Managing Climate Impact Risk and Uncertainty - The Pivot Point in Finance
The precautionary approach to climate risks and their impacts on finance. With most climate impact risk assessments ranging from 0% to -20% losses, more work and knowledge are sorely needed. A ‘race to the top’ and Nature-based investments may prevail, once the bad news (everyone is in for massive losses) is out in the open.
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Following up on an insightful post from Laurie Laybourn yesterday - Are we in a ‘delayed disclosure trap’?
Yes certainly, we are in a multi-faceted disclosure trap, as he articulately describes. All of which contribute to the current (mass) underestimation of climate risk on financial institution and investor balance sheets.
Climate Risk Assessment in Finance
Although climate change awareness has greatly increased, little has been done to develop robust climate risk assessments in finance.
“I must tell you that I marvel that economists are willing to make quantitative estimates of economic consequences of climate change where the only measures available are estimates of global surface average increases in temperature. As [one] who has spent his career worrying about the vagaries of the dynamics of the atmosphere, I marvel that they can translate a single global number, an extremely poor surrogate for a description of the climatic conditions, into quantitative estimates of impacts of global economic conditions.”
Steve Keen - The appallingly bad neoclassical economics of climate change (2020)
Source: Bilal and Känzig (2024) - The Macroeconomic Impact of Climate Change
The exception to this is the insurance (and reinsurance) sector – see also 'Climate Risk Modelling in Insurance' below.
As ultimate underwriters of some climate risks, insurers and reinsurers must know a thing or two about climate risks. How to model and price risks and more importantly, how to offset and repackage such risks.
The Risk Quantification Trap
Contributing to the disclosure trap, there is also a structural and therefore delayed risk quantification trap which exacerbates the problem.
In truth, financial ‘risk managers’ have little experience in robustly assessing, modelling and quantifying climate-related risks. It is beyond the standard remit - yet their firms will seek to appear as in robust, everyday control of all risks.
Historically, it has not been in the finance sector’s interest to go down the rabbit hole of investing in and building full climate risk modelling capabilities. Not unless they are compelled to by their regulators. As a result, finance sector balance sheets have been ignoring, under-researching and therefore underestimating climate risks.
This explains the huge divergence in climate-related risk impact assessments to date. All of which should be viewed as early-stage risk impact assessments in the scheme of things. Stepping stones to more robust future measures of impact.
Yet seen with an eye on the future, it is very much in their interests to develop climate risk management capabilities, and to be at the front of the pack regarding the taking on of new business and new risks.
Better models and approaches will consequently take time and will require investment to build greater understanding and modelling of the climate /nature-related risks.
“The degradation of nature not only threatens these ecosystem services, but also increases the risk of us reaching ecosystem tipping points, i.e. non-linear, self-amplifying and irreversible changes in ecosystem states that can occur rapidly and on a large scale.
Through these tipping points, we are at risk of going beyond the Earth’s safe operating space for sustaining life on the planet.
From the perspective of central banks and supervisors, the degradation of nature makes our economies, our companies and our financial institutions increasingly vulnerable.
We cannot ignore these vulnerabilities. Indeed, we need to deepen our understanding of how nature-related financial risk affects the economy and the financial system.”
Frank Elderson, Vice-Chair of the ECB Supervisory Board – Sept 2024 speech
Regulators and central banks are now on the case, ushering in new requirements for the integration of climate risk into existing risk assessment and capital adequacy frameworks. But this will likely be a slow progression.
The end result will be a much more sanguine view of risks (and uncertainty) lurking in financial balance sheets, with major adjustments to solvency and capital adequacy calculations as a result.
This failure of the financial sector to adequately prepare for climate-related risks is undoubtedly because of the above disclosure traps and conflicting commercial interests. It is also associated with human biases:
Myopia - Myopia has the effect that people focus on near-term risks and neglect (and under-invest in) long-term risks, for which action is delayed. Myopia is especially problematic with climate change, often not considered to be salient and viewed as a long-term risk.
Herding - Under uncertainty, choices are guided by the behaviour of others and social norms.
Bystander effect / apathy – the greater the number of firms and people with the problem, the less likely for any one of them to take responsibility and do something about it.
