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Speaker 1: ESG is constantly evolving. Over the years. It is shifted from socially responsible investing to impact to sustainable finance. While the terminology continues to change, what hasn't changed are the underlying science market pressures, tangible physical and financial impacts of the climate prices, as well as increasing regulatory scrutiny and rising consumer expectations. We aim to filter out the noise by speaking with industry experts to identify what is really driving value. Welcome to ESG Currents, brought to you by Bloomberg Intelligence.
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Speaker 2: Today.
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Speaker 3: On ESG Currents, we're changing up the format and Oxford style debate around the motion to the extent that matters for investors. Climate risk is already priced in. If markets are efficient, climate risk should already be reflected in asset prices and investors can rely on price signals. If it isn't, investors may be misallocating capital at scale and facing standard assets and potentially abrupt disorderly repricing. This is not a debate around climate science or about climate politics. It is a debate about financial markets, risk valuation and where the climate exposure is already reflected in prices. Today, I am grace Osborne, the mere ESG integration analyst and your host for this episode. Speaking for the motion is doctor Jacob Tommy, co founder and CEO of THEA Finance Labs, where he has helped develop sustainability tools including Pactor and Asset Impact. He is also Research director of the Inevitable Policy Response and Professor in Practice at Sous University of London, author of two books on sustainability, and writes a monthly column for Responsible Investor. Speaking against the motion is doctor Ben Cardecott, the founding director of the Oxford Sustainable Finance Group and coordinating lead author on finance for the IPCC's seventh Assessment Report. Ben chairs the Advisory Group of the International Transition Plan Network, advising institutions managing trillions in assets across every major asset class and brings a global perspective on how capital markets are responding to climate risk. Each side will deliver opening statements, followed by robuttals, cross examination and closing remarks. I will intervene to keep us focused and within time, Let's begin, Jacob. The flora is yours.
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Speaker 2: Thanks and thanks for the opportunity to speak here and the Oxford style debate pattern and tradition, it's my job not just to make the case for the motion, but also to define it, and I think today in particular, that's going to be very, very key. So just to sort of set the terms of the conversation. First of all, obviously this is on Bloomberg, and so what we're really caring about is whether it's priced to the extent that it matters for investors. We're not saying that everyone out there in the world is thinking about climate change the right way. We're not saying that all the economic assets or all economic activity is taking this into account. We know there's still people buying water front properties. They might not be on top of the topic yet, but we're looking at financial markets investors in where they're pricing right, So let's just make sure we're clear on that first matter. The second is we're not asking about whether in a doomsday scenario we might see some repricing. So we're not asking if an alien invasion tomorrow happens, all financial markets were repriced. Doesn't mean it was mispriced today the probability of an alien invasion, right, We're just looking at, given what we know about the climate science, is it correctly priced or not, And then that gets me to the third point, what do we mean with climate risk? And of course we're here really straddling two parts of the conversation. One of them is the risk from climate change impacts on the economy, what we'd normally call physical risk, and then on the flip side, we're also trying to figure out what the risk is if we're trying to prevent those risks from happening in the first place, which we normally call transition risk. And obviously that makes my job a bit harder because I have to make the case that both of these risks are priced. But as I hope listeners will appreciate, once I'm through with my side of the conversation, we'll all agree that indeed that is the case, risk are priced. So let me start with the case of why the motion is correct. First of all, we obviously know that from any sustainability professionals, modern portfolio theory is an impossible word. But this is really the foundation for the case here, as that markets are correctly pricing these risks. And of course the core condition for that to be the case is that markets need information, and anybody who's sort of subscribed to Bloomberg or any other publication will not have missed the fact that climate change is real, that the transition is happening, whatever your view on the climate science. As you said in your introductory remarks, we can see evidence of the climate changing. Investors are exposed to that information. Whether they believe it or not, we'll get into in a minute, but there's no informational gap here anymore. We see the state of play and it is very clear from the evidence that investors are reflecting that state of play. What was the best performing sector in twenty twenty five, better than tech, better than anything else. It was the green sector, Green technologies best performing sector according to Freezing twenty twenty five. What about the insurance companies spiking insurance premium climate risk regions? Withdrawing all together, it seems like they're on top of the topic as well. And we've got a world of academic research suggesting that climate risk are reflected. ECB has just published something about the CUPN Central Bank. We've got SOAS and Imperial College who've done a study showing that country sovereign risk exposure is linked or sovereign pricing is linked to the climate risks that they're exposed to. The fact of the matter is it's just not twenty ten or twenty fifteen anymore. Maybe I would have had a harder job making the case ten to fifteen years ago, but the information is there now. The carbon bubble is not still around the corner. We've seen the growth in renewables, We've seen all these explosive trends, and so I would say that investors are pricing now. Of course, there's going to be some listeners out there who's going to say, how could you possibly make that case? You know, armageddon is around the corner. We've got the doomsday glacier, We've got Amazon die back, We're sitting here in London. We've got the ocean current collapsing any day now and putting London under a mile of ice. Sure, all these scenarios are out there, but for one, they are very long term scenarios, and as we all know, financial markets are not so much. And two, we're not looking at these probabilities, these low probabilities as a central case. And as we know from our pricing, if something has a one percent or zero point one percent probability, even if it's an extreme event, it's just not going to move financial prices massively. The other thing I'll say, and then close with this thought, is we've actually asked investors what they think. This isn't some sort of a mystery voodoo let's sort of read a crystal ball or read the tarot cards. We'd ran a survey, we work. We'd have this climate forecasting project called Inevitable Policy Response. Last year, we surveyed over one hundred investors. We surveyed over three hundred experts around the world, and we asked them what did they think the turns would look like? And they're not believing in a world anymore where there is no economic transition. Again, whatever you view on the climate science, they don't believe in the one point five degree goal, that's for sure. But they also don't believe in a world anymore where nothing else happens. We know that one half degrees is off the table. But when we actually plugged their views into our risk models and showed what kind of repricing would happen if they were wrong, the risk from the power sector went down to one percent. Now if Ben on the other side, he is going to make the case that one percent is mispricing to the extent that's material for investors, then fine, I think I'll lose this debate. But otherwise I think I've got the facts on my side.
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Speaker 3: Thank you, Jacob. So, to summarize, markets are correctly pricing this risk, the transition is happening, and investors are fully exposed to the information needed to reflect the state of play. And with that I'll hand over to Ben for his position against this motion is one percent risk. If indeed it is just one percent risk and mispricing to the extent that it is material to the investor.
