Climate risk in 5 questions with Veena Ramani

Addressing Climate as a Systemic Risk: A call to action for US Financial Regulators – Ceres, June 1 2020

Running the Risk: How Corporate Boards Can Oversee Environmental, Social and Governance (ESG) Issues – Ceres, November 20 2019

Getting Climate Smart: A Primer for Corporate Directors in a Changing Environment – Ceres, May 14 2018

Today I’m talking about climate risk with Veena Ramani of Ceres. This is the first in an occasional series of briefings which take a concept or a term that’s widely used, that can often give rise to confusion or misunderstanding.

Climate risk sounds like an obvious term that anyone can understand, right?

But it turns out to be one those false friends – like when you learn a new language and you think you recognise a word, but it turns out the word has a different meaning.

So what is risk? What is climate risk? What is finance, and what is financial stability?

If you can answer these questions without hesitation, then this episode is **definitely** not for you.

But if you’re unsure, then I recommend you keep listening.

Most of the discussion about climate risk in the financial context relates to its potential to disturb financial stability.

But, can you have financial stability and an unstable climate?
2020 could be a good example of that.

If sea level rise sends a Pacific Island to its grave – but the event doesn’t affect financial stability – does that mean sea level rise in this instance has been low-risk?

You see where I’m going. There’s something about revisiting obvious terms that can often give rise to new questions.

I hope you enjoy the briefing.

Denise: Today’s episode five questions with Veena Ramani about climate risk. Veena is senior program director of capital markets systems at Ceres in the US. Welcome Veena.

Thank you very much for coming on the podcast.

Veena: Thank you, Denise.

Denise: Could you introduce yourself briefly and tell us what your journey has been?

Veena: Sure thanks, Denise. So my background is that I am a lawyer who has moved away from the dark side. So, um, I studied in practice law, um, earlier on in my career, but was bitten by the, uh, public policy and advocacy bug quite early on.

So, um, I spent a portion of my career trying to weave those threads together, lobbying for environmental and consumer related issues in India, but then, um, came to the US um, around two decades ago, um, at this point, um, and started to really marinate in the advocacy community. I realized I’d really cared about saving the world.

And law was just one of the ways to do it. However, um, at this stage in my career I’ve reached a happy medium where, um, I get to be a lawyer, um, and be a climate change advocate as well. My, um, current work, which is focused on climate change as a systemic risk and the role of, um, financial market regulators to address this risk is a great example of that, where, um, you know, I, I, you get to geek out as a lawyer about policy, but then get to think as an advocate about the change I want to see in the world.

Denise: what is the meaning of the word risk in the financial world?

Veena: Right. So to put it pretty simply risk is the potential that something that you want to happen doesn’t happen.

And what that means in financial terms is that, um, where companies or investors have an asset or an investment that they’re focused on, financial risk is the potential that the value of that asset or investment doesn’t go the direction that the company or investor wants it to go.

So typically where an investor has a portfolio of companies that they are invested in, where a company has an asset that they’re invested in, they want the value of the asset to increase and risk is the potential that the value does not in fact increase and risk is the potential that the value of that portfolio or asset in fact, declines.

Denise: That’s very, um, specific, uh, um, actually, because the risk in the normal world is more about, Oh, I’m gonna, you know, make sure that something bad doesn’t happen to me.

Veena: Yup. And that’s pretty much what it translates to in the financial world as well. Right. Where an asset or an investment loses value that is potentially bad for the company or the investor in question.

Denise: What does climate risk mean in the financial world?

Right. So again, let’s replace the word, um, you know, financial with, with climate in my previous answer and we really have it. So, climate risk is the potential that the impacts associated with climate change will negatively impact the value of an asset or an investment.

And we’re starting to see that play out in, in a variety of ways. Right? So we’re starting to see that play out in terms of physical impacts. I’m based here in the US and the US we have wildfires in California. We have a hurricane currently pounding our southern states. And that means that those businesses, um, in California, in the West, are those businesses.

That are situated in the Southern States that are being impacted by the hurricane are now idle or not able to function at all, or have a situation where their employees or their customers are not able to come to work or are not able to buy things.

Right? And that is a negative business impact. And what this means for the investors who are invested in these companies is that their portfolios are also negatively affected.

So that’s what the physical impacts of climate change mean. Climate change also has an impact called a transition impact. And that means that, you know, as our world inevitably starts to move, um, towards a low carbon future starts to move away from its significantly carbon oriented roots, which we have right now towards cleaner options, that there are going to be winners and losers,

And that will also have an effect on both the company and the investors in question.