Simplification – risks assigned low probabilities fall below the threshold level of concern, meaning no risk-reduction action or research is undertaken.
Availability - Perceptions and preparedness for future natural disasters increase with personal experience. But there is a low historical probability of such, contributing to underestimation of natural disaster risks by the general population.
Finite Pool of Worry - Individuals cannot worry about too many risks at the same time. If concern about one kind of risk increases, concern about other kinds of risks reduces. For example the 2008 financial crisis and its aftermath, and the COVID-19 pandemic, with increased employment and health concerns.
Anchoring and status quo bias - Because it is not in financial firms’ commercial interests to thoroughly explore climate risks and be the first to disclose such, risk managers also tend to ‘switch off’ / insufficiently revise their approach to climate risk intelligence and new information.
Climate Risk Knowledge in Finance
As undisclosed climate risks and impacts grow, the inadequacy of current climate risk knowledge and approaches becomes increasingly apparent. And then the bubble bursts.
Disclosure might have material impacts, affecting market confidence in the financial institution(s) concerned. However, the situation must be recognised as endemic to all financial institutions, particularly those still supporting BAU (Business-As-Usual) activities.
What is needed is a professional climate research code of sorts – similar to those followed by scientists and mathematicians, adjusted for financial industry participants - we are all trying to solve the same problems:
- A precautionary approach
- Research methodology with full transparency stating challenges regarding accuracy
- Full disclosure of data for reproducibility, to further industry knowledge
- Structure businesses to remove conflicts between research and commercial interests
- Use of third party experts and software
- Open industry review / international coordination and review
- Regulator-enforced operational independence for risk managers / researchers
- Industry climate risk warnings and climate risk ratings, with best practice guidance
- Link climate risk management to firm performance and performance-based incentives
The Pivot Point - from Financial Assets to Nature, Regeneration and Nature Positive Assets
In terms of industry best practices – lying about or playing down climate risks is a commercial instinct, but is not going to inspire confidence and will fall flat sooner or later - when everyone knows the risks are likely enormous. This applies to most businesses not just financial concerns.
Rather than focusing on false reassurances as to expected portfolio losses, a pivot point arises – beyond which it becomes far better to stress the risk benefits achieved from holdings in Nature and Nature-based investment strategies.
And a ‘race to the top’ may prevail, once the bad news (everyone is in for massive losses) is out in the open.
Then the discussion and focus moves on to why the Nature and Nature positive assets are value additive / risk reducing for the overall portfolio of the firm.
The nature of uncertainty and risk from climate change
“An emissions pathway consistent with plans submitted for Paris COP21, implies that we are headed for temperature increases of 3°C or more within a century. Such temperatures carry grave risks to humankind and the planet as a whole... These kinds of temperatures could involve sea-level increases of scores of metres and inundation of many of the coastal cities of the world.
Those kinds of temperatures would radically change lives and livelihoods across the globe. Many parts of the world would become uninhabitable. One of the most densely populated regions in the world, the North China Plain, would likely experience deadly heatwaves later this century with ‘wet-bulb’ temperature exceeding the threshold defining what people can tolerate while working outdoors. Similar heatwaves could also occur in other densely populated parts of the world, such as North India. Hundreds of millions, possibly billions, would have to move, likely resulting in severe and extended conflict.
A global cascade of multiple tipping points in the climate system would be an existential threat to civilisation… … The stakes we are playing for are immense.”
Section 3.1 (citations removed) - Stern et al (2020) - The economics of immense risk, urgent action and radical change: towards new approaches to the economics of climate change
- 1.5°C is not a political limit, it is a physical limit.
- Breaching 1.5°C risks triggering multiple climate change tipping points and every fraction of a degree increases the risk.
- 1.5°C is already breached (ignoring the long-term averaging) and on the same basis, 2.0°C is highly likely before 2035.
- The Earth may be more sensitive to greenhouse gases than we thought, which means net zero carbon budgets may already be negative for the 1.5°C limit
- The severity and frequency of extreme events are unprecedented and beyond model projections.