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Speaker 4: Great well, thank you, Grace, and thank you Jacob. And I think you will lose this. Jacob, and I have a great deal of respect for your work and the work of the Finance labs. But I think you have set yourself an impossible task today. And let me explain why. Now the motion is to the extent that it matters for investors, climate risk is already priced in, and so to win the debate, Jacob must convince you that all climate related risks that matter for investors are already priced in across all markets, for all investors all the time. My task is much easier. I need only show that some material climate risks are not currently priced in by some investors some of the time. If markets are anything short of perfectly efficient on climate, the motion falls at that first hurdle, and that is an asymmetry at the heart of this debate. And I believe the proposition has already fallen at that first hurdle, But obviously we want to keep this a bit more interesting. Will say a bit more, and I'm going to draw on findings from the European Central Bank, the Bank of England, and the Bank for International Settlements to show that the institutions that supervise the global financial system have reached the opposite conclusion to the motion, the opposite conclusion to Jacob and the proposition. And I'm also going to use the proposition's own research to make the case against their motion. So there are structural reasons why capital markets are poorly equipped to price climate risks. These are not temporary inefficiencies that are going to self correct. Their features related to how markets work. So, first, climate risks does involve deep uncertainty, not the kind of uncertainty markets handle well. This is not coin flip uncertainty with known distributions, but ambiguous probabilities can tested pay off distributions are nonlinear dynamics where uncertainty is this deep markets either attached the wrong prices or applied discount rates that bury long tailed losses that is not priced in second investment mandates benchmarks and career risk shortened investor horizons. A pension fund CIO who knows that coastal real estate will be impaired over twenty years still faces a benchmark measured over twelve months long dated. For seeable risks are systematically discounted away, and when the repricing does come, it comes all at once. Because physical climate shocks and policy shifts hit many portfolios simultaneously, you cannot diver diversify away from climate risk. Now let me move to some of the evidence I mentioned before. So the ECB the Eripen Central Bank in twenty twenty two did a climate risk stress test and found that eighty percent of significant Eurozone banks had either basic or no climate related risk management practices in place. What followed was not reassurance that markets were going to self correct. What's happened is that there's been a multi year enforcement escalation. In March twenty twenty three, the ECB issued a binding superviser decisions to twenty eight banks that had failed to manage climate related risks, with the threat of penalties to be enforced afterwards in November twenty twenty five. The ECB issued its first climate related risk fine against a banker in February of this year at find Credit Agricol seven point six million for the same failure, and the ECB has as of January this year formally embedded climate and nature related risks into its core supervisray and monetary policy functions, so if climate risk were already priced in, the supervisor of the Eurozone banking system would not be issuing binding decisions, imposing fines and restructuring its own operations to address it, and that progression from twenty twenty two highlights widespread and inadequacy across the financial system, particularly the banking system. The Bank of England found something similar in its climate buyin and exploratory scenario, and there it found that firms were assessing climate risk for counterparties and finding wildly different results for the amount of climate risk that the counterparties faced by a factor of ten for the same borrower, and that highlights again some of the issues here in relation to supervised firms pricing these things. The Bank of International Settlements they published a study last year focused on sovereign bonds and physical risk. They found that transition risk is associated with high sovereign yields, particularly for high missing countries, but they found that physical risk was not being priced into sovereign borrowing costs at all. And given that sovereign bonds are the bedrock of the global financial system, they're the benchmark for interest rates influenced the pricing of every other asset class, they're the most liquid asset. That is a very significant gap and shows why this motion can't hold. I mentioned Jacob's own work excellent work which couldn't I agree with strongly, But his organization published research from their one and one thousand initiatives showing that once you incorporate climate tipping points, ecosystem decline, and social risks into financial stress scenarios, the losses in equity markets from climate change could be amplified by a factor of two point five to three point five times compared to standard estimates. So Jacob's own shop says that standard models may be underestimating climate related to financial losses by a factor of two point five to three point five. And if that's right, clearly the motion does not stand. So where does that leave us? In just a close So the proposition must defend the world where every material climate risk is already priced in for every investor, everywhere, all the time. That's obviously a hard thing to demonstrate. Jacob hasn't demonstrated that. Unfortunately, that is not the world we live in. We live in a world where the ECB, the Bank of England, the BIS have found that these things are not being priced in. There's lots of other research and I could cite as well the proposition's own organization has said this too, and then it it's also worth just remembering too that there are climate risks that not even the best research groups in the scientific community fully understand or can properly model, tipping points, cascading hazards, compounding events. You can't actually accurately price some of these things. There are no unknowns and unknown unknowns. So I think with that it's very clear. So the motion fails.
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Speaker 3: And sorry, Jacob, thank you Ben. Okay, Jacob, So are you now convinced that climate risks are in fact not fully priced in? Given your own research house bea Finance Labs one in one thousand initiative. Essentially, once you incorporate climate tipping points, ecosystem decline, and social risks into the financial stress scenarios, the losses in acty markets from climate change could be amplified by a factor of two point five to three point five compared to standard estimates. Is this enough to change your mind?
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Speaker 2: So Ben's obviously delivered the knockout blow. Is any self respecting researchannels will tell you the moment they get cited, they go into a state of shock and paralysis and immediately feel compelled to agree with the counterpart. No, indeed, I am not fully convinced, despite Ben so eloquently citing our own research. You know, we're just a small thing tank, the little engine that could. But Ben works for Oxford, obviously, and you know that's where the real research happens and the real work is done. And he cited so many wonderful studies, but not the one that his shop put forward that did show how much cost of capital had now shifted in favor of green technologies and how that had really fundamentally transformed as sort of from a risk premier perspective in particular over the last couple of years. I just want to, I think interrogate maybe two or three points that have been highlighted, and also that I feel like the audience should really try and reflect upon as they think about where they stand on this motion. Right, So, I think the first thing is the idea that to believe that climate risk are mispriced, you have to believe that all investors are pricing climate risks. I just don't think that's the right way to think about it. If you said to me now that you know if you take AI or any other risk, well, there's a handful investors who are not really on top of the AI trend, and that means the AI dynamic is not properly reflected. We wouldn't really think about it like that, right. What we're just saying is that, you know, we're in this big market. There are a lot of many players in the market. They have a lot of many different views, and all these players do have the informational access, not the least thanks to Bloomberg, I should say, not getting paid for this shout out that about the climate issues we're talking about, right, and the fact that some of them are choosing to ignore them, doesn't mean it's mispriced. It just means that they've concluded that that information is not material for pricing, right, And we don't accept expect or accept that, you know, for things to be properly priced, every investor has to agree that's material risk, and every investor has to integrate it, or in fact integrate it in the same exact way. There's I think one area to enter right. The second one is about this radical uncertainty, and I have some sympathy for that for sure, especially as we're thinking about the world more broadly. You know, it feels like when have things been more uncertain than they have been today? Name your topic of choice over the last couple of months. But actually, I think on this topic a lot of that uncertainty has gone away. On the one hand, on the transition side, obviously in particular, we really you know, know where these green technologies are going and know the trajectory of them, and so you know, there's uncertain there's obviously some risk profiles and different assumptions, but I don't think people would talk about uncertainty when it comes to that topic anymore. And on the physical risk profile, I mean, sure, twenty years thirty years forty years, but you know, insurance companies are writing one year insurance contracts. We've got short term you know, return pro risk return profiles that we're working towards. And I don't think it's true that over the next three to five years we have radical uncertainty when it comes to physical risk, for example. It doesn't mean that there may not be tail events. You know that we could see in the next couple of years a dramatic shift in some of the tipping points Ben highlighted, some of the social dynamics been highlighted, but again from the distribution of a pricing perspective that is sort of in the normal order of things. And just because a tail event materialized, it doesn't mean we were wrong about thinking of it as a tail event Exanta. So I think those two areas in particular are you know, really when investors try and think about whether they think it's priced now or not, after this conversation we're having, I think they need to kind of wrap the head around Yeah.
00:18:36
Speaker 4: I mean, good, good points, Jacob. I might just come back on some of them. I mean, I think obviously it was a difficult motion meanly set by Bloomberg and obviously we can agree.
00:18:47
Speaker 2: You're just buttering me up. Then either I'm not going for.
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Speaker 4: It that you know, investors are you know, increasingly pricing these risks and have the means to do so. But but I think that the way you are characterizing it, you know that investors are kind of going through a process and then deciding to not price these risks, I don't think is right. I think, you know, there might be some investors that are doing that. I think there are all sorts of reasons why institutions have found it hard to think about this systematically and kind of exclude it from there their risk pricing processes. I mean, I think that's that's harder to say for you know, large regulated firms for example in Europe. But I think you could point to all sorts of financial institutions around the world where you know they haven't gone through some sort of systematic process to go no one, we're discounting the risks like investment Committee.
