The Climate to Storm Debate in 2020
Australian markets strategist, Saxo
Summary: The impact of the climate crisis on public policy and investment decisions will be broad reaching. We discuss the potential for Green QE, increased food prices and social unrest as well as the rise of ESG investing.
Changes to our planet Earth’s climate have been observed across the globe in many ways, including, but not limited to, measurements of temperature at the surface, rising sea levels, increased sea surface temperature, and increased water vapour in the atmosphere. Global warming has seen average air temperatures rise by more than 1 °C since records began in 1850, and each of the last four decades has been warmer than the previous one. Sea levels globally have risen 20cm since 1880 at a rapidly accelerating rate. Decreased polar ice sheets, and a reduction in glacier volumes have also been observed as the earth’s temperature changes alongside the atmospheric concentration of greenhouse gases.
Joseph Stiglitz, Nobel laureate in economics, a Professor at Columbia University, and former chief economist of the World Bank says: “The climate emergency is our third world war. Our lives and civilization as we know it are at stake, just as they were in the Second World War.”
Australia's climate alone has heated by greater than 1 °C since 1910, causing an increase in the frequency of extreme heat events, drought and fires. Something we are witnessing in real time as the bushfire crises rages.
Governments, policymakers and nations must come together and collectively reduce emissions in order to minimise the burden of climate change and ensure the prosperity of future generations. As the incidence of extreme weather events wreaks havoc on farmland and agricultural activity, water security, biodiversity, welfare and human health, the climate crisis will not be left unaddressed. This paves the way for climate change to shape the public policy debate, not only in 2020, but for years to come. The need for adaptation will spur the adoption of policy solutions aimed at funding for example, renewable energy projects, water security, sustainable energy efficient infrastructure developments and technological innovations in clean energy, emissions capture/measurement and energy storage facilities/breakthroughs.
Hence, the idea of Green Quantitative Easing (GQE) is one that is gaining traction, alongside MMT justified by the climate crisis. The purchase of green bonds under a GQE package would be intended upon reducing the borrowing cost of green projects, incentivising businesses and governments to undertake more environmentally friendly investments and increasing green economic activity whilst reducing greenhouse gas emissions. Central banks could consider introducing a GQE package via their financial stability target, given that the cost of the climate crisis could pose financial risks.
Extreme weather linked to climate change
As the earth’s climate changes, extreme weather events are not only becoming more frequent, but also more intense. The economic and social cost of climate change is also on the rise. In economic terms rapidly increasing to reach on average $200 billion per year over the past ten years, which is four times more than in the 1980s. Alongside an ever increasing social cost via non market impacts on the environment and human/animal health.
Scientists are now increasingly able to quantify the role that climate change plays in the increasing incidence of extreme weather events. There are number of scientific institutions and agencies that have documented the scientific evidence of human contribution to climate change. As a research paper from the National Academies of Sciences, Engineering, and Medicine plainly states “In the past, a typical climate scientist’s response to questions about climate change’s role in any given extreme weather event was “we cannot attribute any single event to climate change.” The science has advanced to the point that this is no longer true as an unqualified blanket statement.”
Whilst extreme weather events have occurred throughout the history of the planet, and long before humans walked the earth, there is evidence of human contribution to climate change. Academic studies find direct linkages to changes in temperature extremes, heavy rainfall events, and an increase in sea levels in a number of regions via human influence.
Food Prices, Social Unrest and Public Policy Challenge
Green QE will play a big part in debate over 2020, not just because central bank’s must pass the baton to fiscal as their tools are inadequate in combatting structural challenges and reviving growth sustainably, but because the cost of climate change will force action as we have detailed above. As the incidence of fires, floods and drought increases, the economic cost ensures change, and not least by the fact that rising food prices will act as a tax on consumption across low and middle income earners.
The Actuaries Climate Index is an educational tool designed to help inform actuaries, public policymakers, and the general public about climate trends and some of the potential impacts of a changing climate and how these vary over time.
The Index shows changes in the frequency (rate of occurrence) of extreme high and low temperatures, heavy precipitation, dry days, strong wind and changes in sea levels. These components have a strong correlation to risk, an area of expertise for actuaries. Insurers are one of the most obviously exposed to economic cost of climate change through the potential for higher claims
As the impact of climate change through drought, unseasonably heavy rains, temperature changes and fires affects agricultural output and productivity, a clear outcome is likely to be increased food prices. This translates via loss of farmland or production capacity as well as crop destruction, or increased costs of exposure to climate variability.
The marked rising trend in extremes is undeniable. Another contentious area for public policy debate lies in the impact of climate change on food prices, which in turn correlates to social unrest (although not always a causal relationship).
In India, onion prices have rocketed, more than tripling as a result of drought followed by heavy rainfall which rotted the crop. Past governments in India have met demise as the cost of onions rose on prior occasions. In the 1980s Indira Gandhi campaigned on the notion that high onion prices equalled economic mismanagement.
After peaking in 2008, food prices started rising rapidly again in the second half of 2010 along with the incidence of “food riots” prevalent particularly throughout the Middle East and North Africa.
An average household in the US dedicates about 13% of its budget to food, but in developing countries this can be well over 50%. If the price of food increases, the trade-off is a greater share of household budgets are spent on food, reducing the amount that can be spent elsewhere. This can be especially disastrous for poorer developing countries.
