Climate Change – will the financial system survive?

One of the few bright spots in an otherwise dismal global response to the escalating climate crisis has been the preparedness of financial market regulators to force their regulated institutions to face up to the implications of climate risk.

In so doing, they have been acutely aware of the lessons learnt from the 2008 Global Financial Crisis, where scenario analysis, expert financial modelling and stress testing failed to foresee the crisis and the consequences for the banking system, investors and business alike. As a result, the global financial system was only save from collapse by a massive trillion-dollar bail out, for which the banks and corporations who caused it have yet to be held accountable.

When questioned by the Queen in 2008 as to why the crisis had occurred, the British Academy, after much introspection, responded that a “psychology of denial” led to “the failure of the collective imagination of many bright people … to understand the risks to the (financial) system as a whole.”

The reaction to the ominous warnings in the first part of the Intergovernmental Panel on Climate Change’s (IPCC) 6th Assessment Report, recently released, demonstrates that the same psychology of denial is alive and well, particularly in Australia. The financial press has erupted with ever-more incredulous claims as to why gas, oil, and even coal are absolutely essential to solving the climate crisis. Politicians are suddenly experts in silver bullet technologies that will solve our problem without understanding the limitations of their claims, and trawl the web even more vigorously than normal for any sliver of denialist evidence that the climate issue might just go away.

Fortunately, regulators with independent mandates to ensure the stability of the global financial system are taking their responsibilities seriously. To make climate risks more transparent, central banks and regulators globally are stress-testing the financial system. Most notable have been initiatives by the Task Force on Climate-related Financial Disclosures (TCFD), the European Central Bank (ECB) and the scenario work of the Network for the Greening of the Financial System (NGFS). In Australia, regulators have coordinated their work through the Council for Financial Regulators, with the Australian Prudential Regulatory Authority (APRA) initiating a climate vulnerability assessment for banks, encompassing scenarios up to 3°C of global mean warming, and issuing draft guidance for companies to stress test their own finances against scenarios up to 4°C warming.

Stress tests are simulations, relying on scenarios of future circumstances, and on models of the climate, the economy and the financial system. These techniques are valuable in reasonably well-understood circumstances, but they have severe limitations in addressing the threats which climate change now presents. The latest IPCC report has begun to discuss these issues, which include non-linear processes such as climate tipping points, cascade effects and radical uncertainty, where probabilities cannot be attached to specific outcomes, but even now the IPCC remain relatively reticent on these potentially existential, but increasingly possible, threats.

It is particularly challenging to map first-order physical climate warming impacts onto the second-order impacts in the social and financial spheres because it depends on the responses of complex human systems which cannot be reduced to probabilistic terms. In a complex world, systemic risks can arise from interactions between changes in the physical climate and human systems, so that small changes can lead to large divergences in the future state of human society.

Scenario analysis creates coherent, credible stories about alternative futures, allowing for constructive discussion on alternatives that should take into account the full range of credible evidence. But too often it is devalued and represents little more than sensitivities around some conventional strategic plan. Scenarios, properly used, can assist in securing a safe and stable future, but only if applied with brutal honesty in exploring extremes and not just a predetermined path.

Unfortunately global leaders, and Australia’s in particular, have not acted fast enough to avoid locking in extremely dangerous, and potentially catastrophic, climate impacts. Those impacts are close to moving beyond human control as global warming accelerates, evidence of which was clearly seen with the unprecedented 2019-20 Australian and Californian bushfires, the Chinese floods and Indian extreme temperatures. Even greater extremes are occurring in recent weeks in the Western USA, Canada, the Arctic, Siberia, Europe, China and the Amazon, resulting in some impacts that were not projected until around 2100.

In that context, the approach currently being used by regulators in assessing the future assumes compliance with the Paris Climate Agreement, unsustainable economic growth, a reliance on technologies not yet proven or deployed at scale, an overshoot of the Paris temperature target, and a big continuing role for gas. This worldview is being rapidly overtaken by events.