00:19:47
Speaker 2: Ignore this please, although perhaps in the States in some cases you might I'm with you here.
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Speaker 4: Yeah, yeah, exactly. And then I think your point around, you know, you know, institutions and have and investors are going to have very different views, right, and they can disagree, and of course that's what happens in markets. Clearly. I think there's a sort of a view sometimes promoted by you know, NGOs and others, that sort of thing, that there is some single version of the truth when it comes out to climate risk and everyone must adopt that. Yeah, that's not true.
00:20:20
Speaker 2: Maybe just one more thought, and you know, I'm going to dare break up the format just a tiny little bit. But one of the key points obviously in the motion is that the word climate risks specifically, right, And I sort of somewhat loosely in the beginning said, you know, it's the impact of climate change directly, but I think a lot of the areas where probably investors are the least equipped to think about it are those second order facts that you talked about in my research as well. Right, And you sort of pulled that into climate risk because they're driven by climate change. Right. If we're thinking about resource conflicts, if we're thinking about climate related migration patterns, even if we're just thinking about political conflicts around the transition, you know, and the extent to which that dominates the political dynamic, you know, the anti net zero pro net zero forces at each other's throats and many Western democracies now and that obviously leads to reduction social cohesion, all these second order effects, and I think that's the area where investors, you know, are clearly not on top of the topic. I would say there is no evidence whatsoever that these second order effects are really well captured.
00:21:23
Speaker 1: You know.
00:21:23
Speaker 2: My I can defend the motion by saying, well, those aren't climate risk in the narrow sense of the term. Those are the social risks, Those are other types of risk. But that's obviously the area where you know, if you're thinking about climate risk just as a matter of a storm, a flood. You know, we have these flood and storm maps, we have insurances responding to them, we see some pricing. Is it enough or not? Who's to say, but you know, there is clearly some investor response to these realities and evaluation of these realities from a financial perspective, not a political perspective, non ideological perspective, but in the overwhelming majority of case, from a financial perspective. Where that falls apart is that moment when we're thinking about, right, if we do have habitability thresholds in India that are being crossed if we have, you know, some of the conflicts around land and food security that are now arising potentially as a result of climate change. Where those things materialize, we're in absolutely uncharted territories, and we're not really entail risk territories. Because it's worth reminding ourselves that the air of spring was started by a food seller and food seller responding to the conflicts around food security and food prices in those kind of dynamics, right, And so if we agree on the motion being climate and the second order social effects, I'll you know, pull, I'll pull, I'll draw the pull the white flag. But those are different things. And so in the narrow sense, I think when we're just talking about climate, in the narrow sense, I actually think investors are have really changed the way they think about this topic.
00:22:58
Speaker 3: So perhaps the way we'd find climate risk directly shapes whether we think it's being effectively priced him by investors. The more we expand that definition, particularly to include second order and seismic events, potentially, the harder it's becoming to see that this risk is fully reflected in the markets. I think another interesting lens is the temporal considerations in how climate is being priced in both of you, I think have touched on this, but in quite different ways. Jacob, you pointed to emerging alpha and green technology suggesting some kind of forward looking pricing of the opportunity, and Ben, on the other hand, you've emphasized that kind of shorter term investor perspective. Many risks still aren't therefore being priced in, and Jacob, your point about the challenges of second order effects things like food insecurity as not being fully captured, seems to reinforce that gap. I'm curious, is this kind of where the fundamental mismatch lies effectively pricing climate risk requiring kind of a medium to long term horizon. Yeah, so much of the financial system remains structurally short term, and this creates kind of a disconnect between where risks and opportunities actually sit and where the capital is willing to go. So maybe this raises the question of whether we need more fundamental financial innovation to bridge that gap. So if we take something like natural capital investments like mangroves, we know that they are a phenomenal asset for building resilience to physical risks and mitigating climate change through climate sequestration. But from an investor perspective, the profile is quite challenging. I think it can take around returns take around seven years to materialize, and outcomes are quite uncertain. On average, we see half of every one dollar spent going into a mangrove project that fails, So on the face of this, it's not a great investment prospect. And by contrast to this, if we were conversing that land for development, it may offer kind of fast and more predictable returns, even though it ignores the significant economic losses associated with removing natural protection systems. And I think this is where things like blended finance comes in. Do you risking projects and making them more attractive to private capital? So perhaps kind of a broader question remains, do we need to fundamentally rethink and innovate within our investment structures if we're really serious about properly pricing in climate risk, or.
00:25:27
Speaker 4: Just to jump in on that. I mean, I think a lot of people talk about blended finance, and what they're really talking about is transferring risk from the private sector to the public sector. And obviously private investors are generally quite happy to do that and want to promote that. Now the question for the public sector is, well, what are we getting for taking on that risk and is it proportionate? Is a good value for money here? And they're going to be cases where that's true, and they're going to be cases where it's not true. But I think kind of pointing to blended finance and saying that, you know, that's that's the solution, you know, I think it can be a solution for for for some things, particularly investments where they're significant positive externalities, right, so you know, significant adaptation benefits for example, where you have second and third or third order you're you're avoiding second or third order negative effects and you're generating positive externalities. And you know, nature based solutions might be one of those things for example where it makes a lot of sense, but policymakers need to be kind of quite astute and aware of the the capacity of private investors to to advocate for more risk transfer.
00:26:43
Speaker 2: I mean and think on the on the time horizon point, I agree, agree with you on the blended finance point. This is the moment where the podcast gets boring because we now start agreeing with each other. No, not you worry, but on the on the time horizon point. You know, it's I go back and forth on this at the moment, it does feel someday that everyone has now decided that climate and sustainability is out, and that suggests to me a very short term lens, because you know, from a pure semantic point, sustainability just just another way of saying able to sustain yourself. That feels like it should still be important. And you know, in America, some American puns like to say facts don't care about your feelings. Well, the climate doesn't care about your feelings neither, as we're finding out. But then on the other hand, you know, we are seeing still a lot of renewable deployment, and actually, when we run these forecasts with investors where we go really inside the organization figure out what they think about the transition, there's still quite a decent amount of optimism about medium to long term trends. So it is, like I said, to be honest, I'm kind of going back and forth on this at the moment, because at least the noise on climate acts like there is no tomorrow, and not in the sense that climate is taken tomorrow away, but acts like whatever is happening in the White House and on Capitol Hill right now is a global true about how we should feelbout sustainability. But this, the signal, does suggest that we are not entirely prisoners of the moment, and that makes me I don't know if hopeful is the right word, but at least hopeful to the extent that we that were not just short short short short short short, short term all the all the all the all the all the time. Yeah.
00:28:19
Speaker 3: I think it's interesting the time lags whatever you're investing in, perhaps where you're investing in transition, where you may need substantial upfront capital expenditure. I think of something like the cement industry where they're investing vast amounts into carbon catcher, but actually those players that have invested, say companies like Heidelberg and Wholesome, have significantly outperformed. I believe Wholesome is up about sixty percent in the last year, and that has had a time lag on it. And of course the regulatory infrastructure of things like the European emissions training schemes with carbon prices had made this investment make sense in the short term. And Ben, you mentioned the role of regulatory enforcement and order for climate rest to be priced in. So I'm curious, do we need to create kind of regulatory transition risk and order for physical risks to be fully priced in unpricing climate in effectively.
