Climate change has the potential to bring about a financial meltdown on a scale which could dwarf anything yet seen. Some estimates put the value of assets which could be left stranded by the twin tides of climate change and decarbonisation at $40 trillion. To put this in context, the impact on global property values during the Great Recession has been estimated at between $1 trillion and $2 trillion.
But it is not too late to avert this calamity. And the signs are encouraging that society is moving in the right direction to do so. We have seen sustainability climb to the top of corporate agendas, moving from the CSR Manager’s desk and into the CEO’s office.
This shift is being led by Fortune 500 companies and adopted by corporates around the world. It is being driven primarily by three very potent forces – investor sentiment, supply chain pressures, and employee power.
Investors are beating the sustainability drum more loudly than ever. If investee companies are not taking climate change and broader sustainability issues seriously investors may walk away with their capital. We are seeing this come up with increasing frequency at investor briefings, EGMs and AGMs.
Corporates are also putting new pressures on their supply chains in order to achieve overall carbon and climate targets. Suppliers must meet increasingly stringent decarbonisation targets if they are to continue doing business with top companies. We are only at the start of this trend.
Most fascinating of all is the way in which employees forcing change in employers. New generations of workers are saying they want to work for employers with a purpose and that salary is not the only consideration. Oil companies are already reporting difficulties in hiring top talent and employers will increasingly be scored on their sustainability performance by prospective employees.
These drivers are being compounded by climate risk which will manifest itself in many ways. From a financial perspective there are increased risks from floods, drought and other weather events while reputational risk will increase dramatically as certain behaviours become unacceptable to new generations of consumers.
Companies need to understand that they don’t have to be in the oil or other extractive industries to be exposed to this risk. Businesses in areas such as airline catering, fashion, building materials and just about every sector will be affected. Products and services taken for granted today will not be acceptable tomorrow and business models will have to change in response.
Investment managers and corporates are beginning to understand the scale of the coming climate crunch. The transport sector is just one example. Even before COVID-19 hit we had seen a pronounced and growing decline in business travel and flight shaming was establishing itself as a corporate trend.
There had also been a fall-off in demand for heavy carbon shipping and there was pressure on the major transport companies to switch to alternative fuels and more efficient ships. Investors were putting pressure on corporates not to use those types of ships in their supply chains.
At a political level, the EU is going out of its way to reengineer itself as a green economy by backing a green agenda. The EU Sustainable Action Plan on Green Finance, which has become known as the EU Taxonomy, looks at every single industrial and commercial activity and defines what is sustainable and what is not. This is having a powerful influence in persuading the capital markets to put money into sustainable activities. Investors and lenders putting money into activities defined as non-sustainable will find themselves exposed.
At the same time, investors are now requiring banks and other institutions to report on their performance in relation to the EU Taxonomy.
These actions by governments, capital markets, employees and society in general are forcing companies around the world to change behaviour and re-examine their business models.
The world has very definitely shifted on its axis and COVID-19 has provided some of the impetus for that change. In many ways, COVID-19 has acted as an incredible catalyst for change for the ESG and sustainability agendas. At the early stages of the pandemic the belief was that it would shift the focus away from climate change. But it has actually awakened people to the realities of climate change. There is now an understanding of what can happen when the world is unprepared for a major event.
COVID-19 has not just been a health crisis, it’s a financial and economic crisis as well. But its impact will be minor in comparison to climate change. One consequence of climate change is the permafrost melting in certain regions. This will result in the release of multiple pathogens that have been locked in the earth for millennia. We haven’t seen anything yet when it comes to pandemics if this is allowed to go unchecked.
COVID-19 is also providing us with the chance of a lifetime to address climate change through economic stimulus packages. When governments invest in economic recovery it should be a green recovery. In that context, it is very good to see that the EU package will have green strings attached.
While climate and decarbonisation have dominated the agenda up until now, the “s-word” in ESG is becoming more important. Movements like MeToo and Black Lives Matter have exposed and highlighted unacceptable social practices in various realms, and they have energised many people to say that the old ways won’t work.
People now want to do things with a purpose and, very importantly, the link has been made between purpose and financial return. Companies which are not seen to have a purpose will have a less than healthy long-term financial outlook. Companies are no longer getting away with poor social practices. We saw a major global fashion company’s share price collapse recently as a result of poor behaviour in its supply chain.
The bar has gone up quite significantly in ESG.
Wealth transfer from developed to developing nations is another emerging theme. The world has to find ways to transfer wealth that will generate financial returns. That will happen if we can find ways to deal with the risks involved, sovereign and political risk in particular. One of the big issues is to find ways to incentivise investment in developing markets. There is no simple answer, but progress is being made.
Future progress on all fronts will be critically dependent on innovation. If we look back at the digital and technology revolution of the 1970s, we can see something similar happening now in relation to sustainability. Innovators around the world are doing some incredible things but what’s missing is the capital.
That will come and I confidently believe that the wave of innovation we are about to see will change the way we all live our lives. The technological changes we are seeing now will be trifling in comparison to what will happen over the next 10 years. We are about to enter a period of unprecedented disruption driven by the transition to zero carbon.
A version of this article originally appeared in The Irish Independent and is reproduced here with their kind permission.