Sustainable finance: short-termism, climate crisis and the need for a transition
Our current climate crisis is often seen as one of human greed run amok. Many are rightly indignant at the oil majors, automotive and utility companies that have continued to favour safe profits over decisive action, and who have actively lobbied to sow doubt and block legislation. These have become the familiar antagonists of the climate movement. Yet it’s also becoming increasingly evident that climate change poses a threat to the economy as a whole. This suggests a different perspective – that however we got into this mess, it’s now a problem for all of us to solve, together. In the face of planetary crisis, it’s impossible to work on the basis of opposing sides. The question then becomes, how to get the economic system onside?
The scale of the risk is clear. If business were to continue as usual, with no immediate action to mitigate the effect of climate change we face at least a 50% risk of exceeding 5°C global average temperature change in the coming decades. Given that we are currently only around 5°C warmer than in the last ice age, climate change is banishing us, or better, we are banishing ourselves to completely unchartered territories. It is beyond a doubt that these changes would irreversibly transform the physical geography of the world, but perhaps more importantly for some, this self-imposed exile would fundamentally upend our economic system.
The Cambridge University Institute for Sustainability Leadership has been working to studiously model the risk climate change poses to the economy as a whole. In their Unhedgeable Risk Report they model three scenarios, one where we pursue growth without consideration for the economy, one where we step up our existing climate commitments progressively over time, and one where we actually do enough to meet a 2 degree target.
The warning they deliver is stark: the economic shocks that will result from unchecked climate change will cause ‘substantial losses in financial portfolio value within timescales that are relevant to all investors’. In the scenario where climate policy has stalled, they predict that only half of these losses can be avoided by moving out of risky investments and into safer ones. The other half are simply unavoidable – or in financial terms ‘unhedgeable’. This would cause a global recession, dipping into negative growth for most of a year, and a permanently depressed global growth rate. Meanwhile there would be grave impacts to poverty reduction, as the poorest countries in the world are the most susceptible to the geophysical effects of climate change, and investments in these countries would face particularly acute risks. Avoiding these risks would require radical measures that go beyond the financial system. But if market players face unavoidable losses due to this unhedgeable risk, then there is a purely self-interested incentive to support a socio-economic environment where these systematic changes can take place.
All this means that while it may be true that the geophysical consequences of climate change are likely to occur in the second half of this century, financial markets, macroeconomic trends and the reduction of poverty are likely to suffer much sooner because of the uncertainty regarding the climate crisis on behalf of consumers and investors. This suggests not only that the fate of the economic system is inextricably tied to the climate crisis, but also that there should be an incentive for businesses and investors to get proactive, and deal with these risks before either the physical consequences of climate change, or the uncertainty they will inevitably generate, become real. Here, investors have a particularly important role to play, in providing the signals that can guide the market towards a sustainable future, or deeply astray.
After nearly a decade of stories uncovering the self-serving greed of bankers and investors which triggered the 2008 financial crisis, we might be forgiven for forgetting that financial systems were designed to serve a social purpose. Yet a well-functioning financial system has a role: to provide funds to those ideas and enterprises which it thinks will provide value to others. It is meant to bridge the gap between ideas and execution, by providing the cash businesses need to get going, or to continue on.
Yet our current financial system has drifted far from this core purpose. Trading has become increasingly frenetic, and increasingly ruthless in search of profit. In the mid-20th century 15% of all stocks held by investors would be traded within a year. By 2010, this figure had climbed to 250%. This represents a fundamental shift in our attitude to trading: from one where stocks were bought largely as an investment into a business’ long-term prospects, to one where investments shift rapidly, chasing marginal profit in the fluctuation of share prices, rather than looking for sustainable businesses.
This has driven a change in the behaviour of businesses. For instance, a study presented 400 corporate Chief Financial Officers with a hypothetical project that would have guaranteed an overall return, but would have reduced a quarterly earnings. The authors found a majority of CFOs unwilling to take on the project, prioritizing being able to report higher short-term earnings, and thus safeguard their share price, over producing anything of value and ensuring the company’s long-term success. In line with this short-term culture, between 2000 and 2009, average CEO tenure dropped from 8 years to 6 years. In thrall to the financial markets, which control the perception of their value, businesses are increasingly focused on short-term profit themselves. This has been described as a shift from “a culture of management to a culture of speculation”, and it is proving disastrous for our ability to get businesses to confront the realities of climate change.