The nature of steadily increasing anthropogenic risk
“It is by using additional fossil fuel energy sources that humans have been able to develop economic systems of resource use that have sustained growth at levels well beyond that of previous societies. However, there is no evidence that they are able to avoid or manage the consequences of doing this. There is no evidence that contemporary economies have or are able to in the near future decisively ‘dematerialise’ or transition from some degree of ‘relative decoupling’ to ‘absolute decoupling’ of economic activity and growth in material and energy use and associated issues like carbon emissions. And it is now widely acknowledged that we have surpassed the Earth’s capacity to restore and repair the damage imposed by this kind of increasing human activity. Current trends in extinction rates, coral reef decay, ocean pollution and acidification, overfishing, deforestation, air pollution and climate change point towards critical tensions, if not collapse. Increased social strife around the world can be considered another sign of unsustainable growth pathways. Ultimately ecological damage and accelerated climate change and its consequences are a signal that economic growth and likely population growth are not realistic options if we are to avoid dangerous Earth System transitions.”
“… the message is clear, transfers and technological change alone cannot solve planetary-scale problems if undifferentiated and continuous economic growth remains the basic premise of our economic system, since this has inevitable consequences for continued material and energy overuse. This must change and it seems this is something that civil society around the world increasingly recognizes...”
"The major carbon polluting nations – along with the multi-national corporations over which they can and should exercise control – retain the capacity to dial-back the CO2 control knob, yet in defiance of the common interest they continue along a fatal path."
“More than three decades have passed since States committed “to achieve… stabilization of [GHG] concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.” That stabilization has not been achieved… Most significantly, humanity continues to heat up the planet by releasing massive quantities of greenhouse gases (GHGs).
Increasing GHG concentrations in turn strongly influence top-of-the-atmosphere radiative imbalance – known as Earth’s Energy Imbalance (EEI)… EEI is the most critical number defining the prospects for continued global warming and climate change… Earth’s Energy Imbalance has increased markedly in recent decades. Indeed, we have found a total heat gain of 358 ± 37 ZJ over the period 1971–2018. EEI is not only continuing, but increasing…”
Dr. James Hansen
Wood et al (2023) - A Climate Science Toolkit for High Impact‐Low Likelihood Climate Risks
Climate Risk Modelling in Finance
We have a ‘life blind’ economic system with profitability and growth as its core objectives, regardless of the externalities. In similar fashion, risk managers are ‘risk blind’ to life/nature:
- They are professionals who typically deal in measurable uncertainties (quantifiable 'risks') with familiar risk budgets, tolerances, confidence intervals.
- Indeed, most of professional risk management works this way – we focus on things within our control. We tend to over-emphasise that which can be measured (“if it can’t be measured it can’t be managed” school of thought).
- Most risk managers are in the main risk measurers and risk monitors (of known market risks) - with typically little mandate to invent, categorise and model ‘unknown risks’ – with inherent uncertainty, ambiguity, complexity.
- The new climate risk discipline is to incorporate non-market climate and system-related variables (non-traded, observed, uncertain) into contemporary financial risk management systems - and to price, integrate, model and manage such unfamiliar and complex risks in ways that are robust.
- The task in future is to manage and model such real-world risks - they may ultimately play a dominant role in economic risk assessments.
- Professionally, the consideration of longer-term risks has not been necessary. Risks that are emergent and typically unobservable (until they crystallise). Unfamiliar risks which, collectively, may have major impacts on markets, asset and collateral values, value chains, risk insurability etc.
Beyond measurable ‘risk’ we have ‘uncertainty’ (‘Knightian’ uncertainty, as first introduced):
- observable time series but misleading/meaningless historical correlations to other familiar, market risk variables.
- information is imperfect, knowledge and understanding gaps exist; some inputs are non-observable / less measurable.
- A world with more qualitative analysis and decisioning, combined with quantitative modelling
- A world with decisioning based on informed guesses and probabilistic confidences.
- Uncertainties that are probabilistic and complex system-driven.
Acute climate risks - Event-driven risks, typically short-term extreme weather events such as floods, hurricanes, wildfires, heatwaves, and droughts.
Chronic climate risks - Longer-term shifts in climate patterns / 'state variables', e.g. global temperatures, sea level, and precipitation patterns.