Scientists and analysts consider 4°C of warming to be an existential threat, incompatible with the maintenance of human civilisation, and 3°C to be catastrophic, perhaps leading to outright chaos in the relations between nations. Applying stress tests to such circumstances is problematic. Even at 3°C, the impacts may be so great as to be potentially infinite and unquantifiable, making scenario testing largely irrelevant.

It is unlikely that the banking system could survive such levels of warming, as discussed in our latest report: “Degrees of Risk: can the banking system survive climate warming of 3oC?”

Markets crave stability, but the world is entering an era of instability and uncertainty driven, inter alia, by climate-related financial risks. This makes the current approaches to managing these risks not fit-for-purpose. Sensible risk management, especially for highly uncertain events such as we are now facing, demands a precautionary approach, which must be applied to prevent these risks materialising.

Such precautionary action must ensure temperature outcomes do not trigger further tipping points or cascading effects which move the climate system beyond human influence, and are capable of returning it to the stable climate conditions under which human civilisation flourished. This means emergency action to keep the temperature increase to a minimum, as close to 1.5°C as possible, coupled with drawdown of current atmospheric carbon concentrations.

If the financial system is to survive and prosper, reactive disclosure of risks alone is no longer enough; time is short and mitigating those risks must become the absolute focus of regulators and regulated alike.

Company directors have a fiduciary responsibility to identify the risks to which their organisations are exposed, and to implement suitable systems to manage those risks. In the context of climate risk, boards of directors have too readily adopted recommendations from regulators and from supranational organisations such as the International Energy Agency or the IPCC, without bothering to understand the limitations of such analysis, thereby failing in their fiduciary responsibility to fully assess risk.

Regulators, here and overseas, exert great influence over financial and corporate players. If climate risk regulators imply warming of 3-4oC is manageable or can be adapted to, and such thinking becomes enshrined in the corporate psyche, as is currently happening, then regulators will be institutionalising failure, which is certainly not their intent.

Instead, regulators must now demand that the regulated proactively disclose what emergency precautionary action they are taking to ensure the world remains as close to a 1.5oC global mean temperature increase as possible.

This is just one change amongst many that must occur if humanity is to survive and prosper through the 21st Century and beyond. And it is an important one, because we cannot afford another failure of imagination.


Ian Dunlop is Chair, Advisory Board, Breakthrough National Centre for Climate Restoration.
David Spratt is Research Director of Breakthrough.

This article was published in Pearls & Irritations on 17th August 2021

The Net Zero Emission Illusion

As the need for serious action to prevent runaway global warming becomes critical, it is not surprising that efforts from the denialist lobby to prevent that action intensify, albeit in more subtle form than the blanket refusal of yesteryear to even accept that a climate problem existed.

Around the world, companies, investors, governments and other institutions are committing, with much self-congratulation, to reach net zero emissions by 2050 (NZE2050), the point at which any remaining emissions can be counterbalanced by offsetting absorption in carbon sinks, using technologies which currently do not exist at scale.

Regulators and central banks, concerned that global warming might de-stabilise the world’s financial system, are urging their regulated institutions to disclose the implications of climate change risk to their investors, and to undertake stress testing against scenarios with up to 4oC of global mean warming relative to pre-industrial levels.

Missing from this debate is any understanding of the real risks posed by climate change. Recent events such as the unprecedented 2019/20 Australian and Californian bushfires, Chinese floods and Indian extreme temperatures, along with even greater extremes occurring this year in the Western US, Canada, the Arctic, Siberia, Europe, China and the Amazon, should be a wake-up call that climate impacts are accelerating and close to moving beyond human influence.

But that is far from the case. Despite impassioned pleas from scientists and much lofty institutional rhetoric from global leaders on the need for emergency action, the emphasis on a NZE2050 pathway, is actually locking-in extremely dangerous, and potentially catastrophic, climate outcomes by refusing to rapidly reduce carbon emissions, which is now necessary to stop runaway warming.

