Jo Paisley and Richard Barker on Planetary Health and financial stability

The first of the Green Templeton Lectures 2024 was held on Thursday 8 February. It was introduced by Dr SanYuMay Tun and moderated by Dr Marc Thompson.

Read the report of the lecture

Antonia-Olivia Roberts (Clinical Medicine, 2022) writes

In two enlightening presentations on ‘Planetary Health and Global Financial Stability‘, President of the GARP Risk Institute Jo Paisley and member of the International Sustainability Standards Board (ISSB) Richard Barker delved into the intricate relationship between Planetary Health, financial systems, and corporate sustainability. Paisley dissected the impacts of climate change on the financial sector, while Barker elucidated the necessity of sustainability reporting for investor transparency.

Climate change and risk

Paisley’s talk focused on climate change as an indicator of poor Planetary Health. She looked at two main impacts: the impact of climate change on the Financial System, and the impact of the Financial System on climate change.

Paisley first highlighted that climate risk impacts are not the sole domain of the future – they are being felt already. This includes both physical risks, such as the 2022 flooding in Pakistan which threatened 33 million people, as well as transition risks arising from the adjustment towards a low-carbon economy. For example, companies face uncertainty over whether and when to invest in new green technologies.

The Impact of climate change on the financial system

The world is experiencing a change in the distribution of climate outcomes, with extreme weather events becoming significantly more common. For example, livelihood crises may be caused by physical risks such as extreme weather, and transition risks arise as industries change to become greener. Therefore, methods of estimating future risks based on past events will be inherently unreliable. Instead, the mixture of physical vs transition risks we will experience in the future is determined by how well we limit future greenhouse gas emissions. For example, if emissions carry on unchecked and warming occurs at a faster rate, we will see an increasing and high burden of physical risks. However, following policies to decarbonise and decrease emissions will lead to more transition risks as new opportunities develop. Paisley emphasised that physical and transition risks are not mutually exclusive, rather they reinforce each other. Therefore, it is likely that the world will become increasingly risky in the future.

Modelling future risks

Paisley explained that as the understanding of climate risks has grown, so has regulatory focus. One of the most commonly used families of regulatory scenarios has been produced by the Network for Greening the Financial System, established in 2017. They have developed a series of scenarios, each with a different set of assumptions for how climate policy, emissions and temperatures evolve. These models allow companies to undergo climate change stress testing. However, Paisley noted that these models do not capture all the risk, and their adequacy is increasingly being questioned. For example, mass migration and environmental tipping points are not considered in these models. Therefore, she argues that economic losses could be two to three times higher than anticipated, and climate change could well be a threat to global financial stability in the future.

The impact of the financial system on climate change

Paisley highlighted the importance of the Paris Agreement, signed at COP21 in 2015, in recognising the role that financial systems have to play in tackling climate change. The agreement aimed to make finance flows consistent with low greenhouse gas emissions and climate-resilient development.

Paisley explained that there is currently far greater focus from firms on the ‘alignment’ of their portfolio with a chosen temperature pathway. However, this pathway approach has several challenges. Firstly, alignment requires good quality sustainability data from firms producing goods and services. Secondly, alignment may have unintended consequences. For example, if one firm sells highly polluting assets, a less committed firm may buy these, and this could result in worse climate impacts. Finally, alignment does not necessarily correlate with impact – attempts to avoid transition risks may be counterproductive to attempts to decrease physical risks. Paisley used the example that lending to Shell may protect us from the impact of climate change on the financial systems, but would worsen the impact on the environment and hence physical risks. Therefore, she argued that policy is needed to guide the financial system by channeling investment into areas we need, such as green technologies.

Paisley ended the talk with the parting thoughts that we are facing rising physical and transition risks, which could threaten global financial stability.  This is because finance is ‘aligned’ with the real economy, which will be affected by physical events and shifts in industry, politics and the legal system as a result of climate change. To combat this, transparency and education are important, but policy is fundamental in driving changes.