Of course businesses are not the only ones in denial. As Rolling Stone noted, the US Republican Party are the only mainstream political party in a major polluter nation who still systematically deny climate change, and they do so with almost religious fervour. With the US as the second-largest emitter of CO2 worldwide, behind only China, and having just installed a climate-denier-in-Chief, things look bleak. And if you trace how this state of affairs came about, the financial system is deeply implicated.
On one hand there are the now all-too-familiar stories of companies lobbying and lying about climate change for private profit – whether it’s Exxon Mobil burying decades of climate data, or Volkswagen lying about their vehicle’s’ emissions. Such machinations are constantly justified in terms of securing shareholder value – fighting climate change simply isn’t a good investment. On the other hand, the same American foundations such as the Searle Freedom Trust, the John William Pope Foundation, and the Howard Charitable Foundation which have championed the sorts of radical free-market ideas that have secured the dominance of short-termist, quick-profit practices in the financial sector, have also given hundreds of millions of dollars to climate change denial think-tanks and lobbyists.
The result is a world where we directly subsidize the fossil fuel industry to the tune of $492 billion every year. At the same time, the IMF estimates that the damages caused by fossil fuels to health, and the environment amounted to $4.8 trillion in 2015, comprising an astonishing 5.9 percent of global GDP. This not only represents a huge barrier to tackling climate change, but it should also disturb anyone who believes in the market system as a fair arena for competition.
The financial system is undoubtedly a major part of the problem when it comes to creating change. In fact, in many ways it’s invested in the problem. Yet the scale of the climate challenge means that any solution to the crisis we’re in will have to harness the financial system to drive change. To avoid catastrophic global warming, we will need to move a lot of money into sustainable solutions, and fast.
The International Energy Agency estimates that in order to switch from fossil fuels to sustainable energy will cost $44 trillion, between now and 2050. Meanwhile, looking beyond the energy industry, the World Bank estimates an additional $70-100 billion per year will be needed to allow the rest of the world to adapt to the changes we’ve already caused, in terms of dealing with impacts on health, agriculture, forestry and fisheries, water supplies and much more. This means investment on a scale beyond what most governments are currently putting forward. In fact, between 2011-2015 private and public investment totalled $1.195 trillion. If that trend continues, we’ll miss the 2050 IEA target by over 71%. It’s clear, then, that halting global warming will take everything we have.
Getting the financial industry to shift, from being invested in perpetuating the climate crisis to being invested in solving it is no easy matter. Yet there are clear financial motivations to tackling climate change – at least for some. The Cambridge Institute for Sustainability Leadership argue that although we will need to take a short term financial hit, to properly face down climate change, halving the global growth rate from 0.7% to 0.3%, this best-case scenario, within 8-12 years we would end up seeing growth rates above any other possible model. In other words, there’s a smart case to be made for long term investors to back climate solutions.
Meanwhile for those who feel that pandering to the financial system is an abandonment of questions of justice, there’s good news – pushing investors towards climate-friendly solutions also has the potential to help reform the financial system – by reorienting it towards more long term investments, and empowering the sorts of investors who care about sustainable, well-governed companies over those out to make a quick buck. It’s not a comprehensive solution to the flaws of the industry, but given the destruction a short-termist focus has wrought, it’s a start.
Given the importance of finance to climate, it’s disconcerting then that we hear so little about it when it comes to discussing how to tackle climate change. Beyond headline grabbing pledges from the likes of Bill Gates, and the complex question of carbon trading, it’s a topic that barely registers in the frantic debate about policy and legislation. Over the next few weeks, we hope to provide an overview of exactly how the financial system might be harnessed towards a more sustainable future, what some of the barriers are to doing this, and what we, as citizens can do.
 Author’s calculation, based on figures in the paper, but taken to remove pre-tax subsidies.
This article is the first in a short series on sustainable finance with Cambridge University.