A paper by Professor Steve Keen (UCL) with Mark Campanale and Joel Benjamin (Carbon Tracker) and Professor Tim Lenton and Dr Jesse Abrams (University of Exeter)
In the following academic paper presented at the Yale Institute of Sustainable Finance (YISF) annual symposium on 01 November 2024 – Professor Steve Keen explains how the work of mainstream economists on assessing future climate related damages has misrepresented the work of climate scientists. This leaves policy makers and the financial sector unprepared for the scale of likely losses, as the gulf in expectations between economists and climate scientists continues to grow.
Professor Tim Lenton and Dr Jesse Abrams present the risks of ignoring looming climate tipping points in prevailing integrated assessment models (IAMs). They argue for a science led peer review of economists work on climate change, and that new science informed damage function for use within IAMs are necessary to prepare investors and policy makers for the looming financial disruption.
Carbon Tracker’s Mark Campanale and Joel Benjamin explain how the work of mainstream economists has permeated the financial sector via investment consultants inadvertently misleading financial fiduciaries by taking at face value the work of mainstream economists on climate. Their work has been repackaged and presented to pension funds as explained in our 2023 report Loading the DICE Against Pension Funds.
The paper is intended for financiers, financial policy makers/ regulators, and economists.
Misleading financial fiduciaries
The standard practice of economic consultants is to convert the results of economic and financial research into policy and business guidance for their clients. Overtime clients come to rely, and all too often, become over-reliant on the consultants advice, warns UCL academic Marianna Mazzucato[1].
Consulting firms and investment consultants have taken this approach to advise institutional investors. The result being that the unbelievably low numbers generated by mainstream economists for future climate damages were accepted by investors and fed directly into the global financial system as accurate guides to the impact that global warming will have on their beneficiaries, with barely a pause as to the likely consequences.
Previous research by Carbon Tracker[2] using the representative example of UK local government pension schemes (LGPS) finds at least 80% of LGPS pension funds in England, Wales & Scotland use investment consultants – including for advice on climate risk (refer Appendix 2).
Because many investment consultants are subsidiaries of regulated entities providing governance, actuarial, benchmarking and investment advice – their wholly unregulated climate risk advice tends to be accepted at face value by fiduciaries, and seldom challenged.[3]
It should be remembered that pension fund trustees and committee members who receive such advice are typically non-financial experts, and are conditioned and compelled by legislation to seek expert advice in areas where their skills or knowledge are lacking.
Recent implementation of TCFD guidance and policies on the disclosure of climate risks has driven phased implementation of climate scenario analysis as a tool for investors analysing the impacts of climate warming scenarios and resultant damages on stock portfolios and/or GDP output in advanced Western economies such as the UK, EU, US, Norway and Canada.
Prior to TCFD implementation, scenario analysis was already in use by regulatory authorities and central banks to ‘stress test’ portfolios of regulated financial institutions to climate related damages, via the Network for Greening the Financial System (NGFS).[4]
However, the increasing use of climate scenarios by investors which ignore, downplay or defer looming climate risks creates a false sense of security in the minds of those deploying capital, that financial consequences of climate change for markets, can be divorced from the severe social & ecological damages, as forewarned by climate scientists.
Because Integrated Assessment (IAMs) models and climate scenario outputs minimise and defer future mid to long term climate damages (or ‘tail risks’), in relative terms, they thus over-emphasise the short-term transition risks associated with near-term climate action by investors to enable rapid decarbonisation of portfolios.
Due to modern portfolio theory, rapid decarbonisation results in high tracking error from a standard benchmark index typically comprised of high carbon energy, industrial and financial stocks today. The result of rapid climate action is then a so-called disorderly transition for investors – with high volatility, benchmark tracking error & stock corrections. The very thing asset managers are taught to avoid, in the pursuit of stable returns for fund members.
For investors and fiduciaries – the risk is that climate scenario models overcook the cost of doing something today, whilst artificially lowering the cost of doing nothing on climate tomorrow – providing a crutch for hesitant investors wedded to business as usual investment practices and fearful of taking definitive action to decarbonise their portfolios and deliver on climate targets.
