Companies should be required to stress test their business plans against risks of climate change actions and impacts say climate experts
- Published: Tuesday, 07 June 2016 07:54
Companies that fail to plan for business scenarios in a low-carbon economy risk decline or even bankruptcy, according to a submission to the Task Force on Climate-Related Financial Disclosures by the Grantham Research Institute on Climate Change and the Environment and the ESRC Centre for Climate Change Economics and Policy at London School of Economics and Political Science.
The authors of the submission, Dimitri Zenghelis and Nicholas Stern, argue that there is a significant gap between the stock market valuations of carbon-intensive companies today and what their value would be if the commitments made in the Paris Agreement on climate change were taken seriously. This has serious consequences for investors; and for the companies themselves.
The submission has been made to the Task Force on Climate-Related Financial Disclosures, which was set up in December 2015 by the Financial Stability Board to “develop voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders”. The Task Force is chaired by Michael Bloomberg, and published its initial findings in March 2016. It is due to publish its final report by the end of the year.
The submission states: “[There is a] gap between what politicians have signed up to in Paris and what markets and fossil fuel companies are assuming. This gap should alarm policy-makers and central bankers: it suggests either asymmetric information or a lack of credibility in policies”
The authors argue that companies should not only disclose the “carbon exposure” of their past activities, but they should also undertake an assessment of forward-looking business risks.
They call for companies to carry out ‘stress tests’ for the risks associated with climate change, including business risks from new policies to reduce greenhouse gas emissions, and to disclose to investors their findings, as well as their strategies for dealing with those risks.
The submission states that “it is becoming increasingly risky for companies to pin all business strategies on the assumption that extensive decarbonisation will not happen” and that “business models reliant on the assumption that governments were not serious in Paris are looking increasingly vulnerable.”
The authors warn that financial markets could struggle to cope if there is a sudden revaluation of companies exposed to the risks of climate change and to risks from efforts to reduce greenhouse gas emissions.
They state: “The speed at which such re-pricing occurs is uncertain and could be decisive for financial stability. If the transition is orderly, then financial markets will likely cope.”
The authors emphasise that the risks to businesses are not limited to physical changes from climate and weather patterns. In fact, the authors suggest that greater attention should be given to ‘non-physical risks’, which include new policies and laws, technological advancements, changing consumer preferences and risks to a company’s reputation.
The risk of a negative economic shock resulting from such changes can be reduced if investors are given more information about the risks that companies are exposed to from climate change impacts and actions, and what their strategies are for coping with them.
The submission states: “Resilience requires the presence of forward-risk management and hedging strategies. In addition to answering the question “what is your most likely scenario?” investors will seek to ask “what will you do in alternative scenarios such as a net-zero emissions world?” The answer to this puts market players in a better position to assess market capitalisation.”
The authors call for companies to carry out stress tests to changes in regulations, and changes to carbon taxes and carbon prices, as well as to the physical risks posed by climate change. They suggest that one way to stress test in relation to new regulations and policies would be to convert them into the carbon-price equivalent, much as non-tariff actions can be converted into tariff equivalents in analyses of trade.
The authors also recommend that companies fully disclose this information to investors. Companies should make clear their strategy for coping with the possible scenarios as a result of climate change impacts and action on climate change.
The submission concludes: “Climate risks and climate policies are likely to have a profound impact on firms in the global economy in the years to come. The commitments expressed by almost every country in the world in the recent Paris Agreement cannot be safely dismissed.”