting to cater for the high level of interest. Greenpeace delegates at the meeting saw clear signs from some of these bankers of a growing concern about climate change, and a willingness to countenance firm proactive action to avert the risk at source. Pensions funds There are as yet no signs of concern about climate change from pension-fund managers. However, it will probably only be a matter of time before such concern arises, should the concern in the insurance and banking sectors proliferate. New York's public pension fund trustees, with assets of $45 billion, have professed that "when corporations treat the environment badly, they treat their investors badly...The fiscal health of our pension funds is the absolute measure for any decision we make. We can never endanger the check of a beneficiary. That is why we will not tolerate endangerment to our portfolio due to corporate environmental carelessness." Such sentiments, when a fair threat-assessment of climate change is undertaken, brook no other course than progressively divesting from climate related exposure. Clean energy entities, meanwhile - for example solar power, wind power, and electric utilities involved in demand-side management - offer huge medium term market opportunities. AVERTING THE THREATS Alternative investments await There are "substantial opportunities for those able to exploit them," according to the Delphi Report. "The alternative energy industry offers greater growth prospects than the carbon fuel industries. Diversification into this sector also offers substantial scope to offset the risks of climate change effectively." With the kinds of policies that governments will be finding themselves forced to enact "the competitiveness of alternative energy sources would increase significantly, and would lead to their widespread introduction." The Delphi Report concludes that such developments could certainly be expected within ten years, and most probably within five. The nuclear industry has argued that it should benefit from the inevitable upcoming switch in capital flows away from carbon-fuel industries. The fallacy of this argument is clear on economic as well as environmental grounds. Nuclear power cannot compete economically with energy efficiency and most forms of renewables, in terms of $ per kilowatt saved or generated, even on today's energy playing fields, massively skewed as they are in nuclear power's favour. The problems experienced during the attempted UK nuclear privatisation serve to illustrate this point. In addition, the nuclear industry carries huge environment-related risk for investors, including liability for clean-up, and manifold uncertainties over the as-yet unsolved problems of waste-disposal and decommissioning. A win-win alternative for the private financial institutions Simply stated, insurance companies, banks, and pension funds are threatened as a result of climate change with direct economic impacts, indirect economic impacts, and eroded investment income. That eroded investment income could come as a result of an environmental disaster driving panic policy measures and abrupt drops in share value, or it could come from steady decline of share values, following incremental changes in market perceptions of the risk involved in climate change. Therefore stablizing atmospheric greenhouse-gas concentrations at levels that pose no danger of economic disruption is clearly in the interests of the private financial institutions. Most governments agreed to this very goal when they signed the Climate Convention in 1992. But none of them yet have policies in place capable of delivering on this promise. To do so, will require deep cuts in greenhouse gas emissions [10]. To achieve such cuts will require a concerted international effort, in the years ahead, progressively to replace today's fossil-fuel dependent, energy profligate, status quo with renewable-energy supply and optimal energy demand-management. Though windpower, biomass, and other renewable-energy technologies can play vital roles in energy supply, there can be no doubt that the backbone of a sustainable global energy infrastructure for the next century will have to be solar power. So the challenge can be stated another way. Given the central importance of the financial institutions in debt and equity markets, saving the capital markets - not to mention the planet - will require kick-starting multi-billion dollar markets in solar energy. The fashioning of such solar markets is in the interests of the financial sector first because it helps address the climatic environmental threat at source. In fact, it also helps head off other environmental threats at source, in particular those relating to toxics (reduced oil-related liability risk, or contaminated-land clean-up risk), and nuclear (less risk of nuclear liabilty, and less risk of proliferation, nuclear terrorism, and nuclear contamination). Second, as the Delphi Report makes clear, investing in the upcoming solar revolution now makes good business sense in its own right, with or without such an environmental imperative. FROM AWAKENING, TO ACTION: THE PROBLEMS WHICH NEED ADDRESSING 1. The financial sector's interests are not being represented in the climate policy arena Unless the ongoing inter-governmental climate negotiations speed up, greenhouse gas concentrations in the atmosphere will rise ever more steeply, ever further undermining the security of the capital markets via