BlackRock CEO Larry Fink’s most recent annual letter to other CEOs made news because of its clear-cut prediction that climate change has brought us “to the edge of a fundamental reshaping of finance.”
Fink’s letter also came with a more subtle message aimed at asset managers who’ve been hiding behind the idea that climate change and the havoc it may wreak is too complicated to fully comprehend: Figure it out now or risk losing everything.
The bad news for those asset managers is that in some ways they’re right: climate science is a massively complicated world. The good news is that they’re not as right as they think they are, and not only is there much more data now than there’s ever been for those seeking to understand what a changing climate will do to investments, it’s also more available than it’s ever been.
Until now, asset managers and financial authorities may have had good intentions in working toward greener investing, but they’ve essentially been fumbling in the dark due to a lack of reliable climate predictions and disclosure models.
Thankfully, there’s been a profound shift over the past four decades in our ability to model climate change and in turn predict its financial implications.
In the recently released book “Brave New Arctic”, for example, the former director of the National Snow and Ice Data Center recounts his own decades-long journey to understanding the incredibly complex factors involved in the thawing of the polar ice caps. The fact that it is only now, he says, that a reasonable trajectory for global warming can be charted, suggests that the data for modeling a system as complex as climate hasn’t been available until recently.
What that author and asset managers can both benefit from now is a plethora of previously unavailable, observable data. In more plain English, that means thousands upon thousands of buoys measuring ocean temperature, airplanes and satellites measuring pressure systems at the atmospheric level, our first videos of melting glaciers critical to our ecosystem, and a whole host of other data-producing systems that have provided scientists some level of comfort that the models they’ve been using to predict change are actually lining up with the change being measured in the field.
As Fink’s letter makes plain, no one in the investment community is asking for belief in climate science any longer; the perception has changed so much that it’s now focused on how to respond to it.
This added confidence is even beginning to show up amongst competing models. And in a further sign that climate science is now more available to anyone who seeks it out, those competing models are now, for the very first time, available all in one place — just last month, Google announced that it would host, for free, models created across 30 working groups.
The big challenge today is to combine this improved science on the global climate and weather system with comprehensive disclosure rules and stress-test modeling that gives investors better visibility into companies’ exposure to climate change risks and opportunities. This promises to create a positive climate feedback loop. Firms will be rewarded by investors for carbon reductions, incentivizing them to implement more sustainable solutions, in turn boosting investors’ returns through increases in long-term profitability.
Attitudes about businesses’ climate risks are starting to change at a high level, as represented both by Fink’s letter and other developments that have received less notice. The outgoing governor of the Bank of England, Mark Carney, for instance, recently issued a stark warning of his own that many companies risk seeing their assets become worthless unless they wake up to the climate crisis. As Carney noted, some $120 trillion on the balance sheets of banks and asset managers are at risk due to climate change.
The Bank of England is one of several big institutions that have introduced climate stress tests, focusing on the vulnerability of U.K. banks and insurers under different temperature rise scenarios. The EU’s recently introduced “universal taxonomy” is an important regulatory step toward mandatory disclosure of climate risks. The taxonomy will allow money managers to see the extent to which their portfolio companies are supporting the transition to a lower carbon future.
On a global level, the Task Force on Climate-related Financial Disclosures (TCFD) has provided concrete guidance for public companies on how to report risks and opportunities arising from climate change. The TCFD lays down climate change assessment metrics and robust sustainability reporting guidelines that can help promote better-informed investment, lending and insurance underwriting decisions. This takes it a step beyond “greenwashing” or green certification efforts, and makes it amenable to integration with mainstream company reporting.
Some financial firms are trying to fill the disclosure gap with their own analysis. Major banking groups, ratings agencies and investment advisory firms have adopted different approaches that are giving investors better metrics with which to assess climate risks.
However, these different stress tests and the ways they are being used remain too siloed. One type of test isn’t enough.
The only thing that rivals the complexity of modeling climate change itself is the act of modeling its financial implications. Just as climate scientists like the one who revealed why our data hasn’t been reliable until now know they need a variety of methods, so too do asset managers.
The challenge is to find a more comprehensive solution that integrates these top-down and bottom-up approaches. If asset managers can use these stress tests collaboratively to focus on what’s important and establish relevant data feeds, they will have taken a big step toward the transparency that sustainable investment demands.
Pooja Khosla is head of product development and director of data science at Entelligent. Thomas H. Stoner is the CEO and co-founder of Entelligent and author of “Small Change, Big Gains”.
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