Financial sector and adaptation
Financial sector and climate change
'If we do not adapt, the economic costs will be extreme. Over the next 50 years, we expect to see: windstorms losses increase by two thirds to $27 billion per annum worldwide, additional flooding costs of €100-120 billion a year in Europe and a 15-fold increase in UK flood costs to £22 billion'. Stephen Haddrill, Director General of the Association of British Insurers
The banking sector potentially faces a high level of risk when investments are made in assets that are particularly vulnerable to climate change, such as property, energy and transport infrastructure.
Many pension funds in the UK operate under trust law that places a fiduciary duty on their trustees to act in the best interest of their beneficiaries. Given the major financial implications of climate change for companies, both directly through the physical impacts of climate change and indirectly through potential government action to encourage businesses to adapt, there are climate change implications for pension funds’ assets. (Mercer, IIGCC and Carbon Trust. (2005) A climate for change - A trustee’s guide to understanding and addressing climate risk)
- Lock-in factors: Products such as life and pension funds are based on assumptions such as mortality, morbidity and consumer behaviour, all of which could be affected by the impacts of climate change. (London Climate Change Partnership: Finance Sub-Group. 2006. Adapting to climate change: Business as Usual?) (PDF)
- Timeframes: Within the financial sector, corporate investment decisions made now should take into account the potential physical impacts of climate change. This is rarely the case at present.
- Value of securities: The impacts of climate change can have considerable effect on the value of securities that banks hold. For instance, more frequent and severe flooding can cause damage to the property market, impacting upon the value of the properties affected. As lenders of capital, banks are also increasingly at risk of borrowers defaulting on their repayments if businesses are interrupted by climate impacts.
- Reputational risk: Banks face potential reputational risks if the impacts of climate change are not included in their decision making.
Insurance and climate change
Because of the impacts of climate change on the financial sector, banks and insurers have started to develop strategies for managing them more effectively by:
- Reducing risk by engaging with governments on flood-defence funding and land zoning.
- Pricing climate risk appropriately. Incorrect calculation of risk can lead to inappropriate claims being made.
- Spreading the risk posed by climate-change impacts by diversifying products and services, for example, by opening up new markets such as weather derivatives and catastrophe bonds.
Relevant policy, legislation and standards
Beyond the potential economic impacts of climate change, investments could be impacted by regulatory measures directed towards enforcing adaptation. In the financial sector, it is more a case of cross-compliance with regulation and legislation in sectors that are linked to finance: it is conceivable that there will be ‘an increasing number of regulatory interventions outside the financial sector which will have implications for the financial sector’. (ABI, 2007, Insuring our future climate: thinking for tomorrow, today (PDF))
UK Companies Act 2006 (CA2006):
Corporations are under a legal obligation to consider the environment when taking business decisions. The following sections of the Act are of particular relevance:
Section 172 - Duty to promote the success of the company
(1d) ‘A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to … the impact of the company's operations on the community and the environment.’
The duty to consider the company’s operations on the community and the environment is not specific to adaptation but the use of the word ‘environment’ could include adaptation issues, eg where a company's actions have environmental consequences that directors have failed to consider and failed to implement the adaptation measures appropriate to deal with the impacts of climate change on the company.
Section 260 - Derivative claims
(1a/1b) ‘This Chapter applies to proceedings in England and Wales or Northern Ireland by a member of a company … (a) in respect of a cause of action vested in the company, and (b) seeking relief on behalf of the company.’
(4) ‘It is immaterial whether the cause of action arose before or after the person seeking to bring or continue the derivative claim became a member of the company.’
This provision might encourage environmental lobbyists to become shareholders in a company to challenge its previous actions, such as failing to produce and implement an adaptation policy. Where such a failure caused subsequent loss to a company, lobbyists might bring a derivative action to further their own cause by making an example of the company.
Legal considerations
- Banks face legal liability issues when taking over ownership of an asset from a defaulting client.
- Claims for negligence could become an issue if decisions on projects, investments or funds are made with disregard to current climate science.
European legislation
The EU Commission published the first EU Adaptation White Paper in April 2009, containing an official set of proposals on adaptation for public consultation. The Association of British Insurers had previously issued a response to the consultation (PDF) on the EU Adaptation Green Paper, highlighting the importance of the issue of adaptation to the insurance sector. The key points were:
- the emphasis on the role of the insurance sector in facilitating adaptation and communication of climate risks
- the need for public-private partnership to spread the risks adequately
- the importance of empowering local authorities to implement adaptation measures locally.
Produced in association with Ecofys UK Ltd