Climate Risk Modelling in Insurance
Climate risk insurance modelling estimates current and future risk through catastrophe modelling, actuarial approaches and probabilistic methods. Over the last 20 years, numerous climate hazard and risk models for different perils have been developed. Climate risk insurance models can also be applied to assess the simulate the impact of climatic risks on insurance uptake, supply/demand and insurance premia, and how insurance can incentivise adaptation.
Risk can be subdivided into Hazard, Exposure and Vulnerability:
Hazard - is the frequency and intensity of the natural hazard
Exposure - is the presence of exposed values, such as buildings, property, or crops that can adversely affected
Vulnerability - is the susceptibility of these exposed values to losses.
Adapted from Simpson et al. (2021) - A framework for complex climate change risk assessment
Climatic HazardRisk can be subdivided into five main groups:
- flooding (riverine flooding, coastal flooding and other - pluvial flooding, surface water flooding, flash floods and flooding in general)
- wildfires
- hurricanes/cyclones
- windstorms
- other hazards (forest-related damages, earthquakes, debris flows, drought and natural disasters in general)
Modelling of individual hazards is standard, with a multi-hazard approach less common (for forestry-related damages, flooding and earthquake damages). Compound climate risks are increasing rapidly, and an expanding literature focuses on multi-hazard climate risk assessments. See also the CAT Modelling section below.
Climatic Exposure Risk is typically modelled using data on land use. Aggregated information on land use, housing data, housing characteristics and usage. Forward-looking models often include GDP growth and population growth as a proxy for the growth in exposure.
Hurricane insurance models have a heavier focus on residential buildings than in flood models i.e. the approach is less land-use-based and more focused on the buildings themselves. Exposure may be aggregated by building class, or on the value of insured assets, or the value per building. Wildfire and windstorm insurance models are mostly forestry-related, so that exposure input data are related to forest stand value, and the age of the forest stand.
Climatic Vulnerability Risk for flooding is assessed using depth–damage curves applied to various building or land-use categories. For riverine and coastal flooding, protection standards (e.g. dykes and levees) are considered as risk mitigants. Hurricane vulnerability may be assessed relative to adaptation standards compliant with local building codes, or current observed adaptation standards. Other examples include modelling the building resistance level as a parameter, grouping buildings by location and category. Wildfire and windstorm vulnerability are mostly assessed relative to forestry practices, through a forest management parameter - the level of preventative measures taken is inversely related to the risk. Empirical vulnerability functions may also be used, based on the age of the trees and the probability of destruction. The effect of age on vulnerability is more apparent for windstorms than for wildfires - an increase in the percentage of damaged trees occurs when diameter and height attain higher values.
LocationRisk - Climate risk insurance models are most often applied to western and developed countries, rather than less-developed countries. Risk databases for less-developed countries will be more sparse / harder to acquire in general, but such areas are more vulnerable to climatic hazards and would therefore benefit more from insurance coverage. Innovations such as satellite imagery will lead to greater information availability going forwards.
Scenario Modelling - forward-looking models can project how risks develop over time. This is often done by using a climate change scenario (RCP, SSP) in the risk component of the model. Due to the uncertainty of climate change, it is common to use multiple scenarios to estimate future natural disaster risk.
- RCPs (Representative Concentration Pathways) are radiative forcing trajectories out to 2100 for different climate change scenarios, ranging from 2.6 to 8.5 W/m2. These trajectories are applied to simulate future climate conditions and compare outputs under different scenarios, capturing the range of uncertainty around climate change.
- SSPs (Shared Socioeconomic Pathways) describe different socio-economic development trajectories such as sustainable development and fossil-fueled development. SSP2 (middle of the road) and SSP5 (fossil-fueled development) are often paired with RCP4.5 and RCP8.5, as they have similar traits. SSPs are also used for simulations of future land use.
Adaptation (or DRR – Disaster Risk Reduction) measures have the potential to reduce natural disaster risk – a form of proactive risk management that lowers risk, risk premia and encourages societal engagement in resilience-building. For exampleHudson et al. (2016) showed that correctly incentivizing adaptation via insurance can lead to a reduction in household flood risk of 12% in Germany and 24% in France by 2040. Adaptation is usually financed by governments and insureds (households, agribusinesses). Wildfire and storm modelling do not typically consider adaptation measures.