the threat of climatic destabilization. Yet at the climate negotiations, the private financial institutions have yet to be represented. They have lost many opportunities to date in registering the interests of insurers, bankers, and pension funds on governments. The oil, coal and auto industries, meanwhile, have been represented from day one, by a number of well resourced lobby groups. These tend to present themselves and their perceived interests as entirely representative of the wider business community, and diplomats have little reason to doubt them. But the current agenda of the carbon-fuel businesses when it comes to climate change is very different from the interests of the private financial institutions. Just as the tobacco companies denied in the early days of the smoking debate any link between smoking and lung cancer, so the carbon-fuel lobby has been denying any possibility of dangerous global warming. 2. Investment opportunities in clean energy are being overlooked Both solar-thermal and solar-photovoltaic energy technology are waiting to take off. Dr David Mills of the University of Sydney, Vice President of the International Solar Energy Society, is one of the world's most accomplished solar-thermal researchers. After a recent breakthrough by his team in the efficiency of solar-thermal collectors, he told journalists "I am confident that solar thermal electricity will be competitive across two thirds of the US, all of continental Australia and Europe, and in the developing countries of Africa, South America and the tropics." Dr Martin Green of the University of New South Wales, is one of the world's leading solar photovoltaic researchers. His team were responsible for another technical breakthrough recently, this time in the design of cheap and efficient solar cells. He told the press at the time that "we have developed a new design strategy which should eventually meet all nations' needs for cheap and environmentally sound energy supplies" [11]. But both technologies - along with all the other renewables, plus energy efficiency - suffer from underinvestment. While insurance companies, banks and pension funds currently invest willy-nilly in carbon-fuel businesses that undermine their own market security, the technologies that can correct the situation go largely ignored. 3. Market signals favouring clean energy are not being sent Aside from their own investment practices, there are two main ways that insurers, banks and pension funds can help send signals favouring clean energy. One is to undertake unilateral actions in their own corporate ambit which favour renewable energy or energy efficiency. Many opportunities are currently being lost here. The second is to advocate, and pressure for, greenhouse- related performance indicators to be included routinely in corporate reporting and in the information compiled by the rating agencies. The UK government's Advisory Committee on Business and the Environment, in a 1993 report, argued that all companies should file detailed environmental reports. The report recognised that "the level of disclosure is still low, there is no standard for the quality of environmental reporting and... institutional investors have still to focus fully on the value of environmental data" [12]. Such arguments apply just as much to climate change as they do to contaminated land and other existing liability issues. THE WAY FORWARD 1. Lobbying and contributing to climate policymaking The interests of the private financial institutions can be represented effectively in a number of ways. At minimum, the larger companies, banks, or pension funds could send emissaries to the climate negotiations. Better still would be the creation of an umbrella lobbying organisation, serving the financial services industry. A third alternative is for existing industry umbrella organizations to send specially appointed emissaries, ideally experts seconded from within companies or banks who are intimately familiar with both the technical issues and the industry's operations and needs. An early goal for such an entity, or entities, should be to pressure agreement by governments on a protocol, or protocols, designed to strengthen the commitments on emissions limitation in the climate convention. Such a goal should ideally be achieved at the First Conference of Parties to the Convention (March 1995, in Berlin), or soon thereafter. Another vital role would be the contribution of technical expertise from within the industry. World-class meteorologists work for some of the big reinsurance companies, for example. Encouragingly, the Intergovernmental Panel on Climate Change now has a Financial Sector Working Group, and its chapter in the IPCC's Second Assessment Report (due in 1995) will no doubt make very interesting reading. 2. Sending unilateral market signals promoting clean energy There is much that can be done at the level of individual companies or banks, with virtually zero risk. One option for a robust zero-cost market signal would be to mandate high mileage vehicles in all future acquisitions for car fleets. Another might be the installation of solar powered conversions of existing buildings, or the erection of "zero emissions" new buildings. The cost of photovoltaic building facades is now cheaper than marble. Glazing units incorporating solar panels can be deployed to deliver both an electrical and a thermal load, thus boosting the combined supply efficiency. In addition, with insulation materials installed behind a solar- photovoltaic facade a beautiful synergism can be achieved between improved end-use efficiency and clean energy supply. There are spin off benefits for insurers and bankers. Business-interruption costs can be cut to the bone. Fire risk can be cut. Energy bills can be slashed. And it can all be made to look good in corporate advertising. 