Climate crisis and finance, what should we tackle?
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By Cho Hong-kyoon
Cho Hong-kyoon, economist at Bank of Korea
In the fall semester of 2020 amid the coronavirus pandemic crisis which we are still struggling with, I taught a graduate-level finance class at a university.
A part of my syllabus was climate crisis and finance, during which a student raised a question about the relationship between the two. As a contemporary graduate student, it might be impossible not to be aware of the reality humanity is facing, which is called a climate crisis, beyond climate change.
But that question paradoxically made me think that I did the right thing to include this topic in the syllabus and it later became necessary to address the subject with more interest in the educational field. I believe the purpose of contributing to the press includes an educational aspect to the public, such as allowing readers to broaden their horizon. From this perspective, it is meaningful to expand the classroom to the broader public regarding this issue.
Climate change can be by and large a financial problem. Insurance companies have suffered from the effects of wildfires due in many places to climate change, and banks can lose money if their collateral is submerged due to rising sea levels. There is a risk that direct or indirect material damage caused by climate change in the real sector of the economy may spread to the financial sector through business relationships such as insurance contracts, loans and investments. Financial risks may also arise in the process of transitioning to a low-carbon economy to respond to climate change. Carbon taxes and renewables can devalue oil and gas bonds. These financial risks may be amplified through investment losses in carbon-emitting industries and a consequent portfolio rebalancing.
The transition to a low-carbon economy can create both a decline in carbon emission-related asset values and new investment opportunities in low-carbon and eco-friendly technologies. In other words, it can create losers and winners at the same time.
Issues such as climate change and environmental protection have traditionally been recognized as one of the domains of governments and the public good.
However, when looking at the climate change issue in relation to finance, it would not be an exaggeration to say that the market moved first this time. Until the Biden administration took office, the US government was lukewarm in responding to climate change compared to Europe.
While the 27 EU countries have been active, such as announcing in 2020 that they will reduce greenhouse gas emissions by 55% by 2030, the United States was comparatively passive in responding to climate change, with the Trump administration announcing its withdrawal from the Paris Agreement, an international climate accord.
In addition, the composition of the U.S. Supreme Court was also reorganized in 2020 into six conservatives to three liberals, which was evaluated as the largest conservative bloc structure since the 1930s. The conservative position on green or environmental law was generally in the direction of reducing the government's regulatory authority related to environmental protection. Unlike the mixed movements of international politics in the United States and Europe, changes in the financial markets to actively respond to the climate crisis were clearly detected after the coronavirus pandemic crisis.
The term ESG may sound familiar. Environmental, Social, and Governance (ESG) can be said to be the latest standards of corporate evaluation and investment. When talking about climate change issues in finance, the ESG principle may apply particularly when discussing so-called sustainable companies and investment in these.
ESG has been receiving attention during the coronavirus pandemic. Why is that? Crisis factors such as COVID-19, geopolitical risks and climate change provide evidence that companies pursuing long-term and sustainable strategies are better at surviving these crises than companies that do not. What is crucial is that investors have taken notice of this point. This can be thought of as the basic background for the recent rise in the ESG paradigm.
As the performance of ESG-based investments overwhelms those that ignore this paradigm, the flow of investment has become more concentrated in ESG. As a result, an interesting but paradoxical situation developed in which US financial companies were urging the government, which was passive in responding to climate change under the influence of the Trump administration, to respond promptly.
US financial companies sent letters to government agencies last year urging them to respond to climate change. The recipients of these letters included the Federal Reserve chair, SEC chair, insurance regulators, and the heads of financial supervision-related institutions. The letters called on the authorities to act immediately in the face of climate change that could pose systemic financial risks.
This can only be considered as an example demonstrating that the private-led response to climate change has already progressed to a level that cannot be resisted by market principles. In October 2020, the Korea Investment Corporation (KIC), a sovereign wealth fund, announced a policy to expand investment based on ESG, and many Korean financial companies are also making sustainable investments to respond to climate change.
As the financial market has performed well through ESG-based investments despite some critical viewpoints, particularly after the coronavirus crisis, the market is doing much to address the climate change issue. This appears to be due to the fact that investors have recognized the vulnerability of the global community's public health to climate crises, and value companies that pursue sustainability through these crises. Under these internal and external circumstances, what kind of work should the relevant stakeholders, including financial supervisory bodies, central banks and the legislature that regulate financial markets as well as educational institutions, prepare for to respond to the climate crisis?
Climate crisis and finance are areas where the expertise, experience and wisdom of relevant stakeholders should be gathered. Starting small things today for tomorrow has always been a shining code of conduct that has led to progress and the development of individuals and human history. In this season of greenery, as one of these contemporaries, I am again immersed in my thoughts on our tasks to prepare for tomorrow.
The writer is an economist at the Bank of Korea.