Climate crisis urgently necessitates ESG compliant accounting standards: Transitioning and mitigating the carbon footprint!

My presentation at the CICIRM 2021, Harbin, China.

Right from my early days with the insurance profession, the message was shrill and clear: ‘insurance is a handmaiden of the industry’. I believe I have a more appropriate phrase now – corporate capture. #CorporateCapture goes way beyond insurance. However, as a common denominator for the global economy – it ensures we remain for as much and as long as possible within a firm grip of the fossil fuel industry. Well before it started belching carbon dioxide, nitrous oxides and methane at levels which have precipitated the Climate Crisis – it ensured an insurer DNA at its lethargic worst.

The agenda:

•What gets measured gets done  •Oxymoron  •Regulatory vacuum  •ESG activism  •Net zero  •Greenwashing  •IFRS wake-up call  •IAIS missing in action  •Reimagining the DNA.

This, broadly, was the framework of my presentation. The idea as I told my audience was to make them uncomfortable. This quote from Raj Thamotheram was my first salvo: ‘The greatest promise of ESG-focused activism is precisely in filling in the gaps that law and culture otherwise fail to address’. What an awesome vision to borrow for (and lend to) a broken regulatory system.

“[I]nvestors must shift the narrative away from a company-first model and focus first on the ecological and social boundaries that all companies must respect. They should continue to make sure portfolio companies are *optimizing* financial return, but only within those boundaries.” What could be a better source than The Shareholder Commons – which is tackling capital system failures that are endangering our future?! Yes, by binning Milton Friedman.

Shareaction’s defiance of status quo and ability to spot the cracks is admirable. Here is what Felix Nagrawala highlights in their recent survey: “Sustainability scores were lower for underwriting than investment across the board… It shows that the insurance industry is yet to realise the systemic risks that climate change, biodiversity and rights violations pose to the economy.” A unique dichotomy that manifests insurers.

Again, from Shareaction: Majority of large insurers do not live up to their role as ‘risk experts’ as they fail to adequately address systemic risks such as climate change and biodiversity loss. 1. Insurers’ boards remain ill-equipped to appropriately manage the environmental and social impacts of their organisations.   2. Despite the insurance sector’s focus on risk, the world’s largest insurance companies are largely failing to assess the impact of climate change on their investment portfolios. 3. Vast majority of insurers have not yet started to develop their approach to biodiversity loss.  4. Most of the world’s largest insurers (top 70 were surveyed) show severe negligence of their impact on human and labour rights across their investment and underwriting activities.  

A letter sent out to CEOs of eight major US insurance companies – signed by four Democratic party senators (I have been repeating this ad nauseum): “In order to better understand your fossil fuel underwriting and investment policies:  1. Have you studied how your company’s annual claims and premiums will evolve as climate-related losses burgeon over the coming decades? Which climate scenarios have you studied?  2. Have you conducted a stress test of your company’s exposure to fossil fuel assets? Which scenarios have you used? What did any stress tests reveal about your company’s exposure to fossil fuel assets?  3. How are your company’s fossil fuel underwriting and investment policies consistent with your broader commitments to sustainability? 

Net Zero Conundrum (Source S&P):

In Net Zero theory, companies are expected to first physically reduce their actual CO2 emissions, then take other actions, such as purchasing carbon offsets, to at least equal remaining unabated emissions.  ​

Mathematically, the “net” CO2 emissions attributable to the company then become zero. Yet not every entity is taking reasonable steps to curb their emissions before turning to offsets.  ​

In order to achieve the Paris Agreement 1.5 degree scenario, global spending trends must change. Today, companies expend more effort on offsets and other financial “solutions” than on actual emissions reductions, including pollution control technologies, clean energy production and energy efficiency.  ​

Financial expenditures on actual reductions must almost quadruple from its 2019 level according to the International Energy Agency (IEA) to achieve alignment with the Paris Agreement. ​

Claims that Net Zero is merely greenwashing are, not surprisingly, growing. The Washington Post criticized the financial sector for its focus on solutions that some argue do not contribute to actual emissions reductions, instead emphasising offsets.  ​

