While the East Coast of the US avoided a direct hit this weekend by Hurricane Joachim, it was still a not-so-welcome reminder that we may not be as ready as we should be for as severe weather events that will likely become the norm (and not the exception) thanks to a changing climate.
My work is not weather forecasting but finance and specifically the nexus of climate change and finance. Given the attention climate change is now getting with these more frequent weather extremes many people ask why is it that so little finance flows towards “climate smart” investment.
The definition of climate smart is not always clear but most people use the phrase to mean two things: investment in more low carbon technologies, and increasing investment in more resilient infrastructure. For the first part of this definition many investors say that truly significant amounts of financing will flow with the proper policy signals, including a price on carbon. For the second part of this definition, many investors are at a loss to come up with an equivalent policy measure (or signal) that would incentivize more financing of resilience. This is because the way you understand your resilience is through understanding your risk, and when it comes to climate change, “climate risk” is not so well understood.
What can policy makers do to help us understand our risk better, so that investors can channel more capital towards climate-smart – and resilient – investment? If a price on carbon is a policy signal that will unlock significant capital for low-carbon investment, is there an equally compelling policy “signal” that helps us proactively invest in our own resilience to a warming world.
Understanding Climate Risk
Policymakers, academics, and industry are looking to better understand how to quantify and eventually commoditize climate risk. Long term warming trends are a fact, and in a business-as-usual scenario, well respected international organizations, such as the Intergovernmental Panel on Climate Change (IPCC), predict that warming could well surpass 4°, 5° or even 6° Celsius by next century without significant action to limit emissions. What we know, though, is that at warming of even 3°C, managing climate risk will be the least of our troubles. Most scientists agree that we need to cap warming at 2°C to avoid the most dangerous consequences of climate change.
Over the last few years a number of respected reports have quantified the economic costs of climate change given the IPCC projections, and within a 2°C world. The Risky Business Report, the New Climate Economy work and the World Bank’s series Turn Down the Heat all lay out in great detail the expected economic impacts of climate change. The challenge for investors to integrate climate resilience into decision making now seems to lie in both the uncertainty of climate outcomes, and the short-term nature of their decision making.
Investors looking for stability and resilience
The good news is that some businesses and investors are actively looking for better information about the risks and opportunities associated with becoming resilient to a changing climate. One of the more interesting meetings I attended last week during the New York Climate Week was the Climate Data Summit, hosted by Risky Business. The conference brought together investors, scientists, insurers, and government to discuss ways to bridge the gap between known weather data (eg: short term conditions) with climate data (eg: observed long term changes, and the future) and how to translate that into meaningful information and tools from which investors can make good business decisions.
At this meeting last week, a private equity investor in the room asked one panel of modelers a simple question: “so, when you are layering on top of your historic data the IPCC data in order to understand future trends, what do you use as your center line? Do you use 2 degrees? Do you use 4 degrees? Where do you expect these trends to go?”
What he meant was something that all students of statistics would know: when understanding your probability distribution, the “center line” is the peak (or center) of your distribution curve, and the likelihood of events happening above or below this line are equal. We know from our friends in the insurance industry that probabilities of some extreme events are already starting to shift, signaling an expected increased frequency. When thinking about outcomes and future climate risk, and in particular the probability of certain climate related impacts, knowing where to ground the “center line” is indeed critical.
This got me thinking. A policy signal could very well impact how we are modeling our risk, but unlike carbon pricing, policy actions on climate risk must be global to work. That “center line” can only come from collective ambition. And too date, such a policy signal has not existed.
Paris, INDCs as a Market Signal for Resilience
The upcoming international climate meetings in Paris (the Conference of the Parties, or “CoP”) will be the latest effort to garner a global agreement. Whether or not we have a successful outcome in Paris is likely to be a matter of perspective. For some, significant progress and meaningful commitments will have been gained, and others may leave this year’s CoP feeling like the global community did not promise enough.
But one thing Paris will deliver, regardless, are the Intended Nationally Determined Contributions, or the INDCs. These proposals have been rolling in all year, and set out individual country ambitions to limit emissions. Collectively they will tell us whether our global ambition will keep us on a 2°C, 3°C, or warmer world. Most agree that success in Paris will depend upon, among other things, ensuring that the collective ambition keeps us within 2°C.
From these INDCs we should have the only type of policy signal that gets us to a “center line” that my private equity friend was looking for last week. Of course, if those INDCs add up to 2°C or 3°C is of critical importance.
For so many reasons, let’s hope then that Paris gives us – and investors – the “signal” below 2°C. Such a signal will not only help investors begin to seek out climate-smart opportunities and channel financing to proactively build-in resilience to our warming world, but it could also indeed save us from a world where managing such climate risks is the least of our troubles.