Risk and Uncertainty Management
The Keynesian adage is most apt: with so many sources of risk and uncertainty, we will necessarily need to be roughly right, not precisely wrong.
The tools required for uncertainty management are more in the realms of actuarial, mathematical and multi-disciplinary science. But also in the disciplines of gambling and psychology.
So risk managers must now adapt - away from their non-natural economic risk practices - and towards a more encompassing, comprehensive system that integrates financial-world and real-world risk management.
However sophisticated they have become, financial risk measures are still a subset of the universal set of Gaia /Earth system risks.
The challenge is mostly one of building knowledge, building modelling capabilities and moving quickly in the right direction.
Translating Future Climate Risks into Financial System Risks
In order to transcend the current BAU (Business-As-Usual) setting of the planet, climate risks must be seen as more than an environmental and climate issue. They will fundamentally (and permanently) change the landscape of investment and financing.
BAU will ultimately result in, to name a few, catastrophic property damages, greater non-insurability, higher debts and loss of GDP/revenues at all levels - for sovereigns, states, corporates and households.
Climate Losses and Damage Functions
- How will national finances (and social cohesion) fare in a world of permanent climate-driven losses and economic turmoil, with declining revenues, mass debt and mass migration?
- What value will loan collateral have to banks, in a BAU world of mass business defaults and damage to physical assets?
- What value will bonds have in a BAU world of mass debt issuance, accelerating debt/GDP levels, reduced liquidity, declining asset and credit quality?
In such scenarios, a robust climate ‘damage function’ will assume a maximum 80-90% decline in GDP, above 4°C threshold MAT (Mean Annual Temperature).
Good business practice and future regulatory compliance will ensure that financial institutions and institutional investors get with the program. They will be obliged to systematically address the significance of such large climate risk impacts and map them, integrating them into their funding and investment decisions, risk management and, disclosures.
With a range of climate-related damages affecting most supply chains over time, the potential for capital appreciation from consistent profits growth will become more challenging in the future.
This negative premium is natural physics (or years of unpriced negative externalities) finally catching up with everyone. The Faustian Bargain has come due.
For equity investors, yield-based returns will start to become more important corporate exposures.
The exceptions will be those corporates in a strong cashflow position and those benefiting from green and/or circular business models – producing in the same way Nature does (closed loop, no waste, no pollution).
More generally, it necessitates a greener investment approach and investment in natural capital assets (assets that rely on ecological systems to generate cashflows e.g. land restoration / remediation, sustainable forestry, agriculture, fisheries, water rights).
Crystallisation of Risks
A so-called Climate ‘Minsky moment’ could be triggered in many ways – with financial system risks manifesting across the board:
- Transition risks - the socio-economic losses and costs associated with legal, regulatory and market developments as part of the global transition to Nature Positive economic activities and net zero / lower GHG emissions. Transition risks will escalate with progress to mitigate GHG emissions and the introduction of new technologies, environmental laws and litigation, environmental taxes, and changing consumer behaviour.
- Physical risks – the losses and costs associated with lands, value chains and built capital (property, infrastructure, transport) affected by climate change, extreme weather, sea level rise, natural disaster events etc.Physical risks are already manifesting as global temperatures rise, further affecting the hydrological cycle and biosphere dynamics. Physical risks are likely to be greater in developing countries, which have less ability to adapt to impacts. Physical risk may not entirely materialise where the investees have bought risk insurance. Physical risks are more problematic for companies where location determines the value of assets e.g. physical properties, ports, facilities which are vulnerable to inundation, damage and loss from flood, storm, cyclone, water stress, and sea level rise.
- Geopolitical / Societal risks – assorted losses may also manifest in the form of damages from resource-driven conflicts, or conflicts/actions and mass migrations relating to life-essentials (health, food, water security), or the realisation that cumulative climate risks are high certainty, high impact and unmanageable, with societal unrest and revolution as possibilities.
