Carbon Tracker’s Rob Schuwerk explains why the FSB’s climate risk recommendations are an important step towards helping financial markets to price climate risk

Any scientifically honest review of our climate predicament concludes that changing the earth’s climate is best avoided.  Reports from staid institutions, including central banks and militaries, warn that ocean acidification, sea-level rise, and extreme weather events will adversely impact food supplies, reduce economic output, and aggravate existing social conflicts.

The magnitude of these risks is only overshadowed by their probability—the Iinternational Energy Agency (IEA) estimates that, even with the NDC commitments under the Paris Agreement, the expected emissions would most likely result in 2.7°C of warming by 2100, leaving significant effort to have just even odds of achieving the Paris Agreement’s goal of 2°C, much less “well below” that level.  Most fossil fuel companies acknowledge that their business plans assume continued emissions levels that far exceed that limit.

Some studies indicate that the equity market impacts from climate change cannot be fully hedged.  This means that investors cannot avoid losses by simply moving their money from one carbon intensive asset to a less intensive one.  Given this, investors would have every reason to prefer a smooth low-carbon energy transition, both in terms of policy and as an investment proposition.

But actually adjusting an investment portfolio for such megatrends is easier said than done.   There are many obstacles, including short-termism, the lack of company-level information, the need for diversification, and the search for an appropriate level of portfolio risk and return that make it difficult for investors to consider the big picture in the context of an investment.

One key balm for these problems is better information.  In practice, this means information that allows investors to price future outcomes into present day investment decisions.  It also means data that allows for comparison of and differentiation between competitors.

The Task Force on Climate-Related Financial Disclosures (TCFD) has taken a significant step to bring that information to market with its recommendations.  Of particular note is the TCFD’s proposal to require companies to analyse how their business models and results would fair in a world focused on limiting warming to below 2°C.   This is a central focus of our work at Carbon Tracker, where we consider the implications for the extractives sector through a market lens.

The details remain to be spelled out but such disclosure may serve to “make the market” for climate-related financial disclosure by differentiating between those companies who can and cannot align to a low-carbon transition.  This, in turn allows investors to evaluate and price those risks and, through their investments, send a signal to company management about how they want capital allocated.  This could be a meaningful step towards breaking what Mr. Carney, the outgoing FSB Chair, has termed the “tragedy of the horizons.”

Much work remains to be done.  The TCFD recommendations are only that.  A key question is how they will be incorporated into existing markets disclosure regimes—whether as an application of existing regulations or a set of new disclosure requirements.   However, by translating climate risk to financial risk, the TCFD is speaking a language that investors can understand.

Rob Schuwerk is a senior counsel for The Carbon Tracker Initiative

This article first appeared on Business Green