The 1.5°C global mean warming, the lower limit of the Paris Agreement, is inevitable by 2030 irrespective of any mitigation action in the interim. The upper 2°C limit is likely before 2050, with the possibility that irreversible, self-sustaining warming may be triggered by tipping points between 1.5 – 2°C. The current global trajectory is likely to result in catastrophic warming in excess of 3°C in the second half 21C, with little chance of changing that trajectory over the next two decades by mitigation alone. 4-5°C warming is possible before 2100. The dangerous impacts we are already experiencing are happening at only 1.2°C warming.

3°C warming would be catastrophic, perhaps leading to outright chaos in relations between nations, and 4°C is an existential threat to human civilisation, with many parts of the world becoming uninhabitable leading to mass migration and social conflict. Regional temperature increases on land will be considerably higher than these global means, increasingly beyond the limits within which human physiology can operate. These temperature increases cannot be adapted to, rendering financial system stress testing irrelevant.

The assumption behind the current enthusiasm for NZE2050 is that, with a bit of tweaking and gradual action, an orderly transition can ensue, leading to a perpetuation of the current economic system and its power structures.

That is no longer possible. The degree of change required to avoid catastrophic climate impacts, and the speed with which it must be implemented, means that emergency action, akin to a wartime level of mobilisation, is essential. A major discontinuity is inevitable; we must re-boot our societies on to genuinely sustainable pathways if human civilisation is to survive

NZE2050 could result in mean temperature increases above 3°C if global tipping points trigger within the 1.5 – 2°C Paris range. As our latest Briefing Note, “Net Zero 2050 – a dangerous illusion” indicates, net zero must be reached as soon as possible, ideally by 2030, if catastrophic outcomes are to be avoided. This is a massive task far greater than anything yet contemplated officially.

Sensible risk management in these circumstances demands a precautionary approach quite different from conventional risk-management practice. It must ensure, to the extent possible, that temperature outcomes do not trigger these tipping points, and is capable of returning the climate system to the stable climate conditions under which human civilisation flourished. This means emergency action to keep global temperature increase to a minimum, as close to 1.5°C as possible, coupled with drawdown of current atmospheric carbon concentrations from the current level around 420ppm CO2, to below 350ppm CO2. The technology to achieve such drawdown in the limited time available, is not yet fully to hand at scale, further adding to climate risk.

The Australian mainstream media, with a few exceptions, ignore these realities, consumed with the supposedly disastrous short-term economic implications of any climate action, oblivious to the infinitely greater cost of inaction. The Australian Financial Review (AFR), recently opined that “Coal, along with oil and gas, will continue to supply the world’s energy during the decades-long transition to net zero”, and that, “as the demonisation of coal and gas by Australian activists shows, extremism makes the politics of the energy transition more challenging”.

The real extremists are organisations like the AFR, the Murdoch press, ideologues and fossil fuel vested interests around the world whose denialist stance has succeeded in allowing carbon emissions to continue to rise at worst case rates, placing humanity in grave danger with their insatiable greed and determination to hang on to the reins of power at all costs. If these views prevail, human civilisation as we know it will not survive.

Quite apart from the implications for humanity, directors of these organisations, even those who claim leadership on climate action like Shell, BHP, Rio, Woodside and Santos, are now in clear breach of their fiduciary responsibilities to their shareholders, because in so doing, they are destroying their shareholder’s, and their own, future. Ben van Beurden, Managing Director of Royal Dutch Shell conceded last year that: “Yeah, we knew. Everybody knew. And somehow we all ignored it.” That is not good enough, particularly as they had access to the best available science and for years have known perfectly well the implications of their actions. A failure made even more egregious by their current refusal to cut emissions rapidly, or far worse, their determination to massively increase fossil fuel use with gas-led recoveries on the erroneous, self-serving grounds it will reduce carbon emissions globally.

But nowhere is this leadership failure, and the moral and ethical vacuum behind it, more evident that with the current Australia Federal government.

