Four years ago, on September 29, 2015, Mark Carney, Governor of the Bank of England and Chairman of the Financial Stability Board (FSB), delivered a keynote speech to Lloyd’s of London. In it he spoke of the need to move beyond the “tragedy of the horizons” and outlined the three types of risk that the financial world will face. The following are excerpts from the speech, the full text of which is available on the Bank of England website.
While there is always room for scientific disagreement about climate change (as there is with any scientific issue) I have found that insurers are amongst the most determined advocates for tackling it sooner rather than later. And little wonder. While others have been debating the theory, you have been dealing with the reality: since the 1980s the number of registered weather-related loss events has tripled; and inflation-adjusted insurance losses from these events have increased from an annual average of around $10bn in the 1980s to around $50bn over the past decade. The challenges currently posed by climate change pale in significance compared with what might come. The far-sighted amongst you are anticipating broader global impacts on property, migration and political stability, as well as food and water security.
Climate change is the Tragedy of the Horizon. We don’t need an army of actuaries to tell us that the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix. That means beyond the business cycle, beyond the political cycle and beyond the horizon of technocratic authorities, like central banks, who are bound by their mandates. The horizon for monetary policy extends out to 2-3 years. For financial stability it is a bit longer, but typically only to the outer boundaries of the credit cycle – about a decade. In other words, once climate change becomes a defining issue for financial stability, it may already be too late.
There are three broad channels through which climate change can affect financial stability:
- First, physical risks: the impacts today on insurance liabilities and the value of financial assets that arise from climate- and weather-related events, such as floods and storms that damage property or disrupt trade;
- Second, liability risks: the impacts that could arise tomorrow if parties who have suffered loss or damage from the effects of climate change seek compensation from those they hold responsible. Such claims could come decades in the future, but have the potential to hit carbon extractors and emitters – and, if they have liability cover, their insurers – the hardest;
- Finally, transition risks: the financial risks which could result from the process of adjustment towards a lower-carbon economy. Changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent.
The speed at which such re-pricing occurs is uncertain and could be decisive for financial stability. There have already been a few high profile examples of jump-to-distress pricing because of shifts in environmental policy or performance.