Climate change, financial services

The finance sector provides the wheels that turn the economy and without proper investment and responsible finance, the initiatives for renewable energy and climate change adaptation are not possible, writes Lisa Bowyer, principal consultant, Liberty Consulting Ltd.

Bad news

Climate change presents a risk. Climate risk can manifest itself through damage and business interruption caused by violent and erratic weather, liabilities from greenhouse gas regulations and lawsuits, higher operating costs through increased energy prices and impacts on competitive positioning due to changing customer demands.

An article published in the Harvard Business Review in 2007 titled Competitive Advantage on a Warming Planet highlighted that climate change risk differs from other business risks because the impact is global, the problem is long-term and the harm is essentially irreversible.

Many organisations have known for up to 20 years that climate change presents a significant risk to the financial sector. At the domestic level, non-sustainable communities will see their local economies contract and with it, demand for property finance, investment and banking services generally. Brief illustrations are that property assets acting as security for lending may plummet in value as those properties become uninhabitable or uninsurable. Adverse climate change will also negatively affect insurance and reinsurance companies as extreme weather, natural catastrophes including rising sea levels and flooding gives rise to greater claims, raising premium levels to a point where insurance is unaffordable for many.

Thus companies should factor environmental criteria into their risk analysis as there is now sufficient evidence on the investment materiality of climate change. In a 2011 United Nations Environment Program Finance Initiative report, the estimated annual environmental costs from global human activity was put at US$6.6 trillion equating to 11 per cent of global GDP in 2008. The cost of environmental damage caused by the world’s 3,000 largest publicly-listed companies in 2008 was put at US$2.15 trillion and more than 50 per cent of company earnings could be at risk from environmental costs in an equity portfolio weighted according to the MSCI All Country World Index.

Good news

The shifting economy and move to renewable technology means new opportunities. Evidence of the relevancy can be seen, when in 2009, 181 leading investors and financial institutions responsible for the fiduciary management of US$13 trillion issued a Statement on the Urgent Need for a Global Agreement on Climate Change, to be agreed on in Copenhagen that year. Of course the Copenhagen talks were disappointing and failed to reach an effective political agreement. Again, in Cancun in 2010, over 250 investors responsible for the management of funds the size of US GDP called for policies to unlock low-carbon growth and avoid economic devastation. Representing the world’s largest global investors, it was a powerful message for world governments and climate negotiators in Cancun – take action now in the fight against global warming or risk economic disruptions far more severe than the recent financial crisis.

Domestic finance sector

Sustainability policies must be incorporated into business practices; for example, banks can encourage responsible building practices and energy efficiency. It is these entities that largely facilitate property development and thus they have a great deal of power to effect change and it is these entities that will suffer first from a distressed property market. Insurers can also offer favourable terms to encourage energy efficiency and renewable energy; for example, domestic solar panels. There are a number of reinsurers making specific coverage available for renewable energy technology and so early entry into this market could provide competitive advantage. Without investment in mass production of renewable energy in Cayman, generation by individual homes and businesses appears to be the best way to mitigate the energy security problem that Cayman may face as oil prices rise. Other examples of finance for new business opportunities and private public partnerships for a reduced carbon economy are green transport initiatives; for example finance for public transport and alternative fuel vehicles.

International market

The two most important areas to focus upon in averting disastrous climate change are to prevent deforestation and to improve energy efficiency to shift from a coal and oil based economy. Investment in clean technologies, especially in developing countries and project finance generally, not to mention growth of existing products such as weather derivatives and catastrophe bonds, suggest significant opportunities especially for many players in Cayman and thus possible development of a niche of expertise. The development of a green energy infrastructure is reported to require finance of $10.5 trillion by 2030. Many in the international insurance industry are already looking toward risk consulting opportunities and developing schemes for carbon as an insurable asset and carbon trading and emissions off-setting is developing fast in other jurisdictions and could create opportunities in Cayman.

Mutual benefits

Thus there is hope of moving past the politics, which are failing to provide the solutions and action needed. The link between financial capital and economic capital, which ultimately links with natural capital means there are economic incentives for responsible investment which drives the economy.