Global and Regional Climate Tipping Elements
The severity of climate losses is a function of time:
- Temperatures are rising over time, as a result of fast and slow Earth system feedbacks
- As temperatures rise, so does the amount of atmospheric water vapour and the vapour pressure deficit over land and sea – key determinants of extreme weather events, drought, dry seasons, crop failures and so on
- As temperatures rise, so does the probability of tipping elements reaching their point of no return and moving the Earth system to a less hospitable state
Insurance as a Shock Absorber
As ultimate underwriters of some climate risks, insurers and reinsurers must know a thing or two about climate risks. The field of climate risk insurance encompasses natural and earth sciences domain expertise e.g. meteorology, geology, ecology.
Major catastrophes in the 1990s have already prompted the industry to reconsider their products in a world with increasing climate-related risk, and to develop new tools for risk management and risk transfer.
Insurers and reinsurers can play the socially-useful role of financial shock absorber for several historical reasons:
- Financial strength – the ability to absorb large losses and maintain solvency even in the face of catastrophes.
- Global diversification – the ability to spread exposure over different geographies and lines of business and to obtain deeper insight into risk distributions
- Risk structuring – the ability to develop new financial and investment tools for risk mitigation, risk offset and transfer. Namely CAT bonds, ILS (Insurance-linked securities), weather derivatives, staggered claims, sidecars, smart contracts, indexing, parametric insurances, multi-layered insurance programs, public-private partnerships and risk pools, co-investment to build rebuilding, infrastructural, technological and nature-based solution capabilities
Adapted from Generali: Parametric Insurance to build Financial Resilience, Oct 2024
The methodological steps of the new Integrated Volcanic Risk Assessment (ADVISE) model
Risk Mitigation for Insurers
Annual global insured losses of USD 100+ billion have become the new normal. But these represent c.30% of estimated total global losses i.e. $260 billion p.a. of global uninsured losses (source: McKinsey, period 2016-2023).
With exposure to increasing physical climate risks, (including floods, precipitation, storms and water scarcity) insurance payouts will become increasingly loss-making for certain risk lines, requiring (i) new forms of insurance contract; (ii) new forms of insurance and reinsurance risk offset; (iii) insurance premiums to be repriced and frequently.
Source: Oxera - The economic cost of extreme weather events (2024)
Insurance gaps will become increasingly common, as with the California (LA) wildfires, with the state obliged to provide backstop cover in such scenarios.
As risks and damages continue to rise in number and scale, new risk transfer mechanisms and pricing will continue to be required. For example,flood resilience and crop resilience programs will require the combined efforts of government and private sector. Risk-prone areas may ultimately become uninsurable for certain risks, and property owners will be more reliant on government funding and assistance. Similarly for other major risks. Adaptation measures will likely only be effective for certain insured risks.
Catastrophe modelling for Insurers
Catastrophe risk model development is a multi-disciplinary discipline, with an assortment of insurance, engineering, technology and geophysical inputs. Models are used for loss exposure simulation and management, pricing of risk and for capital reserving purposes. Economic loss estimates are generated for ranges of High-Impact Low-Probability (HILP) events, covering natural perils (e.g. storm, flood, earthquake, wildfire) and man-made perils (e.g. cyber, terrorism, conflict).
Significant gaps exist in the catastrophe model landscape – and significant variability in event occurrence probabilities. The largest difference seen to date is a 10-fold difference between two vendor CAT models for the same region peril at OEP 1:250 (Winspear 2020).
The table below illustrates some of the complexities and challenges of catastrophe risk modelling. As can be seen below, it is a necessarily granular discipline, with some overlaps to the climate risk modelling required in finance.
Insurance Industry modelling challenges
Source:Dr Nigel Winspear (2020) - Challenges in Catastrophe Modelling
Conclusion
Navigating the new world of integrated climate and economic risk assessment is unfamiliar for the finance sector - it requires bold, unfamiliar responses in kind, borrowing from other disciplines. Making predictions about impacts on economies and populations, from a range of complex interconnected variables, with potentially massive impacts, tipping points, feedbacks and accelerating transition risks.
First, the finance sector must come to terms with "the patient" and theproblems within: To understand how modern economies have been systematically destroying the overarching natural framework that holds our non-natural daily lives and systems together.
