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The Progressive Policy Think Tank

Climate change stress tests in financial sector could help avoid financial crisis

Banks, pension funds and listed companies should be stress tested against the risks of major financial losses

MPs should consider requiring banks, pension funds and listed companies to be ‘stress tested’ against the risks of major financial losses that could result from climate change according to a report published today by IPPR.

The call comes as the UN climate summit gets under way in Paris and after the Governor of the Bank of England issued a high profile warning in September that the exposure of UK investors to financial losses as a consequence of climate change is “potentially huge.”

The report identifies three categories of climate risk that could cause major financial losses.

  • Risks associated with fossil fuel assets becoming ‘unburnable’ if stringent action is taken to cut carbon pollution. Citigroup has warned trillions of dollars of assets could become ‘stranded.’
  • Risks associated with unchecked global warming so that the physical impacts of worsening extreme weather events damage infrastructure and cause disruption to global business operations. Research for Aviva Investors suggested trillions of dollars in assets are at risk as a consequence of rising temperatures.
  • Risks associated with insurance liabilities if those that suffer loss or damage from climate change seek compensation from those they hold responsible. This is a key discussion point in the negotiations at the Paris conference.

Joss Garman IPPR Associate Director, who co-authored the report with Diana Fox Carney, said:

"An international agreement from Paris could reduce the risks of a major financial crisis resulting from climate change, but even if the talks are incredibly successful the economic risks will still be significant. In spite of the huge potential hit to British pensions and savers, markets currently behave as if these risks do not exist."

"Modelling techniques pioneered in the insurance industry could enable the risks to be disclosed to investors and would make it possible to stress test banks, pension funds and listed companies against different climate change scenarios. This would expose where investments could be vulnerable to financial losses. MPs should consider mandating climate risk disclosure and stress-testing against these risks because ultimately it could help us avoid another financial crisis."

The report also argues that financial markets are currently failing to take account for these climate risks and highlights three main explanations for this.

  • Climate risks are seen as too distant to be relevant to financial decision makers who tend to focus on a short-term timeframe in which climate shocks are seen as unlikely to have a significant, financially material impact.
  • Climate policies are not taken seriously by many businesses and investment managers.
  • Climate risks are uncertain: they are ‘known unknowns.’ It is still unclear what the pace of global warming will be and how the impacts will be distributed across different geographies and which economic sectors will be worst hit.

Notes

IPPR’s new report – Known unknowns: The hidden threats that climate risks pose to British prosperity - will be available from Monday 30th November from http://www.ippr.org/publications/known-unknowns-the-hidden-threats-that-climate-risks-pose-to-british-prosperity

Contacts

Sofie Jenkinson, 07981 023 031, s.jenkinson@ippr.org