Australia is one of the regions most exposed to climate threats, as the community is only too well aware from our recent drought, bushfire and flood experience. Yet politically, it is as if this never happened. For example, none of the recommendations of the Bushfire Royal Commission have been implemented, and many communities remain without adequate recovery support.

Policy, to the extent it exists, is decided by political advisers, with little real-world experience, align with fossil-fuel interests, and ideologically committed to the neoliberal unregulated market which has created the climate crisis, and proved incapable of solving it. Scared of the future, they have no vision for Australia other than a perpetuation of its fossil fuel past. Not surprising, given that former fossil fuel executives dominate government appointments, from the Prime Minister’s office down.

So reality is swept under the carpet as the government rushes headlong into its own gas-led recovery, quite deliberately designed to maximise the use of fossil fuels before the shutters finally come down on the industry.

However, the government recognised rising community concern over climate, and the electoral danger that poses if those concerns are ignored, so something had to be done. Ergo, multiple initiatives are announced, with great fanfare, to demonstrate their climate bona fides; resilience, disaster management, Great Barrier Reef research etc, all of which address the symptoms of climate change, but ignore its fundamental cause, which is excessive atmospheric carbon concentrations and the failure to rapidly reduce emissions

The Minister for Emission Reduction, Angus Taylor, even pours fuel on the fire by presiding over emission increases, re-assuring us that any climate issues will be solved with “technology not taxes “. This ignores the fact that for these technologies to work at scale, and in the short time now available, “taxes” in the form of carbon pricing are essential otherwise the massive subsidy enjoyed by fossil fuels, by not accounting for the damage caused by their use, will continue, markedly slowing the transition to a low-carbon future .

The Minister for the Environment, Sussan Ley, passes any responsibility for climate change to the Minister for increasing emissions, despite the fact it is the greatest threat to our environment; decries any duty of care to protect Australia’s children from climate harm as a result of her deliberations on approving coal mines; then makes common cause with a motley crew of climate denialist countries to prevent the UNESCO World Heritage Committee placing the Great Barrier Reef on the “in danger” list, despite the fact that it is obvious to all but the most entrenched ideologues that the reef is now in terminal decline due to climate change.

Geopolitically, the government’s immaturity and ignorance of Asia has totally disrupted relations with our largest trading partner, China, with subsequent Australian sabre-rattling designed to divert attention away from the far greater threat of climate change. After four years of Australian servility to the Trumpian cause and a long history of Western abuse, it is unsurprising that China is taking a more assertive stance in global affairs, whilst recognising that China has its own problems and wolf warrior diplomacy is not the mark of mature global leadership. But both sides sidestep the real threat of climate change, instead focussing on geopolitical point scoring. Overcoming that threat will require unprecedented global co-operation, otherwise everyone loses.

Part of which is to completely re-think the concept of defence. Vast amounts spent on ever-more sophisticated ways of killing one another are useless on a dead planet. Those resources are desperately needed to stave off the climate threat and implement genuinely sustainable, equitable, economic systems.

It is clear from its actions that the Federal government has absolutely no intention of taking climate change seriously. It has yet to commit to NZE2050, but may well do so finally at the November climate summit in Glasgow, attempting to present it, with yet more fanfare, as “Australian climate leadership”, much as John Howard did with the 1997 Kyoto Protocol “Australia Clause”, the greatest strategic mistake this country ever made which initiated three decades of climate denial.

The government has no appetite to address the big issues confronting this country, and is quite happy to destroy the prosperity and future of Australian society, its children and their own, in the interests of retaining power in the short-term.

The parallels with the Covid crisis are legion. With Covid, the government has shown itself manifestly incapable of leading or managing its core responsibilities, beset by corruption and secrecy. The climate challenge is far greater than Covid, and there are no vaccinations or quarantine against climate impacts, which from now on will increase inexorably absent decisive leadership.

The community must now seek that leadership elsewhere.

Ian Dunlop is Chair, Advisory Board, Breakthrough National Centre for Climate Restoration.
David Spratt is Research Director of Breakthrough.

This article was published in Pearls & Irritations on 8th August 2021