- An unstoppable juggernaut of corporations and industry, maximising revenues and profits in their own self-interest
- A self-sustaining ‘money code’ and governing power law of wealth / influence – corporate interests and capture of governments / institutions, the top 1% owning about half of everything.
- Corporations acting pathologically, with limited liability, and legal protection to pursue profits in their shareholders’ self-interests, irrespective of the increasing ‘negative externalities’ created.
- Corporations circumventing regulations, standards and responsibility for actions that should be crimes against the environment and/or humanity
- As those pathologies have deepened, and governments have rejected keeping them in check, so such activities have become cancerous to humanity and nature. The ‘cancer stage of capitalism’ is not a metaphor, but a real-life destructive process.
This is what has been created – an economic system where the pursuit of profits is protected above all else – even in the face of egregious behaviour by fossil fuel and other interests that are literally destroying the liveability of the planet for humans and most animal species.
The longer BAU activity continues, the higher the risks to the financial sector and the greater likelihood of collapse. The Sixth Great Extinction is firmly on the horizon.
Cartoon by Jonesy Cartoons
Second, the finance sector must understand and get behind "the cure" and the real-world risk paradigm: And how to reverse the existing degradations and risks to Nature and prioritise the funding and actions required with utmost urgency.
- How the current economic system and markets will adapt to a necessary fork on global policy and development, with degrowth and eco-sustainability as survival imperatives
- The need for investors (and policymakers) to go ‘all in’ on the protective and restorative value of Nature and Water - as a hedge to the polycrisis - before its too late
- The IFoA analysis contemplates economic wipeout at some point, if global temperatures continue to rise towards the expected ECS / EES (3.0 - 4.5 C). The effect of this on global yield curves and debt levels will be at least one order of magnitude higher than current modelling.
- Set against this background, this makes investment into nature restoration and conservation far more compelling - in preference to anything else.
- Nature has its own military arm – the laws of physics. And it doesn’t fight fair or discriminate between humans – the ‘Global South’ will be much more affected in the short-to-medium term, exacerbating existing climate problems. In the longer term everyone will be greatly affected.
- Improving our risk management systems is not so much measuring ‘black swan’ or ‘dragon king’ risks affecting our economic risk systems, although this is where it will initially move to.
- Rather it is a new real-world risk management paradigm, with ‘bioregional’ risk approaches and integrated climate modelling of balance sheets.
- The best approach to understand the ‘real world’ risk paradigm we are operating in, is to invest in, study and evaluate (re-evaluate) the very things which we seek to understand.
- Namely, nature, biodiversity and their ecological, hydrological and related support systems. The real value of each will ultimately emerge from such study and investment.
- More generally, investing in ‘life capital’ - its conservation, restoration, remediation and prioritisation.
- The more we invest in this now, through continuous investment and support, the more this creates a positive feedback loop and improvement in these life-essential assets and their management.
- If we fail to remedy the ongoing climate crisis and ecosystems continue to collapse, greater Gaian impacts (Sixth Great Extinction or similar) will be upon us. Ultimately, Gaia will reset the planet against our survival interest.
- We are all on that same sinking ship "HMS Drawdown". There is no excuse for continued lack of action that is well overdue and ultimately self-preserving for all nations.
Survival requires true international co-operation and a collective mindset that desires to
- shrink to sustainable levels – global population, the global economy, the global GHG, waste and pollution footprints. Ultimately we will need to reverse /offset the EEI (Earth’s Energy Imbalance), adopt new sustainable resources and reverse our footprints to within the carrying capacities of the planet. The current BAU approach will accomplish most of this for us, but in a discovered chaotic manner, rather than a centrally planned and accepted one;
- restore as fast as possible – natural capital, diversity and resilience. Massively scaling up Nature-Based Solutions, Nature protection, restoration and remediation - from global government-level downwards. This has the potential, within 20 years, to restore natural cycles and forest/vegetation cover, with multiple potentials for amelioration of climate change.
- The economy, nature and society are meant to co-exist in harmony. Economic units should serve the societies and environments in which they provide services. They should not be a means to generate more and more capital, out of sync with both society and nature.