Even UN climate finance envoy and former Bank of England governor Mark Carney recently tripped up over offsets. He claimed that the investment company he vice-chairs was “net zero” despite investing in fossil fuels because the company also invested in renewable energy. Some called that an “accounting trick”. ‘I call it a pile of rubbish’, says Damian Carrington. ​

​An innovation in the ESG insurance space is the arrival of Net-Zero Insurance Alliance in the ESG insurance space – includes seven insurers that are already leaders of the Net-Zero Asset Owner Alliance. ​Insurers are recognising the importance of exiting fossil fuels for good, although whether they’re moving fast enough, and in line with the latest International Energy Agency recommendations, is less certain (Source: Capital Monitor).

A culture of superficial ESG regulatory compliance could set us back years!​

Since the regulators stepped in with a clear focus on managing impact, the industry has gone into overdrive. At times, it feels like it is trying to run before it has learnt to walk. Take climate change for instance. Major commitments are being made about ‘aligning’ portfolios with Net Zero goals without a deep understanding of how to meaningfully measure the carbon intensity of portfolios (e.g. scope 3) or to effectively reduce them (beyond quick cosmetic gains). The obvious case is offsetting, which should be used as a last resort in situations where reducing emissions becomes too challenging.  ​

A special report by ratings agency AM Best in mid-November 2020 emphasised that insurers and reinsurers that ignore ESG in their underwriting and investment decisions confront serious reputational risks. In turn, this risk can cause buyers and investors to flee to competitors, affecting the companies’ creditworthiness and ratings. ​(Source: www.russbanham.com​).To achieve global net-zero emissions by 2050, we will need financing on a far larger scale than what is currently being dedicated. ​

The cost of transition:

The United Nations Intergovernmental Panel on Climate Change in 2018 estimated the world needs to invest about $3 trillion annually under a 1.5-degree scenario.  ​

Of that amount, about $2.4 trillion – or about 2.5% of global GDP – will be needed annually over the next 15 years for clean energy-related investments, the IPCC said. In comparison, global total investments in clean energy and energy efficiency in 2019 reached only US $635.8 billion, according to the International Energy Agency. ​

The world would need to invest about 3.8 times that amount annually to achieve the IPCC’s 1.5-degree scenario. ​

Transition-focused financing, including debt issuance products like green bonds, could help put a dent in overall investment needs. Transition finance could provide up to $1 trillion annually over the next 30 years, S&P Global Ratings estimates. ​

​IFRS in the ring:

The International Financial Reporting Standards Foundation (IFRS) announces the strategic direction to be taken in the formation of a new sustainability reporting standards board, including its focus, scope, and approach. ​

The International Organization of Securities Commissions (IOSCO), the leading international policy forum for securities regulators, announced that it will work with IFRS Foundation Trustees towards the establishment of a Sustainability Standards Board (SSB), citing an “urgent need for globally consistent, comparable, and reliable sustainability disclosure standards.” ​

Citing the urgent need for better information about climate-related matters, the IFRS said that new board would initially focus its efforts on climate-related reporting, while also working towards meeting the information needs of investors on other ESG matters. The board would build on established, existing frameworks, such as TCFD, as well as work by the alliance of leading standard-setters in sustainability reporting focused on enterprise value. (Source: Mark Segal).

In conclusion:

The presentation is neither a comprehensive account of all the gaps nor the remedies – coming from observers and experts. However, there are pointers in plenty towards possible ambiguities that could do more harm than good. What must be measured to ensure sustainability in unambiguous terms? How to ensure we do not get swept by a tsunami of greenwash? ESG per se is getting pulled into many directions, how to ensure the integrity of the core values around environment, societal and governance? While the IFRS attempts to put together a meaningful protocol, the IAIS must get into the driving seat. It must not only ensure insurers defend their balance sheets from climate risks but also that insurers do not aid or abet climate risks both as investors and underwriters. Insurers in the process have to come of age and shake-off the corporate capture that has, for long, held them back from their logical progression.