Corporate Sustainability Reporting

Richard Barker’s talk deepened exploration of some of the same themes as Paisley’s. Firstly, a healthy planet is needed for a healthy economy. Whilst seemingly intuitive, this is a concept which is only recently being embraced by financial regulators such as the Bank of England, and it has required a mindset shift in the way that financial institutions conduct business. The second theme is that the past is not a good guide to the future, due to increasing levels of risk, as discussed by Paisley. Therefore, we must change the way we measure and report on performance so that it does not rely only on past experience.

What is sustainability?

Barker began by discussing the definition of sustainability, as put forward by the UN’s Brundtland Commission. This is that sustainability is “meeting the needs of the present without compromising the ability of future generations to meet their own needs”. Barker, a professor of accounting, set out how this follows a similar logic to accounting. Growth cannot be allowed to occur at the expense of capital.

The Brundtland report was important because it directed attention to the idea that nature is a type of capital that we possess, alongside human, intellectual, financial, manufactured and social capital. Nature is the foundation for these other forms of capital. However, it is in a critical state of depletion as a consequence of market failures and the ‘tragedy of the commons’ – in that economic and natural capital have conflicted. People have used natural capital in their self-interest until now, leading the natural capital to become depleted. The report acknowledges that we have no obligation to increase capitals, however, we must also not decrease them.

The corporation in a sustainable economy

Barker explained the three demands that sustainability makes on the corporate sector. Firstly, corporations should continue to deliver goods, services and other economic benefits and must, therefore, be financially viable and attractive to investors. Secondly, that corporate activity should not deplete natural capital, as outlined by Brundtland. Finally, corporate activity should progress societal ambitions with respect to human and social capital, following the Sustainable Development Goals. To fulfil these roles, corporations ought to be transparent regarding their influence from and on climate change.

Information for investors

Transparency can come in the form of sustainability-related financial disclosures.

Barker continued by drawing parallels between financial statements and sustainability disclosures. Whilst financial statements are retrospective and report on whether financial capital was maintained and profit made, sustainability disclosures help investors understand the risks and opportunities affecting uncertain future outcomes.

Barker outlined the questions that the disclosure should answer. These include how the company is preparing for an unknown future, such as how the board is informed about climate change. Disclosures should also explain how the company’s financial prospects depend on resources it does not own or control and might not pay for. For example, in the case of car manufacturing, manufacturers of diesel cars may be more exposed to risk than of electric cars as fossil fuels become scarcer. Barker also highlighted the case of the university, which relies on a significant portion of its income from foreign students who fly to the UK. As climate change may influence the price and availability of aviation, the university will be exposed to greater risk. The International Sustainability Standards Board has recently introduced reporting standards for sustainability disclosure, which include the questions discussed above. The UK’s sustainability disclosure standards, to be announced in July 2024, will be based upon the ISSB’s standards.

Is reporting to investors sufficient?

Barker highlighted the fact that we are used to living in a world in which everything we do increases carbon emissions. In such a world, corporate reporting is necessary, as it provides comparable and transparent data. It is also enabling, as it forces corporations to frame and imagine a sustainable future. However, corporate reporting is not sufficient to enact change, as companies can only change as a response to economic incentives. This links to the importance of policy change to incentivise innovations, as outlined by Paisley.

Conclusions

In a world facing escalating physical and transition risks due to climate change, the speakers underscored the imperative for policy intervention and corporate responsibility. As Paisley aptly noted, economic losses could exceed current estimates, necessitating a paradigm shift in risk assessment. Barker’s emphasis on sustainability reporting highlighted the pivotal role of transparency in steering investments towards a greener future. By aligning financial strategies with climate goals, policymakers, financial institutions, and corporations can collectively mitigate risks and improve global financial stability, putting us on a better path towards planetary health.

About the series 

This reports from the first of the flagship Green Templeton Lectures 2024 on Planetary Health. The series is considering intersections with the stability of financial systems, economics beyond growth, and the legal process. The lectures are convened by Research Fellow Dr SanYuMay Tun together with Governing Body Fellow Dr Marc Thompson and Research Fellow Dr Laurence Wainwright.