- Given this, our best (last) chance is to leave significant parts of the Earth as untouched as possible. And to conserve, restore and remediate as much of nature as possible.
Gains in life-capital are the risk parameters / KPIs of the real economy – in sync with nature and society.
- For Nature – air, soil and water quality, wildlife habitats, animal stocks, ecosystems biodiversity, restored and remediated lands and water cycles, ocean acidity, forest cover, nature protected areas (terrestrial and marine NPAs)
- For Society – environmental governance / laws and policing, nutrition levels, green spaces, social wealth, literacy and education rates, disease ratios, equality cohort measures (wealth and power), societal and corporate environmental laws, health and fitness, ratios of poverty, employment and housing and so on.
- For the Economy – focus on the real economy and Nature positive activities; development of nature protection and nature asset markets - long-term environmental funds sector; funding to bridge the Nature Funding Gap; funding through centralised environmental taxes, natural capital valuation frameworks; payments for ecosystem services (PES) and for nature restoration (PNR); circular economy; for-profit versus for-nature sectors.; funding provisions and legal rights for nature, the ‘Most Affected’, the future generations.
All should be protected and developed at the macro level by public resources, planning and investment. Activities negative to Nature / life-capital should be displaced accordingly.
“the conduct responsible for climate change is not just irresponsible—it is unlawful under a range of international obligations, including those under the law of the sea, human rights law, and environmental law. The destruction of Earth’s climate system constitutes an ongoing breach of international law, and it demands immediate legal recognition and cooperative measures to turn the tides, repair the harm, and protect our futures from further destruction"
“Our appeal is to all nations, especially those with the greatest capacity and historical responsibility, to align their actions with the principles of international law and the urgent needs of our shared planet"
“No country can afford to keep its head in the sand any longer. The time for decisive, legally grounded action is now”
Ralph Regenvanu, Vanuatu’s Special Envoy for Climate Change and Environment
Whether this is a dystopian future or not, is largely a function of BAU progression and renewed climate action from here. The faster the transition, the better the prospects for everyone.
Naturally this runs counter to what is happening in some parts of the world – with persistent short-termism and protectionism weighing on the geopolitical landscape. Some nations will not agree at this time, so it is best efforts actions for the sake of everyone.
This is why we need worldwide implementation of legal reforms, the criminalisation of ecocide and related crimes of humanity, and majority decisioning at international level. Worldwide implementation starting with the willing majority and increasing over time.
The sooner we can take remedial actions at scale, the cheaper it will be, and the more results can be obtained. Failing this, debts will likely spiral out of control to pay for the future environmental damages. Early adopters will fare the best in the long run.
Recent posts:
Managing Climate Impact Risk and Uncertainty - The Pivot Point in Finance 02.04.2025
The ICJ Climate Hearings 07.12.2024
Man-Earth system problems and solutions – Part 3 24.11.2024
Towards Ecologically Wiser Management Systems
Man-Earth system problems and solutions – Part 2 17.11.2024
The Great Restoration of Nature – Nature and Water
Man-Earth system problems and solutions – Part 1 10.11.2024
The Great Restoration of Nature – A Proposed Global Environmental Framework
An Update on the 2024 COPs 1.11.2024
Nature Protection in 2045 – The Impending Necessity of Nature Funding 27.10.2024
The 2024 COPs and Climate Finance Solutions 20.10.2024
Restoring Nature’s Green and Blue Lungs 13.10.2024
Beyond Normal - The Mechanisms behind our Extreme Weather 3.10.2024
COP29 and New Climate Finance Initiatives 2.10.2024
Earth's Energy Imbalance and Global Warming Solutions 25.09.2024
Restoring Natural Capital, Diversity and Resilience 21.09.2024
The Environmental Imperative 15.9.2024
Appendix
Biodiversity Intactness Index 2015
Ecological Intactness Index 2023
Source: https://map.unbiodiversitylab.org/
Source: Aqueduct Food 2024 - https://www.wri.org/insights/growing-water-risks-food-crops (Oct 2024)
Source: Planetary Solvency - finding our balance with nature (Jan 2025)