At present, Southern Africa is forecast to receive below-average rainfall until March, further exacerbating the requirement for food assistance following previous droughts which have already destroyed crops and resulted in livestock deaths, according to the Famine Early Warning Systems Network. Southern Africa has been plagued with extreme weather events like drought, cyclones and flooding as the regions temperatures are rising faster than the global average rate, according to the International Panel on Climate Change.
Recently in Chile revolts have been attributed to a resounding dissatisfaction with inadequate pensions, health care, and education systems. But the reality is extended drought conditions and concerns about access to water likely rendered Chileans ready for action. In Syria, crop failures that saw the cost of bread spike helped prompt a civil war. And in France we have seen the “gilet jaunes” mobilised by French President Emmanuel Macron’s plan to increase fuel taxes to fight climate change.
As unprecedented fires burn across NSW, Australian Prime Minister Scott Morrison has faced a huge backlash for not only his inaction on climate policy but his failure to support the country throughout this period of emergency. Instead choosing to jet off on holiday with his family, whilst firefighters from Canada leave their own families in a bid to help tireless Australian firefighters quell flames.
The warming planet has direct implications for public policy, not just domestically but internationally, in order to avoid social unrest resulting from food price spikes and other disruption.
Investment Implications, ESG Pays of which Climate change is the #1 issue for ESG asset managers
ESG funds and companies with heightened moral capital are poised to gain in 2020 and beyond and will warrant a valuation premium as investors and asset managers become more discriminating and focus on integrating sustainability concerns into their investment mandates. This investment theme is set to become more dominant in the decade ahead driven by a redefining of the fiduciary duties of large asset managers and a growing cohort of millenial and Gen Z investors, for whom financial performance as a sole investment goal, is being replaced by positive impact. Ultimately, companies who do not meet this new and improved sustainability and positive impact mandate will trade at a discount. For example, it is not unforeseeable that as the coal phase out obligations of the Paris Agreement in OECD countries by 2030 are implemented some companies and investors will end up holding stranded assets via reserves of unburnable coal. These companies then become much more risky investments over the next decade.
ESG factors cover a broad array of issues that traditionally are not part of financial analysis, but are increasingly coming to the forefront of investment decision making processes. These issues include how corporations are attempting to mitigate climate change and emissions, their carbon footprint, water and waste management practices, how they manage their supply chains, data security and customer privacy, and even how they treat their employees – from diversity and inclusion to welfare and health and safety practices.
As the foundations for a sustainable finance ecosystem are laid a huge reallocation of capital will be underway. Investors and corporates who do not gear their portfolios towards more sustainable business models risk facing large losses in the coming decades, holding stranded assets as regulatory changes could leave many current operating models unviable.
Climate change is the primary issue and takes centre stage for ESG asset managers according to US SIF (The Forum for Sustainable and Responsible Investment). More than one third of assets under management globally are now being invested according to the premise that ESG factors can affect a company’s performance and valuation, that makes climate a #1 priority for investors. The number of asset managers investing with some form of ESG mandate is only growing and already trillions of dollars exclude companies that do not measure up in terms of sustainability. This will only grow larger as fiduciary duty is redefined.
Some of the world's largest asset managers already invest with a clear ESG mandate including the Government Pension Investment Fund (GPIF) of Japan, Norway’s Government Pension Fund Global (GPFG), and the Dutch pension fund ABP. The Government Pension Investment Fund (GPIF) of Japan, who manage more than US$1.5trn, earlier this year moved $40 billion of its equities portfolio away from a traditional passive index based on market capitalization to one weighted for ESG themes, and primarily decarbonization. L&G, one of the U.K.’s largest asset managers, also attracted attention earlier this year when it divested some holdings in ExxonMobil because of the company's inadequate response to climate change. Change is a foot.
Fiduciary Duty Re-defined
A key hurdle to financial institutions adopting ESG principles is the mistaken belief that fiduciary duty means focusing solely on returns, allowing ESG principles to be sidelined in favour of sacrificing return. However, recent legal opinions and regulatory guidelines state otherwise, instead arguing that it is a breach of fiduciary duty not to consider ESG principles. As the voice of the climate crisis grows louder, it is inevitable that policy makers will mandate a requirement for institutional investors to include ESG as part of their fiduciary duty. The UK, Canada, Sweden, Switzerland and other EU authorities are already ahead of the game in this respect. In October this year, binding rules for UK pension funds to consider material ESG issues came into effect. The Minister for Pensions wrote to the 50 largest pension funds asking them what they are doing in this area and that some funds should stop “shuffling their feet” on climate change.
A precedent on whether failing to integrate ESG issues is a failure of fiduciary duty, will be set in Australia as Mark McVeigh, a 24-year-old environmental scientist, is suing his A$57 billion ($39 billion) pension fund for not adequately disclosing or assessing the impact of climate change on its investments.
It is a matter of certainty that investors can expect only increased policy focus in the years ahead. Individual corporations and valuations will no doubt feel the effect of these changes, up first is likely to be increased scrutiny for large corporations owned by passive asset managers and pension funds as a more discerning investment process is undertaken.
It pays to go green - The S&P 500 ESG Index is up around 29% this year, versus 27% for the benchmark and 23% for the MSCI ACWI Index.