00:29:16
Speaker 2: I mean, I think it's it's an interesting point you make because if we take you talk about the cost of capital obviously, and you know, it's one of the reasons why folks are concerned about political instability is even if it drives up the oil price, it also might drive up inflation and by extension interest rates and by extension cost of capital. But I think we've kind of become accustomed to this idea and finance that we're sort of just the enabler, the sort of second fiddle to carbon taxes or to climate policies, and we just kind of kind of wait for these climate policies to sort of give us the incentives to Ben's point earlier, for policy makers to do their thing. And a lot of what we're looking at on the deal side, obviously, is just that the cost of capital is the killer. That these are, you know, cost competitive. But the trouble is you have such high upfront costs that when you're not looking just at the levelized cost of electricity or whatever, the long term marginal cost of the product, but when you're looking at it from an investment case perspective, an investment thesis perspective, the capital costs are just the killer, and so that might mean that as we think about, you know, this topic moving forward, Actually the primary determinant of whether some of the transition dynamics we're seeing right now will hold will be the extent to which central banks and financial markets are going to define costs of capital levels that are going to be viable for these investments to go ahead. And that won't be determined by the level of climate policy, but that will be determined by the level of political stability. That will obviously be determined by the debate we just had about the extent to which people believe in the transition and believe in these technologies, and it will be determined by financial rings starting with monetary policy, but also a lot of the different conversations we've had been highlighted the enforcement actions against European banks and the sort of the infrastructure around monetary policy that determines the conditions of financial market participants.
00:31:15
Speaker 4: Yeah, I mean a key KPI, you know, is our risk premiere for clean energy technology is going down over time, and you know, part of that is, as Jacob pointed out, you know policy story. Part of that's also learning curves within finance. You know, financial institutions becoming familiar with new technologies, getting the deals, getting the pipelines, and that also reduces risk premia, So that's important. I mean, these are things we actually track through an ongoing kind of observatory type tracking project that we have at Oxford for different energy technologies across the world, looking at how risk premia are changing. I think the other thing, the other point just to pick up on, was you know, it feels like climate sustainability is out. I mean, I think I think you said that, Jacob. I think there's a there's a you know, I think we can get too focused on the equity market story clearly, and then you miss out the kind of all the structural stuff that's that's that's going on, and it is very easy to do that. So obviously I would encourage people to focus on the structural drivers. And they're not going They're not definitely not going away. You know, the signals are getting stronger and stronger.
00:32:31
Speaker 2: And I mean sometimes I think this is sort of seen as a wolf in sheep's clothing dynamic, but the reality of the matter is is that the truth for a lot of sustainability solutions is to have a lower resource footprint. That's kind of comes with the territory for many sustainability themes we're talking about. On the social side, it comes with having just more stable and productive workforce, right, So these things, you know, it's it's sort of there's always this debate about sustainability, sort of good for business, good for the planet, and you know, we can debate about this till the cows come home. But in the very concrete realities of running your business, trying to identify areas where you can be more efficient, try and identify the areas where you can be less dependent on many of these resource commodities that are major sustainability restrivers and have major externalities. Is in this day and age, in twenty twenty the leader of our Lord twenty twenty six, probably more sensible than ever. Whether you like sustainability or not, whether you think it means that you're saving the planet while you're doing it or not, simply sort of being ideological about rejecting that is the same kind of ideology, if we're honest, that sometimes exists or sometimes the sustainability tree huggers are accused of, right, and I don't know how productive that is for investors and companies, whatever the political wins and whichever way they're blowing.
00:33:57
Speaker 3: I think it's Injestine talking about identifying the risks and touching us something you said earlier that we investors have the data and they're choosing not to use it and they're not ignorant to the risks.
00:34:10
Speaker 2: This is the part of the podcast where we pivot to the Bloomberg terminal.
00:34:14
Speaker 3: Well, I think that is a very interesting point. One thing we were looking at recently is banks exposure to water stress, and we did analysis of all the European banks twenty European banks, and looked at eight very highly water intensive sectors and then not only what is their water consumption that's been financed, but what is their wall stress exposure? And of those borrowers of those banks, sixteen percent of disclosing their water stress exposure. So how effectively can those banks maybe price that into their loans or just see that impact once it's already materialized through the water stress. So I think it's interesting. Ben. You mentioned that we saw credit cole and February have the seven point six million yeuro fine from the ECB, So we are seeing financial implications from fines, but this might be much more magnitude than, for example, a default on a seven hundred million euro alone due to disrupted operations or fully stranded assets due to water stress. So I'm really curious if there is actually effective oversight of risk that actually enables investors to pricing climate risk.
00:35:31
Speaker 2: I mean, we've got two countervailing forces right now. On the one hand, we on our research budgets are going down, Research capabilities are going down, time and resources for these topics are going down. And by the way, that's not just for sustainability, right, but for you know, if you talk to any bank and about the time they have to assess the loan and to assess where the process and the loan is, obviously it's a very different world. It's spoke business. So you know, the idea that this topic gets elevated in this sort of very short window that you have to assess these things is definitely currently can be questioned. On the other hand, we have more technology and capabilities never to assess these risks. Ben and I we've been working on questions of asset level data for ten years. And you know the idea that where sustainability data comes from is your need sustainability report with the children dancing around the school or the polar bear hugging a penguin. You know, that's sort of a little bit that's very twenty fifteen. I would say, the smart investors don't really use these sustainability reports. They use asset level data, they use crowd intelligence, they use obviously artificial intelligence and all the different things that come with these new tools. So we'll see kind of where that settles, I would say, And we'll see to what extent there continues to be a premium on being the smartest in the room. And if there is a premium for that, then especially on the topic like water stress where it's such a clear financial driver, right, like these high exposed sectors that you're talking about, not like you know, water cooler companies, where you need the water cooler full of water so people can have chats about the rugby from the weekend. They need the water to run their business, and if they don't have the water, they can't run their business. And this is going to be something that, like I said, the smartest people in the room are going to assess and where they don't necessarily are not necessarily just going to rely on some corporate disclosure, but going to rely on these these these new technologies to get a holistic view on the matter.
00:37:27
Speaker 4: Yeah, you know, I think Jacob's right to highlight some of these new technologies, and you know, the potential to deploy them quickly and effectively has grown very, very significantly with AI. But I do think the future large part of the future financial analysis is geospatial and properly integrating geospatial data sets, asset level data sets, but also other geospacial especially determined data sets into financial decisions in a much more consistent way. And so I do think financial and this, whether they're people or AI agents, are going to need those capabilities. But you do need to do a lot of the kind of as Jacob knows, you know, you need to do a lot of the kind of the grunt work at the beginning to make those data sets you useful. So it's all very well having great asset level data, but if you don't know who owns the assets, then you can't make that back to securities. And that's it has been very painful manual work, but AI makes that potentially much much quicker.
00:38:26
Speaker 3: Yes, AI, bringing good things and.
00:38:30
Speaker 2: Checking all the boxes. We reference the Bloomberg terminal, we referenced AI and we disagreed. I mean, really, when are we back next week.
00:38:41
Speaker 3: To wrap it up? Well, thank you both so much for joining. It's been absolutely fantastic to hear debate the motion and would be very curious to hear the audience's view. Do you believe that climate investors have priced in climate risk? Feel free to reach out to us on E SG currents at Bloomberg dot net, or of course, I B S on the Bloomberg Terminal. You can find more information on the cost of climate using the bi Carbon Damages tracker on b I E S G on the Bloomberg Terminal.