Some investors may be emboldened to continue business as usual investment practices because of the advice from investment consultants. Mercer state: “If possible, divestment should be avoided. If investors choose only to divest, the problem is merely passed on, the transition will not progress, and funding will be taken from the companies, sectors and regions that need it most.”[5]
Such blanket advice blindly assumes that all companies and sectors have the requisite skills, plans and management and investor buy in to adapt their business models fit for the energy transition – with little evidence provided to support this assumption.
Typical of the advice investors receive from investment consultants is Norges Bank Investment Management (NBIM) which shows higher short-term damages in 1.5C or Well Below 2C scenarios over the next 50 years, than damages in a 3C+ scenario in 20 years, as warming accelerates and climate tipping points may be breached.
NBIM, otherwise known as the oil fund is the largest sovereign wealth fund in the world, and is accountable to the Norwegian Government, with clearly defined climate strategies and investor engagement goals.
Yet NBIMs 2021 report: ‘Climate Change As A Financial Risk To The Fund’[6] shows lower estimated fund losses in 2080 under 3C and 2C scenarios where loss of the Amazon and AMOC thermohaline ocean circulation system could be triggered, than under the 1.5C target set in Paris – where the climate is still deemed relatively safe by climate scientists.
It states: “The 3°C scenario, which is a proxy for the temperature increase that would result from current government pledges being implemented, is projected to decrease the value of the equity portfolio the least of any of the scenarios, by approximately 50 billion kroner. Overall, the impact of climate transition risk is lower in the equity portfolio than the equity benchmark index across all four transition scenarios assessed, albeit not substantially. The estimates do not include uncertainty measures and confidence intervals.”[7]
For comparison, a 1% equity portfolio valuation loss in a 3C scenario by 2080 or 4% loss by 2080 due to physical risk by 2080 should be compared against a recent Bilal and Känzig, 2024 paper which finds a 1°C increase in global temperature leads to a 12% decline in world GDP.[8]
At the extreme end of the climate change complacency spectrum, the Australian Unisuper fund, advised by Mercer presented 4C warming as an “acceptable risk” to its superannuation fund members in a 2022 report.[10]
Mercer advised the Australian pension fund HESTA that a trajectory towards 4°C of warming by 2100 would reduce the value of its portfolio by just 17%, compared to what it would have been in the absence of global warming.[11]
The net result is that global investors continue to be misled by investment consultants that high levels of warming will see lower impacts to pension funds than a rapid clean energy transition. As a result – pension fund capital continues to be deployed to high carbon sectors lobbying against rapid transition – effectively acting in opposition to investors stated climate policy goals, with capital withheld at the requisite scale from the clean energy projects and companies required to deliver upon global climate goals.
The outcomes for society and institutional investors are likely to be catastrophic, unless such advice to investors is urgently withdrawn.
[1] https://www.ft.com/content/fb1254dd-a011-44cc-bde9-a434e5a09fb4 see Mazzucato, 2022. ‘The Big Con’
[2] https://carbontracker.org/reports/loading-the-dice-against-pensions/
[3] https://www.ft.com/content/1da5c955-b6b1-4695-b61b-ef67f859aa3a
[4] https://www.ngfs.net/sites/default/files/medias/documents/ngfs_guide_scenario_analysis_final.pdf
[5] https://www.mercer.com/content/dam/mercer/attachments/global/investments/gl-2022-net-zero-report.pdf
[6] https://www.nbim.no/contentassets/f5113a9575524a6f92cc873963c49af9/climate-change-as-a-financial-risk-to-the-fund.pdf
[7] https://www.nbim.no/contentassets/f5113a9575524a6f92cc873963c49af9/climate-change-as-a-financial-risk-to-the-fund.pdf
[8] https://ssrn.com/abstract=4826056
[9] https://michaelwest.com.au/report-claims-super-funds-are-lying-to-their-members-on-climate-risk/
[10] HESTA, 2021, ‘Our Path to Net Zero’ p.17