One additional perspective for me to add is that, um, our understanding about the nature of climate change has evolved certainly over the past decades. When I started down this route you know, 15, 20 years ago, we were starting to make the case that, um, acting on climate change for companies and businesses, to act on climate change, it was not just the moral imperative that it was a financial imperative. We were making the case to them that climate change was a financial risk of financial impact.

Then our understanding about climate change has evolved. And we started to have conversations with our companies and investors saying, look, it’s the risk of climate change.

It’s not just financial it’s material. And material risks are financial risks that are so significant to companies that their boards need to think about it, that their investors need to be informed about it. It needs to be a part of it disclosures. But now our understanding about climate change has evolved to a point, we understand that the scope, um, and the extent of the climate crisis is so profound that the risks are not just financial. They’re not just even material. They are so significant that they potentially cause risks to the stability of financial markets.

In other words, they are what we now call systemic risks.

Where our risk is systemic, everybody has skin in the game. These are risks that companies and investors cannot diversify away.

Denise: Right. So I wanted to ask what is finance? What are financial markets? And are they, do they, do they help, are they a way of managing climate risk?

Veena: So, um, financial markets is essentially the system by which finance or capital or money put in super simple terms, go from the, the people who have it to the people who want it.

So the people who are money tend to be financial institutions. So your banks, your investors. It also tends to be retail investors, right? Folks like you and me, anyone who has a savings account, um, anyone where, um, their, their savings account money is invested in certain companies or certain funds. All of us are folks who have money, right?

The folks who want money are typically companies who want to use that money to, to expand their operations, to buy an asset, to, to build a particular kind of infrastructure, to expand their operations due, to make changes in obvious ways.

So financial markets are the system by which the folks who want money signal, that they want money. And the folks who have money, make decisions on who gets the money that they have. So financial regulators are the, um, folks who make sure that financial markets function in a way that’s efficient and that’s fair.

And by efficiency, we mean financial market regulators are the ones who make sure that everybody in question has the right information to make smart decisions on where money is allocated. Um, and they’re also the ones who are figuring out, um, ways to ensure that folks don’t game in the system.

Denise: So what can financial regulators do about climate risk?

Veena: Right. So I talked, um, you know, a few minutes ago about the fact that, um, climate change is so profound that it is in fact, a systemic risk. The thing is when an issue is designated as a systemic risk, um, it automatically becomes a part of the job description of financial market regulators. You, you can’t have efficient markets, you can’t have fair markets when markets as such are not stable.

So a core part of the job description of financial market regulators, and here, I’m talking about central banks, I’m talking about securities regulators, I’m talking about folks who supervise banks and other financial institutions like insurance companies.

All of them have as a part of their mandate responsibility to make sure that financial markets operate in a way that’s predictable and stable. So financial regulators have a role to play, have a very significant role to play, uh, to make sure that markets adequately consider climate change as a financial risk, um, and, uh, price this risk in, in making decisions on where money gets allocated.

Denise: So are regulators doing their job on that right now?

And what’s the situation today.

Veena: Yeah, I think that the situation today is it depends on where you’re looking. I will say that a growing number of financial regulators are starting to acknowledge that climate change is a systemic risk and they are starting to do that assessment of what it means in terms of their own role in markets.

So for instance, um, you know, right next to all of you in France, the Bank of England has been quite a pioneering jurisdiction. As we start to think about these issues, the Bank of England has acknowledged that climate change is a systemic risk. They are the ones who coined the term climate crisis.

Um, and the Bank of England has started to take a number of steps, uh, to try to get their markets prepared, to address the risk of climate change.

So one of the things that they’re doing is they are getting their bands to do what we call climate stress tests. Let me sort of use an analogy here, right?

As you know, your audience becomes a little bit older, they could potentially do a health based stress test, right. Where, you know, to monitor the state of their heart. Um, the doctor might have them run on a treadmill just to sort of figure it out how does the heart react to a stressor?

Right. Think about, um, a version of that, um, in financial market doms, uh, the Bank of England is having its large banks conduct. What we call climate stress test. They’ve identified a number of scenarios in which climate change could impact financial markets. And they have told banks, run the numbers to figure out how you will fare under these scenarios.