Speaker 1: ESG is constantly evolving. Over the years. It is shifted from socially responsible investing to impact to sustainable finance. While the terminology continues to change, what hasn't changed are the underlying science market pressures, tangible physical and financial impacts of the climate prices, as well as increasing regulatory scrutiny and rising consumer expectations. We aim to filter out the noise by speaking with industry experts to identify what is really driving value. Welcome to ESG Currents, brought to you by Bloomberg Intelligence.
00:00:36
Speaker 2: Today.
00:00:36
Speaker 3: On ESG Currents, we're changing up the format and Oxford style debate around the motion to the extent that matters for investors. Climate risk is already priced in. If markets are efficient, climate risk should already be reflected in asset prices and investors can rely on price signals. If it isn't, investors may be misallocating capital at scale and facing standard assets and potentially abrupt disorderly repricing. This is not a debate around climate science or about climate politics. It is a debate about financial markets, risk valuation and where the climate exposure is already reflected in prices. Today, I am grace Osborne, the mere ESG integration analyst and your host for this episode. Speaking for the motion is doctor Jacob Tommy, co founder and CEO of THEA Finance Labs, where he has helped develop sustainability tools including Pactor and Asset Impact. He is also Research director of the Inevitable Policy Response and Professor in Practice at Sous University of London, author of two books on sustainability, and writes a monthly column for Responsible Investor. Speaking against the motion is doctor Ben Cardecott, the founding director of the Oxford Sustainable Finance Group and coordinating lead author on finance for the IPCC's seventh Assessment Report. Ben chairs the Advisory Group of the International Transition Plan Network, advising institutions managing trillions in assets across every major asset class and brings a global perspective on how capital markets are responding to climate risk. Each side will deliver opening statements, followed by robuttals, cross examination and closing remarks. I will intervene to keep us focused and within time, Let's begin, Jacob. The flora is yours.
00:02:15
Speaker 2: Thanks and thanks for the opportunity to speak here and the Oxford style debate pattern and tradition, it's my job not just to make the case for the motion, but also to define it, and I think today in particular, that's going to be very, very key. So just to sort of set the terms of the conversation. First of all, obviously this is on Bloomberg, and so what we're really caring about is whether it's priced to the extent that it matters for investors. We're not saying that everyone out there in the world is thinking about climate change the right way. We're not saying that all the economic assets or all economic activity is taking this into account. We know there's still people buying water front properties. They might not be on top of the topic yet, but we're looking at financial markets investors in where they're pricing right, So let's just make sure we're clear on that first matter. The second is we're not asking about whether in a doomsday scenario we might see some repricing. So we're not asking if an alien invasion tomorrow happens, all financial markets were repriced. Doesn't mean it was mispriced today the probability of an alien invasion, right, We're just looking at, given what we know about the climate science, is it correctly priced or not, And then that gets me to the third point, what do we mean with climate risk? And of course we're here really straddling two parts of the conversation. One of them is the risk from climate change impacts on the economy, what we'd normally call physical risk, and then on the flip side, we're also trying to figure out what the risk is if we're trying to prevent those risks from happening in the first place, which we normally call transition risk. And obviously that makes my job a bit harder because I have to make the case that both of these risks are priced. But as I hope listeners will appreciate, once I'm through with my side of the conversation, we'll all agree that indeed that is the case, risk are priced. So let me start with the case of why the motion is correct. First of all, we obviously know that from any sustainability professionals, modern portfolio theory is an impossible word. But this is really the foundation for the case here, as that markets are correctly pricing these risks. And of course the core condition for that to be the case is that markets need information, and anybody who's sort of subscribed to Bloomberg or any other publication will not have missed the fact that climate change is real, that the transition is happening, whatever your view on the climate science. As you said in your introductory remarks, we can see evidence of the climate changing. Investors are exposed to that information. Whether they believe it or not, we'll get into in a minute, but there's no informational gap here anymore. We see the state of play and it is very clear from the evidence that investors are reflecting that state of play. What was the best performing sector in twenty twenty five, better than tech, better than anything else. It was the green sector, Green technologies best performing sector according to Freezing twenty twenty five. What about the insurance companies spiking insurance premium climate risk regions? Withdrawing all together, it seems like they're on top of the topic as well. And we've got a world of academic research suggesting that climate risk are reflected. ECB has just published something about the CUPN Central Bank. We've got SOAS and Imperial College who've done a study showing that country sovereign risk exposure is linked or sovereign pricing is linked to the climate risks that they're exposed to. The fact of the matter is it's just not twenty ten or twenty fifteen anymore. Maybe I would have had a harder job making the case ten to fifteen years ago, but the information is there now. The carbon bubble is not still around the corner. We've seen the growth in renewables, We've seen all these explosive trends, and so I would say that investors are pricing now. Of course, there's going to be some listeners out there who's going to say, how could you possibly make that case? You know, armageddon is around the corner. We've got the doomsday glacier, We've got Amazon die back, We're sitting here in London. We've got the ocean current collapsing any day now and putting London under a mile of ice. Sure, all these scenarios are out there, but for one, they are very long term scenarios, and as we all know, financial markets are not so much. And two, we're not looking at these probabilities, these low probabilities as a central case. And as we know from our pricing, if something has a one percent or zero point one percent probability, even if it's an extreme event, it's just not going to move financial prices massively. The other thing I'll say, and then close with this thought, is we've actually asked investors what they think. This isn't some sort of a mystery voodoo let's sort of read a crystal ball or read the tarot cards. We'd ran a survey, we work. We'd have this climate forecasting project called Inevitable Policy Response. Last year, we surveyed over one hundred investors. We surveyed over three hundred experts around the world, and we asked them what did they think the turns would look like? And they're not believing in a world anymore where there is no economic transition. Again, whatever you view on the climate science, they don't believe in the one point five degree goal, that's for sure. But they also don't believe in a world anymore where nothing else happens. We know that one half degrees is off the table. But when we actually plugged their views into our risk models and showed what kind of repricing would happen if they were wrong, the risk from the power sector went down to one percent. Now if Ben on the other side, he is going to make the case that one percent is mispricing to the extent that's material for investors, then fine, I think I'll lose this debate. But otherwise I think I've got the facts on my side.
00:07:38
Speaker 3: Thank you, Jacob. So, to summarize, markets are correctly pricing this risk, the transition is happening, and investors are fully exposed to the information needed to reflect the state of play. And with that I'll hand over to Ben for his position against this motion is one percent risk. If indeed it is just one percent risk and mispricing to the extent that it is material to the investor.
