Climate Change as a Risk Amplifier

    Stockholm (NordSIP) – “We don’t’ consider it likely that climate risks will be treated by corporates as a separate risk class,” say Citi Group’s Special Economic Adviser, Willem Buiter, and Benjamin Nabarro, Global Thematic Associate, in a research note about the management of the financial risks of climate change. “Instead, it is likely to be treated as a threat amplifier to existing risks.”

    Willem Buiter joined Citi in January 2010 as Global Chief Economist. Before this role, he was Professor of Political Economy at the LSE, Chief Economist for the EBRD and a founding External Member of the Monetary Policy Committee of the Bank of England.

    Anthropogenic Climate Change Facts

    The report highlights the fact that annual greenhouse gas (GHG) emissions between 2011 and 2018 are estimated to have ranged between 34.5 and 37.1 Gigatonnes of CO2 equivalent (GtCO2e).

    The IPCC estimates according to which we need to bring those emissions to 29GtCO2e by 2030 and 9.9 GtCO2e by 2050, to have any hope of reaching the goal of keeping global temperatures from rising above 2°C of pre-industrial levels. Based on these constraints, the report notes, “the remaining CO2 budget from 2015 onwards is between 590 and 1,240 GtCO2. This is equivalent to between 15 and 31 years of CO2 emissions at 2014 levels.”

    Mitigation and Physical Risks

    The report identifies two primary sources of financial risk associated with climate change and greenhouse gas emissions: mitigations risks and physical risks. The report explains that “mitigation risk is the price of success in the fight against global warming. Physical risk is the price of failure.”

    According to the authors, “stranded asset risk is the focus of mitigation risk”. Stranded asset risk is the risk that a change in demand for a specific asset – due to changes in regulation, taxation, or tastes, for example –  will lead to a sharp decline in its value. The typical example is the decrease in the value of fossil fuels. As the consensus on anthropogenic climate change consolidates, the fight against global warming is creating legislative, and market pressures on fossil fuel consumption as renewable sources continue to gain in popularity and efficiency.

    “Asset destruction is the focus of physical risks”. The issue, in this case, is not the effect that markets and regulations will have on the price of assets but rather the fact that climate change brings about a rise in extreme weather events that can actually destroy physical assets. The research considers several temperature increase scenarios upon which the damage caused by physical is contingent. The studies cited by Citi’s note suggests that rises of up 4°C by 2100 could cost up to 4% of GDP growth to the USA, although the rate of damage increases disproportionately with temperatures beyond this range such that an 8°C could cut GDP by 10%, according to estimates.

    Regulators and International Initiatives

    Echoing and expanding upon a similar note by Swedbank’s Group Chief Economist Anna Breman did earlier in 2019, Citi’s report goes on to highlight several initiatives that seek to bring about the changes necessary to contain climate change risks.

    First among these is the Climate Financial Risk Forum (CFRF), an initiative of the Bank of England (BoE), to support the integration of climate-related factors into the financial decision making of the insurance industry through appropriate modifications in the supervisory and regulatory framework. Another initiative of the BoE, the Task Force for Climate-related Disclosures (TCFD), recommended voluntary disclosures of material, decision-useful climate-related financial risks targeted at all companies that raise capital. The recommendations have been endorsed by over 100 leading companies and credit rating agencies.

    Following the leadership example set by the BoE, the Bank de France pushed for the creation of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The NGFS’s first comprehensive report called central banks to integrate climate risks into supervision and own portfolio managements, improve data availability, facilitate research and foster consistent international definitions and standards of disclosure.

    The report also mentions the Poseidon Principles, which aim to operationalise the GHG 2050 strategy of the UN International Maritime Organization (IMO), which seeks to reduce the maritime industry’s total annual GHG emissions by at least 50% of 2008 levels by 2050.

    “Financial risk from climate change is here to stay. Prepare now or pay later,” the authors conclude.

    Image by Thomas Breher from Pixabay


    Filipe Albuquerque
    Filipe Albuquerque
    Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.

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