Although many lessons have been learnt since the global crisis, the financial system is still not fit for purpose, in one crucial respect, warns Arlene McCarthy.
Arlene McCarthy is a member of the High Level Expert Group on Sustainable Finance and a former vice-president of the European Parliament’s Economic and Monetary Affairs Committee.
We’ve been here before. In 2008, the global financial system was brought to the brink of collapse. The causes? The incentivising of short-term behaviour, the disconnect between the interests of bankers and savers and investors, and risks building up out of sight of regulators and shareholders.
There is a growing awareness that climate risk could pose the next threat to financial stability. Not only do the physical effects of climate change – storms, drought, or sea-level rise – raise the prospect of massive financial losses, but the gradual move away from fossil fuels towards a low-carbon economy could become a rush for the exit, if investors were to rapidly reassess the value of fossil fuel companies. Indeed some have already started to act on these risks by divesting portfolios.
The difference between now and 2008 is that there is no shortage of warnings being given, by investors, regulators and businesses as well as academics and activists.
As the climate science becomes ever more robust – and alarming – momentum is building with the public for a change of direction in the role finance plays in funding the economy.
Last month, the Task Force on Climate-related Financial Disclosures – a body established by Bank of England Governor Mark Carney, under the auspices of the Financial Stability Board and chaired by UN Special Envoy Michael Bloomberg, made its final recommendations.
The Task Force calls for companies to include climate risk disclosures with their annual financial filings, and sets out specifically what those disclosures should cover.
Industry-wide adoption of these disclosures would no doubt equip shareholders with the information they need to assess the climate risk posed by their investments. It would enable them to encourage the companies in which they invest to reduce those risks.
It would help them, where necessary, divest from those companies that are on the wrong side of the economic revolution that is underway.
Meanwhile, it would also allow them to identify those companies that are leading the transition towards the clean energy economy of the future. That is the other side of the climate risk coin – the enormous economic opportunity that the low-carbon transition presents.
In Europe alone, an additional €180 billion needs to be invested each year to meet the EU’s commitment to hold the rise in global average temperatures to well below 2 degrees Celsius. Globally, the figure is closer to €500 billion.
This investment in clean energy and other low-carbon technologies will translate into millions of high-quality jobs around the world, while helping to reduce local pollution and improve human health.
But is the financial system ready and able to supply this investment? The financial system needs to be completely transformed if it is to deliver the energy transition we need, and ensure that we bequeath a healthy and prosperous planet for the generations yet to come.
There is hope on the horizon. The European Commission’s High-Level Expert Group on Sustainable Finance published its Interim Report last week and identifies fundamental imperatives for changing Europe’s financial system namely improving disclosure and assessment of long-term sustainability risks such as climate change; and ensuring capital is delivered to the businesses and projects that can build a sustainable economy.
The report makes a number of concrete recommendations. They include better sustainability related disclosure by the financial sector and labelling financial products. It calls for directors and investors to be compelled to manage long-term sustainability risks and advocates for changes to the regulatory system to encourage green investments while penalising ‘brown’ ones.
The report makes clear that there is a key role for all actors within the financial sector to step up and seize the opportunities presented by the low-carbon transition, and to ensure that they understand, and communicate, the climate risks that they face.
Crucially, the report also calls for greater engagement with society at large. Many of the problems in the financial system in recent years have their roots in the gap between how the system operates, and the needs of consumers, citizens and business.
Too often, the financial system has not addressed the long terms needs of savers, pensioners and entrepreneurs.
By helping Europe’s consumers and citizens better understand the role of finance in meeting the sustainability challenges we face, we can help drive the cultural change needed to enable the financial system to provide the backbone for sustainable growth
By ensuring that finance is accountable, we can ensure that its efforts are directed to meeting society’s long-term need for a sustainable economy, rather than mortgaging the future in exchange for short-term returns.
With a reboot of the financial system, Europe will not only transform the EU economy but can lead the global sustainability agenda. A revolution is already underway.
As the Trump administration has turned its back on science, and retreated from its responsibility to help address climate change, cities and businesses are rushing in to pledge their support and stepping up their activities to meet the Paris commitments.
But access to finance is the key to delivering this new green sustainable agenda. Money needs to be matched to sustainable projects. The public and private sector is urgently called upon to release the capital to make that happen.
Strong political leadership bolstered by a financial sector that recognises and acts on its responsibility to be the driver for a sustainable economy can put Europe in the global lead on building a sustainable future for all and for generations to come. There is an even bigger prize to be had.
Access to affordable reliable and sustainable energy for all is a delivery mechanism for the Sustainable Development Goals. Scaling up financing for renewables and sustainable energy sources globally can help not just in the fight against climate change but in combatting poverty in some of the poorest countries of the world.
Europe has the expertise and the critical mass to deliver a new sustainable finance model. The recommendations in this report are part of the change that needs to happen. Political will and a proactive engagement by the finance community can make it a reality.