00:08:00
Speaker 4: Great well, thank you, Grace, and thank you Jacob. And I think you will lose this. Jacob, and I have a great deal of respect for your work and the work of the Finance labs. But I think you have set yourself an impossible task today. And let me explain why. Now the motion is to the extent that it matters for investors, climate risk is already priced in, and so to win the debate, Jacob must convince you that all climate related risks that matter for investors are already priced in across all markets, for all investors all the time. My task is much easier. I need only show that some material climate risks are not currently priced in by some investors some of the time. If markets are anything short of perfectly efficient on climate, the motion falls at that first hurdle, and that is an asymmetry at the heart of this debate. And I believe the proposition has already fallen at that first hurdle, But obviously we want to keep this a bit more interesting. Will say a bit more, and I'm going to draw on findings from the European Central Bank, the Bank of England, and the Bank for International Settlements to show that the institutions that supervise the global financial system have reached the opposite conclusion to the motion, the opposite conclusion to Jacob and the proposition. And I'm also going to use the proposition's own research to make the case against their motion. So there are structural reasons why capital markets are poorly equipped to price climate risks. These are not temporary inefficiencies that are going to self correct. Their features related to how markets work. So, first, climate risks does involve deep uncertainty, not the kind of uncertainty markets handle well. This is not coin flip uncertainty with known distributions, but ambiguous probabilities can tested pay off distributions are nonlinear dynamics where uncertainty is this deep markets either attached the wrong prices or applied discount rates that bury long tailed losses that is not priced in second investment mandates benchmarks and career risk shortened investor horizons. A pension fund CIO who knows that coastal real estate will be impaired over twenty years still faces a benchmark measured over twelve months long dated. For seeable risks are systematically discounted away, and when the repricing does come, it comes all at once. Because physical climate shocks and policy shifts hit many portfolios simultaneously, you cannot diver diversify away from climate risk. Now let me move to some of the evidence I mentioned before. So the ECB the Eripen Central Bank in twenty twenty two did a climate risk stress test and found that eighty percent of significant Eurozone banks had either basic or no climate related risk management practices in place. What followed was not reassurance that markets were going to self correct. What's happened is that there's been a multi year enforcement escalation. In March twenty twenty three, the ECB issued a binding superviser decisions to twenty eight banks that had failed to manage climate related risks, with the threat of penalties to be enforced afterwards in November twenty twenty five. The ECB issued its first climate related risk fine against a banker in February of this year at find Credit Agricol seven point six million for the same failure, and the ECB has as of January this year formally embedded climate and nature related risks into its core supervisray and monetary policy functions, so if climate risk were already priced in, the supervisor of the Eurozone banking system would not be issuing binding decisions, imposing fines and restructuring its own operations to address it, and that progression from twenty twenty two highlights widespread and inadequacy across the financial system, particularly the banking system. The Bank of England found something similar in its climate buyin and exploratory scenario, and there it found that firms were assessing climate risk for counterparties and finding wildly different results for the amount of climate risk that the counterparties faced by a factor of ten for the same borrower, and that highlights again some of the issues here in relation to supervised firms pricing these things. The Bank of International Settlements they published a study last year focused on sovereign bonds and physical risk. They found that transition risk is associated with high sovereign yields, particularly for high missing countries, but they found that physical risk was not being priced into sovereign borrowing costs at all. And given that sovereign bonds are the bedrock of the global financial system, they're the benchmark for interest rates influenced the pricing of every other asset class, they're the most liquid asset. That is a very significant gap and shows why this motion can't hold. I mentioned Jacob's own work excellent work which couldn't I agree with strongly, But his organization published research from their one and one thousand initiatives showing that once you incorporate climate tipping points, ecosystem decline, and social risks into financial stress scenarios, the losses in equity markets from climate change could be amplified by a factor of two point five to three point five times compared to standard estimates. So Jacob's own shop says that standard models may be underestimating climate related to financial losses by a factor of two point five to three point five. And if that's right, clearly the motion does not stand. So where does that leave us? In just a close So the proposition must defend the world where every material climate risk is already priced in for every investor, everywhere, all the time. That's obviously a hard thing to demonstrate. Jacob hasn't demonstrated that. Unfortunately, that is not the world we live in. We live in a world where the ECB, the Bank of England, the BIS have found that these things are not being priced in. There's lots of other research and I could cite as well the proposition's own organization has said this too, and then it it's also worth just remembering too that there are climate risks that not even the best research groups in the scientific community fully understand or can properly model, tipping points, cascading hazards, compounding events. You can't actually accurately price some of these things. There are no unknowns and unknown unknowns. So I think with that it's very clear. So the motion fails.
00:14:22
Speaker 3: And sorry, Jacob, thank you Ben. Okay, Jacob, So are you now convinced that climate risks are in fact not fully priced in? Given your own research house bea Finance Labs one in one thousand initiative. Essentially, once you incorporate climate tipping points, ecosystem decline, and social risks into the financial stress scenarios, the losses in acty markets from climate change could be amplified by a factor of two point five to three point five compared to standard estimates. Is this enough to change your mind?
00:14:58
Speaker 2: So Ben's obviously delivered the knockout blow. Is any self respecting researchannels will tell you the moment they get cited, they go into a state of shock and paralysis and immediately feel compelled to agree with the counterpart. No, indeed, I am not fully convinced, despite Ben so eloquently citing our own research. You know, we're just a small thing tank, the little engine that could. But Ben works for Oxford, obviously, and you know that's where the real research happens and the real work is done. And he cited so many wonderful studies, but not the one that his shop put forward that did show how much cost of capital had now shifted in favor of green technologies and how that had really fundamentally transformed as sort of from a risk premier perspective in particular over the last couple of years. I just want to, I think interrogate maybe two or three points that have been highlighted, and also that I feel like the audience should really try and reflect upon as they think about where they stand on this motion. Right, So, I think the first thing is the idea that to believe that climate risk are mispriced, you have to believe that all investors are pricing climate risks. I just don't think that's the right way to think about it. If you said to me now that you know if you take AI or any other risk, well, there's a handful investors who are not really on top of the AI trend, and that means the AI dynamic is not properly reflected. We wouldn't really think about it like that, right. What we're just saying is that, you know, we're in this big market. There are a lot of many players in the market. They have a lot of many different views, and all these players do have the informational access, not the least thanks to Bloomberg, I should say, not getting paid for this shout out that about the climate issues we're talking about, right, and the fact that some of them are choosing to ignore them, doesn't mean it's mispriced. It just means that they've concluded that that information is not material for pricing, right, And we don't accept expect or accept that, you know, for things to be properly priced, every investor has to agree that's material risk, and every investor has to integrate it, or in fact integrate it in the same exact way. There's I think one area to enter right. The second one is about this radical uncertainty, and I have some sympathy for that for sure, especially as we're thinking about the world more broadly. You know, it feels like when have things been more uncertain than they have been today? Name your topic of choice over the last couple of months. But actually, I think on this topic a lot of that uncertainty has gone away. On the one hand, on the transition side, obviously in particular, we really you know, know where these green technologies are going and know the trajectory of them, and so you know, there's uncertain there's obviously some risk profiles and different assumptions, but I don't think people would talk about uncertainty when it comes to that topic anymore. And on the physical risk profile, I mean, sure, twenty years thirty years forty years, but you know, insurance companies are writing one year insurance contracts. We've got short term you know, return pro risk return profiles that we're working towards. And I don't think it's true that over the next three to five years we have radical uncertainty when it comes to physical risk, for example. It doesn't mean that there may not be tail events. You know that we could see in the next couple of years a dramatic shift in some of the tipping points Ben highlighted, some of the social dynamics been highlighted, but again from the distribution of a pricing perspective that is sort of in the normal order of things. And just because a tail event materialized, it doesn't mean we were wrong about thinking of it as a tail event Exanta. So I think those two areas in particular are you know, really when investors try and think about whether they think it's priced now or not, after this conversation we're having, I think they need to kind of wrap the head around Yeah.
00:18:36
Speaker 4: I mean, good, good points, Jacob. I might just come back on some of them. I mean, I think obviously it was a difficult motion meanly set by Bloomberg and obviously we can agree.
00:18:47
Speaker 2: You're just buttering me up. Then either I'm not going for.
00:18:49
Speaker 4: It that you know, investors are you know, increasingly pricing these risks and have the means to do so. But but I think that the way you are characterizing it, you know that investors are kind of going through a process and then deciding to not price these risks, I don't think is right. I think, you know, there might be some investors that are doing that. I think there are all sorts of reasons why institutions have found it hard to think about this systematically and kind of exclude it from there their risk pricing processes. I mean, I think that's that's harder to say for you know, large regulated firms for example in Europe. But I think you could point to all sorts of financial institutions around the world where you know they haven't gone through some sort of systematic process to go no one, we're discounting the risks like investment Committee.