And based on the results of these stress tests the Bank of England can then determine how to make certain adjustments to, to, to keep the market stable, um, going forward. Um, they are planning to conduct the stress test next year. Similar stress tests have been announced in France, in Australia, and recently in Japan as well.

Another way in which we are seeing financial market regulators address climate change, um, is by essentially requiring climate change disclosure. So for instance, just last week we saw the government of New Zealand mandate that, um, essentially it’s large companies, uh, essentially talk about their climate change, performance and plans, um, in a way that markets can understand and use

We’re starting to see, um, jurisdictions like Canada link sort of similar climate change, disclosures to loans that they’re making to large companies as a part of the stimulus package.

So we are seeing, um, uh, financial regulators use a number of tools and tactics dues to stop to address the systemic risks of climate change.

Now, is it where it could be? No. Um, does it include the various range of ways in which they could be doing it, given the earth and the extent of the risk? No, but are they starting to do it? Yes.

Denise: If listeners want to know a little bit more about, uh, uh, the work that you’ve been doing at Ceres on capital markets, uh, um, are there any reports about climate risk, uh, that you released recently or resources that they should look for?

Veena: Absolutely. So we released a report in June called “Addressing climate as a systemic risk: A role for us financial regulators” that makes the case that climate change is in fact, a systemic risk and then outlines a series of action steps that us financial regulators can take, um, in addressing this risk.

So, um, we essentially call on us financial regulators to take. Four categories of action.

First, we call on them to affirm that climate change is a systemic risk and start to do that analysis on what it means in terms of their specific mandates. The US financial regulatory ecosystem is large and complex, and various agencies play, um, somewhat different, but interconnected roles.

So having each agency essentially specify its particular role in addressing the climate crisis. Um, and, and have that having that would be based on research. We believe as a fundamental starting point. Um, we then call on financial regulators. To integrate climate change into their supervision of certain markets.

So for instance, a big part of the role that central banks play is to make sure that large financial institutions, um, are essentially operating in a way that’s smart, sound and strategic.

And that’s the role of, of banking regulators globally. So, um, one of the things that we call on regulators to do is to make sure that, you know, as they supervise financial institutions, as they supervise insurance companies, that these institutions are thinking about climate change, integrating climate change into their own decisions.

We call on financial regulators to, to mandate climate change disclosure as issue rules, calling on all companies to talk about that climate change performance. We think this is fundamental to so much of what we’re talking about. You can’t expect anyone to make good decisions without good information. Disclosure is fundamental to all of that.

And finally we call on financial regulators to coordinate with one another, um, to make sure that, um, everyone is following a shared, collective, um, national, regional, but also global playbook, um, in addressing at the end of the day what is a global problem,

Denise: Thank you very much, Veena, Um, uh, for that, uh, uh, I just have one last question, um, uh, from, um, as if I’m worried, uh, as a, as a citizen about climate risk, uh, and my personal finances.

Um, what can I do?

Veena: Um, I’ve talked before about the role that financial regulators can play in ensuring that, um, financial institutions, insurance companies are paying attention to climate change, but in way to have financial markets, um, to pay attention to climate change is, is to have that demand come from market participants themselves.

And all of us are market participants. Right. Um, as I mentioned before, any of us that have money in a savings account that we’re investing in companies or funds. All of us are market participants. So all of us, it could play a role in, you know, really starting to think about climate change. As we make decisions on funds we invest in or companies that we invest in.

So, um, if your audience works with an investment advisor, I would encourage the to speak with their advisors about whether there are funds they can invest in, um, that have, you know, clean energy options. If they personally sort of research and make decisions on companies that they want to sort of put their money in, that they really take into account the climate change, exposure and strategy of the company in question.

Denise: Great. Well, thank you very much, Veena. Thanks for your, uh, thanks for your time. Coming on the show today was a pleasure to have you on to talk about climate risk.

Veena: Thanks very much.

Denise: That’s it for our briefing on climate risk. If you’d like to hear more from Veena, you can find her on Twitter @veenaramani15. Go to the show notes for this episode at climate narratives.co for more resources from Ceres and their work on financial markets and decarbonisation.

Now I have a question for you. We’d love to hear from you on these briefings. If there’s a concept is there a concept that’s been tripping you up? Or a term you’d like us to explore? Please get in touch with suggestions – just send an email to info@climatenarratives.co

Thanks again to Valentine Scherer and Victoria Yates for their help producing this episode. Theme music is by Lucas Laufen.