Financial Disclosure not Enough to Steer Investment in the Energy Transition

Ten years ago this month, a certain Governor of the Bank of England gave a landmark speech that had a major impact on how financial institutions understand, and respond to, climate change.

Titled “Breaking the Tragedy of the Horizon,” the speech was delivered at the global headquarters of Lloyd’s of London, the world’s most influential insurance company.

The orator, who was moonlighting at the time as Chairman of the Financial Stability Board (a global network of top financial regulators under the G20) powerfully spelled out the economic and financial risks of climate change.

Those risks are faced directly by the insurance industry, which confronts a growing toll of climate-related disaster costs every year. But climate change also poses many other risks throughout the financial system: to banks, to individual investors, and to the companies which steward capital embodied in their real investments.

The tumultuous consequences of climate change will spark unprecedented instability in capital markets, the speech warned, unless market participants get better at anticipating those risks, disclosing them to investors, and preparing for them.

Left to their own devices, financial markets are notoriously bad at seeing further into the future than the next quarterly earnings report. Competitive pressures to ‘beat the market’ force lenders, borrowers, investors, and analysts alike to focus on the myopic twists and turns of asset prices. Hence the speaker’s ‘tragedy of the horizon’: a fitting analogy to the better-known ‘tragedy of the commons,’ that describes the challenges of collective action around problems like resource conservation.

To prepare for climate change, and make the very long-term investments necessary to both limit its extent and enhance our resilience to it, we need to look beyond a much further horizon. The speaker put great hope in the effectiveness of financial transparency as a way to bring those long-run concerns forward into current financial decision-making.

He proposed a framework in which firms would be required to publish information about their greenhouse gas footprints, and how they plan to manage risks to their businesses from climate change. He proposed a Climate Disclosure Task Force to develop voluntary disclosure standards. He marshalled conventional financial principles about transparency, liquidity, and efficient markets in urging the financial system to better value the costs and risks of climate change, and adjust investment decisions accordingly.

The speech’s conclusion was stirring and hopeful: “Capital should be allocated to reflect fundamentals, including externalities. An abrupt resolution of the tragedy of horizons is in itself a financial stability risk. The more we invest with foresight; the less we will regret with hindsight.”

This speech still makes for compelling reading. The speaker, of course, was Mark Carney. This speech, and Mr. Carney’s other efforts (including after he left the Bank of England in 2020) to integrate climate concerns into financial markets, were influential.

Indeed, Carney played a central role in establishing the Net-Zero Banking Alliance (NZBA) in 2021, which at peak enlisted over 140 global banks in developing and implementing voluntary climate disclosure, and taking other measures to facilitate private investment in decarbonization and climate adaptation. And while the NZBA did not advocate divestment from fossil fuel industries, it urged financiers to properly acknowledge the costs and risks of those investments – and this, theoretically, would guide investors to making more sustainable decisions.

Unfortunately, these calls for voluntary disclosure of climate risks did not lead to enough meaningful action. Banks and other financial institutions continued to raise trillions of dollars for fossil fuel projects. And in many countries (including Canada), attempts to implement more direct and robust limits on greenhouse gas pollution have been resisted fiercely by those who profit from fossil fuel production and use – including an unholy alliance of oil companies, and their financial partners.

Fast forward a decade, and Mr. Carney is now Canada’s Prime Minister. Donald Trump has become President of the United States, and is quickly dismantling previous government policies to promote decarbonization. His slogan is “drill, baby drill.” And Trump is not only removing the regulatory impetus for business to reduce greenhouse gas pollution; he threatens retribution against companies (including banks) that continue to adhere to ‘woke’ values like sustainability.

In the face of these rather immediate political risks, banks of all nationalities are throwing overboard their previous soft commitments to climate-aware financial practices. Many big U.S., Canadian, and European banks have quit the NZBA since Trump’s election, and the organization has paused its activities while it considers a new, less ambitious mandate.

Meanwhile, fossil fuel production is as profitable as ever – with global oil companies setting new all-time records for profits after the 2022 oil price spike. Oil giants which once paid lip service to investing in long-run sustainable energy opportunities, have abandoned the pretense and doubled down on highly profitable petroleum investments.

For both banks and oil companies, therefore, the hopes of the ‘ethical investment’ community that stronger voluntary transparency and investor education would push companies toward more environmentally responsible behaviour, have proven devastatingly naïve. Companies once went along with voluntary measures, at a time when they feared the threat of more binding (and profit-impinging) pollution regulations. But as prospects of compulsory measures receded (in the face of right-wing populism), companies dropped the mask, and recommitted to doing what’s profitable now – rather than what’s prudent, ethical, or responsible in the long term.

Nowhere is the contrast between the high hopes of voluntary disclosure advocates, and the frightening petro-dominance over current politics, clearer than in Canada. Mr. Carney’s first act as Prime Minister was to cancel the consumer-facing carbon price – which had become politically toxic after years of right-wing disinformation and corporate denunciation. Other environmental measures (such as an emissions cap on further petroleum expansion, or mandates for electric vehicle use) are in jeopardy. Carney’s cabinet is suddenly noncommittal about meeting Canada’s international climate commitments.

And in the context of extreme economic uncertainty caused by Donald Trump’s trade war, petroleum advocates are lobbying hard to remove any remaining barriers to further expansion of Canadian petroleum output (which rose 35% over the last decade, never mind the previous federal government’s climate policies).

The currently grim outlook for climate policy in Canada highlights an important lesson of this ten-year experiment with voluntary disclosure and ‘responsible’ finance. Trying to correct the short-sightedness of financial markets through small tweaks to the fiduciary responsibility regime were always far-fetched. Now they seem tragically naïve.

If polluting the planet and fueling climate change is profitable (as it certainly has been), then financiers and industrialists will race to do it. History has shown we shouldn’t bet on either oil companies or the banks that finance them to do the right thing for the planet.

So long as fossil fuel production and pollution remain legal and profitable, the financial system will undoubtedly generate the resources needed to grease those polluting wheels (including through private equity and other channels unconstrained by ‘environmental responsibility’). The best way to stop polluting activities, and the investments which finance them, is to make those activities illegal and/or unprofitable. That means strong, compulsory regulations to limit or tax pollution, including a binding Paris-aligned plan to phase out most production and use of fossil fuels.

As climate change brings more extreme floods, wildfires, heatwaves, hurricanes and droughts, it’s clear that mandatory regulations are needed to meet Paris commitments. That means governments must resist petroleum industry pressure tactics, and pass the binding regulations (including mandatory climate disclosure for financial institutions) that are long overdue. And Canadians have to push governments harder to do the right thing.

In this regard, the ten years since Mr. Carney’s speech have proven that it is a myopic political horizon, not the financial horizon, most inhibiting the implementation of binding rules to limit greenhouse gas pollution. Petroleum companies, financial investors, and opportunistic politicians are blocking progress toward genuine greenhouse gas reduction. To overcome this, those committed to a habitable world must exert stronger political force on government.

In other words, it is not the hoped-for horizons of prudent financiers, but the human foresight of parents and grandparents who care about the world their children and grandchildren will inhabit, that will save this planet.