In November 2010 over 250 investors responsible for the management of funds the size of US GDP called for policies to unlock low-carbon growth and avoid economic devastation.

The United Nations Environment Programme Finance Initiative

UNEPFI is a global partnership between the United Nations Environment Programme and over 190 financial institutions from the banking, investment and insurance sectors across the globe, working with UNEP to understand the impacts of environmental and social considerations on financial performance. It has become the voice of the finance sector in the global environmental policy making arena. It also develops and issues information and guides regarding materiality and the incorporation of environmental, social and economic factors into business practice. Japan has the most members followed by Germany and then the US and Australia together in joint third.

“It is very important to give a strong political message …only this will enable long term investment and enable the finance sector to plan in advance. If we don’t have a regulatory framework in place which enables sustainable development, it is very hard to appropriately allocate investment,” said Astrid Swik of Munich Re

Benefits of joining UNEPFI

Financial institutions are under increasing scrutiny from investors and regulators asking more and more challenging questions about corporate governance, the social and environmental impacts of operations and investments and how firms support their local communities. Since 1992, membership in the UNEPFI has help signatories to understand stakeholder concerns, exchange best practice and stay on top of the issues.

Membership in UNEPFI also informs signatories on how to turn climate change into an opportunity for growth and shaping the sustainable finance agenda as it develops. For more information go to:

Cayman’s financial services industry

In November 2010 Cayman Island’s Government issued a Green Paper, Climate Change Issues for the Cayman Islands. The paper is a technical report and is the most comprehensive reference document on potential implications of climate change for the Cayman Islands. Of note, the paper provides detail on land and sea temperatures, storm activity, sea level rise, rainfall, water resources, health and food and energy costs and security. During the first quarter of 2011 an executive summary of the paper was presented to a number of the private finance sector associations in Cayman and it referred to risks of climate change for the financial services industry but also the opportunities it will present, particularly for international financial services.

The ability to innovate and respond to the changing economies, the shift to alternative and renewable technology and other mitigation and adaption measures across the globe places Cayman at an advantage. On a domestic level, while two notable effects of climate change increased hurricane activity and rising sea levels appear to be a threat to Cayman, a report by the Caribbean Catastrophe Risk and Insurance Facility in 2010 shows that with the implementation of adaptation measures, up to 90 per cent of Cayman’s climate risk can be mitigated by 2030, which places it in one of the most secure positions in the Caribbean.

Competing with City-based financial centres

One does not need to be sentimental about preserving the natural environment and beauty of Cayman, to recognise that the beautiful environment and ideal climate is the most important resource of all. It is what attracts and retains the necessary human resources. George Town is now reportedly 4 degrees Fahrenheit warmer than it was when the first bank set up here. Despite the climate risks we face, the sun is the resource that gives Cayman an advantage as the world moves away from oil. A strategy is necessary to ensure that Cayman remains able to compete with other financial centres as climate change and rising oil prices is already affecting the cost of living and thereby the cost of human capital and business.

A 2010 UK Department for International Development Report states that, “Cities are the future of the 21st Century. More than half the world’s population lives in towns and cities and this proportion will rise to nearly two thirds by 2030. Cities are seats of government and learning, crucibles of culture – art, theatre and music – engines of economic growth, clusters of innovation and a context for social and political change.”

While many cities face problems of climate change, in particular rising temperatures and sea levels, many including London and New York have been planning for climate change adaption for many years already. If they get it right, cities are better able to distribute energy, water and food efficiently and handle waste and public transport systems more easily. All things being equal, cities are considered to be better able to adapt to climate change in the future, which could affect Cayman’s competitive advantage in the absence of positive action to adapt now.

Cayman became a top financial centre because of its early positioning. The move away from a fossil fuel driven economy has begun and the simple message here is that financial services firms should engage in the climate change strategy for the Cayman Islands to protect their business investment. The Government’s White Paper, Achieving a Low-Carbon Climate-Resilient Economy – Cayman Islands’ Climate Change Policy, that will follow the Green Paper, is due out in 
Quarter 2.