Hello everyone,

The climate finance community erupted in debate this week over a talk by Stuart Kirk, the Head of Responsible Investment at HSBC Asset Management titled ‘Why investors need not worry about climate risk’. The editorial of the Wall St Journal called it “A Financier Tells Some Climate-Change Truths”, so lets dig a little deeper into the arguments.

In the speech, Kirk presents a powerful contrarian view on climate risk in finance. Overall, his core arguments are that there is too much hyperbole on climate, it will only impact markets in the long-term and that we as humans will adapt like everything else. His conclusion: we need not worry about climate risk in finance.

Is this true? And as some asset managers are whispering, is he ‘saying the quiet bit out loud?’ Let’s shed some light on this much talked about speech.

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What to agree with on climate risk?

Although Kirk’s overall thesis - that climate risk is nothing to worry about in finance - is wrong (I will get to that), several of the arguments he presented are true:

The world will not end because of climate change. Yes, it will impact every living thing on a multi-generational perspective, but it will not cause the end of the earth or humanity.
The financial risk of physical climate change tends to be longer-term. While temperatures are rising and human health impacts are already being felt, it won’t impact markets much in the short-term.
Humans are amazing at adapting to challenges. You can’t really argue with this one, we are. But, there’s a huge social inequity in the resources needed and as such, the poor will get hit much harder.
Humans are innovators and markets will continue to rise. There are big opportunities in the transition.

So where did Kirk’s thesis go wrong?

Well, there are two enormous factors at play that he skimmed over which dismantle the argument that climate risk isn’t important in finance.

But first, some of you might be wondering why a climate scientist like me can agree with him in broadly discounting physical climate risk for finance, at least in the shorter-term.

Glaciers melt too slow for short-term markets

The world is warming, glaciers are melting, sea-level is rising and extreme weather events are likely increasing. This is causing human and social impacts across the world, today. However, the rates of warming, sea-level or extreme events aren’t likely to cause huge systemic changes to markets on a time-frame meaningful for investors. Let me explain.

The carbon we emit today will stay in the atmosphere for hundreds of years, causing multi-generational climate impact. However, there is a large asymmetry in the time-frame of impact on climate versus the time-frame relevant for markets.

Abrupt and irreversible changes to the climate system are known as ‘tipping points.’ Once they happen, there’s no going back. Examples of these include the collapse of the West-Antarctic Ice Sheet, the stagnation of ocean circulation patterns or a permanent shift to global monsoons. These climate tipping points are the ‘Green Swans’ for the financial system. While they grow in likelihood with any degree of warming, they only start becoming a higher risk once we hit 2°C. That level of warming isn’t likely until ~2050 - a time frame not meaningful for the vast majority of investors right now.

So while physical climate impacts will continue to get worse as we approach 2050, they’re not likely to be on the scale to impact financial markets (although there is still a risk). Take sea-level as an example. Ice-sheets and glaciers are melting, but in the short-term (say next 5-10 years), the magnitude is unlikely to cause a major step change in damage to infrastructure globally. Local impacts will occur but from a global perspective, the sea-level risk will be felt much more strongly in the latter half of this century, which give financiers time to invest in adaptation.

The physical impacts of climate change are obviously already happening, and will continue to worsen for centuries. But their magnitude and scale is not systemic enough across the entire economy or on a time-scale that is relevant for short-term financial markets. It’s the classic case of short-termism.

Our response to climate is where the financial risk is

So if physical climate impacts tend to be longer-term, what’s the problem with Kirk’s thesis? Well, he neglected the biggest way markets change - us.

How we as a society respond to climate change is orders of magnitude quicker and more disruptive to markets than the physical impact of climate. I write about this in more detail here, but carbon transition risk is very different to physical climate risk - something that Kirk’s argument missed almost entirely.

COVID shows us governments can act quickly

Governments and authorities respond to challenges that protect the interests of their citizens, whether it’s inflation, COVID or climate change. And these policy changes can be imposed suddenly, causing massive financial readjustments on a timescale that impact markets.

Take COVID-19 as an example. During the early days of the outbreak, only a fraction of the global population were impacted by the virus. Yet virtually every person and business on earth was impacted by how their governments responded to it to protect their citizens against the virus.

Markets didn’t crash because of the mortality rates. They crashed because the world’s government imposed lockdowns and shut businesses to protect its people from the virus. Empty streets and closed shops were in response to the virus. There was an enormous asymmetry between the risk of the virus and the response.

It’s the exact same for climate change - it's not the physical or even direct human impact, but the societal carbon transition to stop climate change that will cause immense market corrections in the shorter-term.

Kirk did mention it in passing, stating ‘the one thing the market could get wrong is a whopping big carbon tax out of the blue, $200 - wham’. Even if it comes gradually over 5 or 10 years, that will cause a huge shift to markets.

Glaciers melt slowly, but humans act quickly. For climate, the response will cause huge changes to markets given the magnitude of change required to limit warming to 1.5-2°C. There’s a reason that Larry Fink, CEO of BlackRock says ‘we are in the midst of a fundamental reshaping of finance’.

Beyond Meat and Tesla show us consumers are shifting

It’s not just governments moving against carbon, it’s consumers. When new products come that do less damage to the environment, markets shift. Solar power is the obvious example, but underlying consumer climate sentiment has undoubtedly allowed Tesla to become a trillion dollar car company leading the transport electrification transition.

Similar shifts are occurring across industries, like those in plant-based meat. Lower carbon is creating and growing entirely new product lines and replacing the old, carbon-intensive traditional products.

Carbon is a risk for consumers. This shift will accelerate over the next 5-10 years as consumers demand lower carbon reliance for products. And of course, financial markets will follow the money. You can see it now how companies are investing hugely into low carbon products because the future demand is in these products.

Climate is a big risk for markets because of carbon

It’s refreshing to see arguments and talks that don’t just follow the consensus. In the end however, it doesn't really matter what one person thinks - the government response and consumer sentiment has already shifted towards transitioning away from carbon. This will only accelerate over the next 5-10 years and on a timeframe very important for markets.

So if you’re an investor, carbon is the real short-term risk and you need to understand that across your investments.

Keen to hear your thoughts.

Ben

Carbon Alpha

Memo to HSBC's Stuart Kirk: Glaciers melt…