00:19:47
Speaker 2: Ignore this please, although perhaps in the States in some cases you might I'm with you here.
00:19:52
Speaker 4: Yeah, yeah, exactly. And then I think your point around, you know, you know, institutions and have and investors are going to have very different views, right, and they can disagree, and of course that's what happens in markets. Clearly. I think there's a sort of a view sometimes promoted by you know, NGOs and others, that sort of thing, that there is some single version of the truth when it comes out to climate risk and everyone must adopt that. Yeah, that's not true.
00:20:20
Speaker 2: Maybe just one more thought, and you know, I'm going to dare break up the format just a tiny little bit. But one of the key points obviously in the motion is that the word climate risks specifically, right, And I sort of somewhat loosely in the beginning said, you know, it's the impact of climate change directly, but I think a lot of the areas where probably investors are the least equipped to think about it are those second order facts that you talked about in my research as well. Right, And you sort of pulled that into climate risk because they're driven by climate change. Right. If we're thinking about resource conflicts, if we're thinking about climate related migration patterns, even if we're just thinking about political conflicts around the transition, you know, and the extent to which that dominates the political dynamic, you know, the anti net zero pro net zero forces at each other's throats and many Western democracies now and that obviously leads to reduction social cohesion, all these second order effects, and I think that's the area where investors, you know, are clearly not on top of the topic. I would say there is no evidence whatsoever that these second order effects are really well captured.
00:21:23
Speaker 1: You know.
00:21:23
Speaker 2: My I can defend the motion by saying, well, those aren't climate risk in the narrow sense of the term. Those are the social risks, Those are other types of risk. But that's obviously the area where you know, if you're thinking about climate risk just as a matter of a storm, a flood. You know, we have these flood and storm maps, we have insurances responding to them, we see some pricing. Is it enough or not? Who's to say, but you know, there is clearly some investor response to these realities and evaluation of these realities from a financial perspective, not a political perspective, non ideological perspective, but in the overwhelming majority of case, from a financial perspective. Where that falls apart is that moment when we're thinking about, right, if we do have habitability thresholds in India that are being crossed if we have, you know, some of the conflicts around land and food security that are now arising potentially as a result of climate change. Where those things materialize, we're in absolutely uncharted territories, and we're not really entail risk territories. Because it's worth reminding ourselves that the air of spring was started by a food seller and food seller responding to the conflicts around food security and food prices in those kind of dynamics, right, And so if we agree on the motion being climate and the second order social effects, I'll you know, pull, I'll pull, I'll draw the pull the white flag. But those are different things. And so in the narrow sense, I think when we're just talking about climate, in the narrow sense, I actually think investors are have really changed the way they think about this topic.
00:22:58
Speaker 3: So perhaps the way we'd find climate risk directly shapes whether we think it's being effectively priced him by investors. The more we expand that definition, particularly to include second order and seismic events, potentially, the harder it's becoming to see that this risk is fully reflected in the markets. I think another interesting lens is the temporal considerations in how climate is being priced in both of you, I think have touched on this, but in quite different ways. Jacob, you pointed to emerging alpha and green technology suggesting some kind of forward looking pricing of the opportunity, and Ben, on the other hand, you've emphasized that kind of shorter term investor perspective. Many risks still aren't therefore being priced in, and Jacob, your point about the challenges of second order effects things like food insecurity as not being fully captured, seems to reinforce that gap. I'm curious, is this kind of where the fundamental mismatch lies effectively pricing climate risk requiring kind of a medium to long term horizon. Yeah, so much of the financial system remains structurally short term, and this creates kind of a disconnect between where risks and opportunities actually sit and where the capital is willing to go. So maybe this raises the question of whether we need more fundamental financial innovation to bridge that gap. So if we take something like natural capital investments like mangroves, we know that they are a phenomenal asset for building resilience to physical risks and mitigating climate change through climate sequestration. But from an investor perspective, the profile is quite challenging. I think it can take around returns take around seven years to materialize, and outcomes are quite uncertain. On average, we see half of every one dollar spent going into a mangrove project that fails, So on the face of this, it's not a great investment prospect. And by contrast to this, if we were conversing that land for development, it may offer kind of fast and more predictable returns, even though it ignores the significant economic losses associated with removing natural protection systems. And I think this is where things like blended finance comes in. Do you risking projects and making them more attractive to private capital? So perhaps kind of a broader question remains, do we need to fundamentally rethink and innovate within our investment structures if we're really serious about properly pricing in climate risk, or.
00:25:27
Speaker 4: Just to jump in on that. I mean, I think a lot of people talk about blended finance, and what they're really talking about is transferring risk from the private sector to the public sector. And obviously private investors are generally quite happy to do that and want to promote that. Now the question for the public sector is, well, what are we getting for taking on that risk and is it proportionate? Is a good value for money here? And they're going to be cases where that's true, and they're going to be cases where it's not true. But I think kind of pointing to blended finance and saying that, you know, that's that's the solution, you know, I think it can be a solution for for for some things, particularly investments where they're significant positive externalities, right, so you know, significant adaptation benefits for example, where you have second and third or third order you're you're avoiding second or third order negative effects and you're generating positive externalities. And you know, nature based solutions might be one of those things for example where it makes a lot of sense, but policymakers need to be kind of quite astute and aware of the the capacity of private investors to to advocate for more risk transfer.
00:26:43
Speaker 2: I mean and think on the on the time horizon point, I agree, agree with you on the blended finance point. This is the moment where the podcast gets boring because we now start agreeing with each other. No, not you worry, but on the on the time horizon point. You know, it's I go back and forth on this at the moment, it does feel someday that everyone has now decided that climate and sustainability is out, and that suggests to me a very short term lens, because you know, from a pure semantic point, sustainability just just another way of saying able to sustain yourself. That feels like it should still be important. And you know, in America, some American puns like to say facts don't care about your feelings. Well, the climate doesn't care about your feelings neither, as we're finding out. But then on the other hand, you know, we are seeing still a lot of renewable deployment, and actually, when we run these forecasts with investors where we go really inside the organization figure out what they think about the transition, there's still quite a decent amount of optimism about medium to long term trends. So it is, like I said, to be honest, I'm kind of going back and forth on this at the moment, because at least the noise on climate acts like there is no tomorrow, and not in the sense that climate is taken tomorrow away, but acts like whatever is happening in the White House and on Capitol Hill right now is a global true about how we should feelbout sustainability. But this, the signal, does suggest that we are not entirely prisoners of the moment, and that makes me I don't know if hopeful is the right word, but at least hopeful to the extent that we that were not just short short short short short short, short term all the all the all the all the all the time. Yeah.
00:28:19
Speaker 3: I think it's interesting the time lags whatever you're investing in, perhaps where you're investing in transition, where you may need substantial upfront capital expenditure. I think of something like the cement industry where they're investing vast amounts into carbon catcher, but actually those players that have invested, say companies like Heidelberg and Wholesome, have significantly outperformed. I believe Wholesome is up about sixty percent in the last year, and that has had a time lag on it. And of course the regulatory infrastructure of things like the European emissions training schemes with carbon prices had made this investment make sense in the short term. And Ben, you mentioned the role of regulatory enforcement and order for climate rest to be priced in. So I'm curious, do we need to create kind of regulatory transition risk and order for physical risks to be fully priced in unpricing climate in effectively.