3. Advocating the sending of market signals in routine business practice Greenhouse-related performance indicators in corporate reporting will be essential if analysts and fund managers are to be fully aware of the threats and opportunities involved in climate change. The European Federation of Financial Analysts' Societies has already provided guidelines. A recent report written by it's Working Group on Environmental Issues concluded that "companies should provide data and information that permit financial analysts to assess both threats and opportunities arising from environmental issues." Where global warming was concerned, the report argued that performance indicators should include energy used per $ turnover/net profit/employee, carbon dioxide emissions per $ turnover/net profit/employee, and contribution to Global Warming Potential per $ turnover/net profit/employee [13]. 4. Refocussing investment practice The day the first insurance company, bank, or pension fund invests preferentially in clean energy industries ahead of carbon-fuel industries is surely not far off. When that happens, a snowballing effect would seem probable. In a marriage between the manifest technical viability of solar power, and the redirection of capital flows by financial institutions, lies the seeds of a solar energy revolution. Such a revolution serves the interests of insurers in a stable future insurance market. It serves the interests of bankers in secure loans. It serves the interests of insurers, bankers, and pension funds alike in a viable investment environment. Of course, it serves the interests of a wider community of stakeholders as well. -------------------------------------------------------------- NOTES: [1] M. Mansley, "The long-term financial risks of climate change to the carbon-fuel industry," Delphi International, November 1994. [2] "Climate Change: The IPCC Scientific Assessment," Intergovernmental Panel on Climate Change, Report to IPCC from Working Group 1, edited by J. T. Houghton, G. J. Jenkins and J. J. Ephrams, WMO-UNEP, Cambridge University Press, 1990); 1992 IPCC Supplement, Scientific Assessment of Climate Change, Final Report, Guangzhou, China, January 1992. [3] Enquete Commission "Protecting the Atmosphere" of the German Bundestag, "Climate Change - Threat to Global Development," March 1992. And see "The Climate Time Bomb," Greenpeace International Special Publication, June 1994, for other examples. [4] Article 2 of the Framework Convention on Climate Change, the objective, commits governments to the ultimate goal of "...stabilization of greenhouse gas concentrations in the atmosphere at levels which would prevent dangerous anthropogenic interference with the climate." This must be achieved "...within a timeframe sufficient to allow ecosystems to adapt naturally, ...to ensure food production is not threatened and to enable economic development to proceed in a sustainable manner." Where is the level of "dangerous interference?" That is a multi-billion dollar question for the insurance industry, for example, and it seems certain not to be far above present day atmospheric concentrations. For detailed arguments, see reference 6. [5] "Burned by warming," Time, March 14th 1994. [6] J. K. Leggett, "Climate change and the future security of the reinsurance market: recent developments and upcoming issues for the industry," Journal of Reinsurance, v. 1, no. 2, p. 73-95, winter 1993; "Climate change," a report presented to the 26th Annual Meeting of the Reinsurance Association of America, Ritz-Carlton, Laguna Niguel, California, 29 April 1994. [7] "Munich Re plea for catastrophe action," Lloyd's List, 23 April 1993. See also Lloyd's List, 27 April 1993, reporting Munich Re comments and Swiss Re, Sigma 2/93, Naturkatastrophen und Grossschaeden 1992: neuer Rekord der versicherten Schaeden. [8] "The impact of changing weather patterns on property insurance," Chartered Insurance Institute special report, May 1994. [9] "Global warming: element of risk," Swiss Re special report, 1994. [10] Stablizing greenhouse-gas emissions at present-day levels will simply slow the rate of build-up of greenhouse gases in the atmosphere. The 1990 IPCC Scientific Assessment reported that "we calculate with confidence that ....the long-lived gases (of which carbon dioxide is one) would require immediate reductions in emissions from human activities of over 60% to stabilize their concentrations at present day levels." Furthermore, "the longer emissions continue at present day rates, the greater reductions would have to be for concentrations to stabilize at a given level." [11] "Sunny days for solar power," New Scientist, 2 July 1994. [12] "Report of the Financial Sector Working Group," Advisory Committee on Business and the Environment, UK Department of Trade and Industry and Department of the Environment, February 1993. [13] K. Muller, J. de Frutos, K-U Schussler, and H. Haarbosch, "Environmental reporting and disclosures: the financial analysts' view," European Federation of Financial Analysts' Societies, 1994.