Companies failing to account for the impact of climate change and a transition to a low-carbon economy are at risk of decline or even bankruptcy.
This is the primary finding from a new submission to the Task Force on Climate-Related Financial Disclosures published earlier this week by the Grantham Research Institute on Climate Change and the Environment, along with the ESRC Centre for Climate Change Economies and Policy at the London School of Economics and Political Science.
According to the authors of the report, Dimitri Zenghelis and Lord Nicholas Stern, companies using “business models reliant on the assumption that governments were not serious in Paris are looking increasingly vulnerable” to economic risks.
The report posits that the Paris Agreement, agreed upon at COP21 in December of 2015, and signed earlier this year, has shifted the future of greenhouse gas emissions and created a long-term path towards complete global decarbonization. The shift toward investment in low-carbon energy technology is already beginning, which will only see continued technology cost reductions in the next decades. Additionally, the value of high-carbon assets such as stocks in coal mining companies are declining, with investors increasingly becoming aware of the future risks of such carbon-intensive assets.
Global policymakers are increasingly aware of these issues, and are beginning to make efforts to include these risks into their planning. However, as authors Zenghelis and Lord Stern note in the summary of their report, “business models reliant on the assumption that governments were not serious in Paris are looking increasingly vulnerable.” Specifically, the authors argue that there is a significant gap between the stock market valuations of carbon-intensive companies made today, when compared with the likely value of these same companies if the commitments which are part and parcel of the Paris Agreement on climate change are taken seriously, and enacted globally. The commitments that politicians have signed up for in the Paris Agreement varies wildly with what markets and fossil fuel companies are assuming. Such a gap in current assumptions versus future reality could have significant risks for investors. “This gap should alarm policymakers and central bankers: it suggests either asymmetric information or a lack of credibility in policies.”
The authors therefore highlight the “importance of effective disclosure” immediately, and suggest “careful assessment of forward-looking business risks and stress-testing against possible scenarios, acknowledging that many risks are mutually reinforcing and could unfold rapidly.” Specifically, Dimitri Zenghelis and Lord Nicholas Stern recommend that the Task Force:
- Provide a clearer up-front articulation and unbundling of material risks, matched to the need for corresponding data and statements on forward strategy
- Tackle the marginalization of non-physical risk in the report, and therefore the issue of exposure on account of carbon-intensity of business activities
- Most importantly, tackles the absence of a forward-looking assessment of business vulnerability and ensures businesses provide an answer to the question “what strategy is in place to transition business models to ones that remain valuable if ambitious climate policies are imposed, or if disruptive climate impacts apply?”
“Climate risks and climate policies are likely to have a profound impact on firms in the global economy in the years to come,” the authors conclude. “The commitments expressed by almost every country in the world in the recent Paris Agreement cannot be safely dismissed.” Therefore, all sorts of climate risks “must be clearly identified and business resilience assessed against them.”
More information about the report, and access to the submission can be found here.