00:29:16
Speaker 2: I mean, I think it's it's an interesting point you make because if we take you talk about the cost of capital obviously, and you know, it's one of the reasons why folks are concerned about political instability is even if it drives up the oil price, it also might drive up inflation and by extension interest rates and by extension cost of capital. But I think we've kind of become accustomed to this idea and finance that we're sort of just the enabler, the sort of second fiddle to carbon taxes or to climate policies, and we just kind of kind of wait for these climate policies to sort of give us the incentives to Ben's point earlier, for policy makers to do their thing. And a lot of what we're looking at on the deal side, obviously, is just that the cost of capital is the killer. That these are, you know, cost competitive. But the trouble is you have such high upfront costs that when you're not looking just at the levelized cost of electricity or whatever, the long term marginal cost of the product, but when you're looking at it from an investment case perspective, an investment thesis perspective, the capital costs are just the killer, and so that might mean that as we think about, you know, this topic moving forward, Actually the primary determinant of whether some of the transition dynamics we're seeing right now will hold will be the extent to which central banks and financial markets are going to define costs of capital levels that are going to be viable for these investments to go ahead. And that won't be determined by the level of climate policy, but that will be determined by the level of political stability. That will obviously be determined by the debate we just had about the extent to which people believe in the transition and believe in these technologies, and it will be determined by financial rings starting with monetary policy, but also a lot of the different conversations we've had been highlighted the enforcement actions against European banks and the sort of the infrastructure around monetary policy that determines the conditions of financial market participants.
00:31:15
Speaker 4: Yeah, I mean a key KPI, you know, is our risk premiere for clean energy technology is going down over time, and you know, part of that is, as Jacob pointed out, you know policy story. Part of that's also learning curves within finance. You know, financial institutions becoming familiar with new technologies, getting the deals, getting the pipelines, and that also reduces risk premia, So that's important. I mean, these are things we actually track through an ongoing kind of observatory type tracking project that we have at Oxford for different energy technologies across the world, looking at how risk premia are changing. I think the other thing, the other point just to pick up on, was you know, it feels like climate sustainability is out. I mean, I think I think you said that, Jacob. I think there's a there's a you know, I think we can get too focused on the equity market story clearly, and then you miss out the kind of all the structural stuff that's that's that's going on, and it is very easy to do that. So obviously I would encourage people to focus on the structural drivers. And they're not going They're not definitely not going away. You know, the signals are getting stronger and stronger.
00:32:31
Speaker 2: And I mean sometimes I think this is sort of seen as a wolf in sheep's clothing dynamic, but the reality of the matter is is that the truth for a lot of sustainability solutions is to have a lower resource footprint. That's kind of comes with the territory for many sustainability themes we're talking about. On the social side, it comes with having just more stable and productive workforce, right, So these things, you know, it's it's sort of there's always this debate about sustainability, sort of good for business, good for the planet, and you know, we can debate about this till the cows come home. But in the very concrete realities of running your business, trying to identify areas where you can be more efficient, try and identify the areas where you can be less dependent on many of these resource commodities that are major sustainability restrivers and have major externalities. Is in this day and age, in twenty twenty the leader of our Lord twenty twenty six, probably more sensible than ever. Whether you like sustainability or not, whether you think it means that you're saving the planet while you're doing it or not, simply sort of being ideological about rejecting that is the same kind of ideology, if we're honest, that sometimes exists or sometimes the sustainability tree huggers are accused of, right, and I don't know how productive that is for investors and companies, whatever the political wins and whichever way they're blowing.
00:33:57
Speaker 3: I think it's Injestine talking about identifying the risks and touching us something you said earlier that we investors have the data and they're choosing not to use it and they're not ignorant to the risks.
00:34:10
Speaker 2: This is the part of the podcast where we pivot to the Bloomberg terminal.
00:34:14
Speaker 3: Well, I think that is a very interesting point. One thing we were looking at recently is banks exposure to water stress, and we did analysis of all the European banks twenty European banks, and looked at eight very highly water intensive sectors and then not only what is their water consumption that's been financed, but what is their wall stress exposure? And of those borrowers of those banks, sixteen percent of disclosing their water stress exposure. So how effectively can those banks maybe price that into their loans or just see that impact once it's already materialized through the water stress. So I think it's interesting. Ben. You mentioned that we saw credit cole and February have the seven point six million yeuro fine from the ECB, So we are seeing financial implications from fines, but this might be much more magnitude than, for example, a default on a seven hundred million euro alone due to disrupted operations or fully stranded assets due to water stress. So I'm really curious if there is actually effective oversight of risk that actually enables investors to pricing climate risk.
00:35:31
Speaker 2: I mean, we've got two countervailing forces right now. On the one hand, we on our research budgets are going down, Research capabilities are going down, time and resources for these topics are going down. And by the way, that's not just for sustainability, right, but for you know, if you talk to any bank and about the time they have to assess the loan and to assess where the process and the loan is, obviously it's a very different world. It's spoke business. So you know, the idea that this topic gets elevated in this sort of very short window that you have to assess these things is definitely currently can be questioned. On the other hand, we have more technology and capabilities never to assess these risks. Ben and I we've been working on questions of asset level data for ten years. And you know the idea that where sustainability data comes from is your need sustainability report with the children dancing around the school or the polar bear hugging a penguin. You know, that's sort of a little bit that's very twenty fifteen. I would say, the smart investors don't really use these sustainability reports. They use asset level data, they use crowd intelligence, they use obviously artificial intelligence and all the different things that come with these new tools. So we'll see kind of where that settles, I would say, And we'll see to what extent there continues to be a premium on being the smartest in the room. And if there is a premium for that, then especially on the topic like water stress where it's such a clear financial driver, right, like these high exposed sectors that you're talking about, not like you know, water cooler companies, where you need the water cooler full of water so people can have chats about the rugby from the weekend. They need the water to run their business, and if they don't have the water, they can't run their business. And this is going to be something that, like I said, the smartest people in the room are going to assess and where they don't necessarily are not necessarily just going to rely on some corporate disclosure, but going to rely on these these these new technologies to get a holistic view on the matter.
00:37:27
Speaker 4: Yeah, you know, I think Jacob's right to highlight some of these new technologies, and you know, the potential to deploy them quickly and effectively has grown very, very significantly with AI. But I do think the future large part of the future financial analysis is geospatial and properly integrating geospatial data sets, asset level data sets, but also other geospacial especially determined data sets into financial decisions in a much more consistent way. And so I do think financial and this, whether they're people or AI agents, are going to need those capabilities. But you do need to do a lot of the kind of as Jacob knows, you know, you need to do a lot of the kind of the grunt work at the beginning to make those data sets you useful. So it's all very well having great asset level data, but if you don't know who owns the assets, then you can't make that back to securities. And that's it has been very painful manual work, but AI makes that potentially much much quicker.
00:38:26
Speaker 3: Yes, AI, bringing good things and.
00:38:30
Speaker 2: Checking all the boxes. We reference the Bloomberg terminal, we referenced AI and we disagreed. I mean, really, when are we back next week.
00:38:41
Speaker 3: To wrap it up? Well, thank you both so much for joining. It's been absolutely fantastic to hear debate the motion and would be very curious to hear the audience's view. Do you believe that climate investors have priced in climate risk? Feel free to reach out to us on E SG currents at Bloomberg dot net, or of course, I B S on the Bloomberg Terminal. You can find more information on the cost of climate using the bi Carbon Damages tracker on b I E S G on the Bloomberg Terminal.
