Why financial leaders face their biggest test yet on climate risk

25 Feb 2020

Why financial leaders face their biggest test yet on climate risk

The impact of climate change on the financial system will be profound and far-reaching and the role of its leadership critical in any response.

In light of our recent poll that revealed that only a fifth of UK financial services firms has a well-developed strategy to manage the risks of climate change, the debate at a recent Odgers Berndtson Climate Risk event was particularly relevant.

The keynote speaker on the evening was Sarah Breeden from the Bank of England, who has oversight of the Bank’s work enhancing the financial system’s resilience to climate change.

She laid out the challenge facing the financial system, and the wider economy, and explained how the Bank was leading on helping financial services organisations understand the financial risks resulting from climate change.

Sharing the platform were Saker Nusseibeh CBE, CEO, International, Federated Hermes, and José Viñals, Group Chairman, Standard Chartered.

Climate’s challenge to financial leaders

Sarah made the challenge clear to the audience of 100 CEOs and senior leaders from leading banks, investment firms and insurers.

“To have a two-thirds chance of getting to a two-degree world over the next ten years, we need to have a peak in carbon emissions next year and have them fall over the next 10 years at twice the rate of which they have increased over the previous 10 years.”

The challenge is made even more pressing if you consider that global fossil CO2 emissions from energy use and industry are not yet showing a decline that would make that possible.

“This is the defining issue of our times, and leadership has never been more important.”

Sarah continued, “It is a tough ask. The full financial risks are not yet quantified or even easily calculated. But we know that every single asset will have to be re-assessed, as we have seen with buildings that have become unsellable or credit risk in the automotive industry.

“The risk from climate change is different from any other, and therefore needs a different approach to management.

“The risk is far-reaching in its breadth and scope and will reach every part of the economy and thus the financial system.

“But whilst the effects are as yet uncertain, they are totally foreseeable.

“That’s why brave leadership is key since it can often be about looking decades ahead and making decisions without definitive evidence or indeed widespread support.”

Climate stress test for the financial system

To help organisations understand climate risk and make more assured decisions, the Bank is working with the Financial Conduct Authority as part of the Climate Financial Risk Forum to create ‘how-to’ guides on key topics.

Further to those, and a key to a wider understanding of the impact of financial risk is the Bank’s pioneering effort in creating a stress test for banks and insurers.

As explained in a recent discussion paper, this will ask organisations to consider three climate risk scenarios.

Firstly, what happens if we stay on the current carbon pathway; then, what happens on an orderly transition to zero, and, finally, what are the effects of a late and disorderly route to zero emissions.

Do the smart thing to unlock opportunity

For José Viñals, Group Chairman, Standard Chartered, action on sustainability is not just the right thing to do, but the smart thing. “Amongst the 15 top emerging markets, it opens up an estimated $4 trillion investment opportunity.”

Also looking ahead, Saker Nusseibeh CBE, CEO, International, Federated Hermes, emphasised the importance of asking questions about the kind of future investment is building.

“At Federated Hermes, we are building the kind of future economy you would want to retire in. Not one where water is scarce, food is hugely expensive, and aggressive immigration is the norm.”

He summed up the nature of the climate challenge by asking how someone in the agricultural economy, before the industrial revolution, might have regarded their world with huge change looming.

“For us, it is the same, everything will have to change. We don’t know the detail, but we do know there will be a profound transformation of all our lives. And as financiers, we must be there as our clients try out ideas that might turn out to be blind alleys,  just as happened in the Industrial Revolution.”

Sarah Breeden added, “I am assured by the experts that we have the tech, but we need to make it commercial. We need to finance that innovation.”

Climate risk front and centre at Davos

For José, there was an important signal on sustainability and climate risk and where it is on the global business agenda at Davos.

“This year, for the first time, every one of the top five medium-term risks agreed on at Davos related to climate and the environment.”

“The private sector is truly waking up, and starting for the first time to ‘walk the walk’. Businesses realise they have to look long-term, if not they might lose their business.”

But it is not about walking the walk alone. Everyone agreed it requires public and private partnerships, and national, regional and global co-operation.

The true price of leadership

All the panellists agreed on the key role of leaders in driving the changes required for adjusting to a warming planet.

They have to set the tone and direction and ensure that action on climate risk, mitigation and opportunity is as much a part of their corporate DNA as anything else. In José’s analogy, “It should be as integrated as technology is.”

The final word on leadership goes  to Saker, who reminded the room that,  “leadership always comes with a price, and that price is responsibility.”

When it comes to the future of the planet and the role of the financial system, that has never been truer.

Preparing for impact: financial risk and climate change.

Watch an in-depth interview with Sarah Breeden of the Bank of England.