March 2021

Essays

Patrick Lau

The changing climate of risk

© David McNew / Getty Images

Financial institutions, investment funds and governments are being held to account over the costs of climate change

Bonds are kind of boring; government bonds are really boring. That’s okay. Everyone thinks so, if they think about bonds at all, and there’s no shame in saying it out loud.

Government bonds are boring because they’re designed to be boring. They’re known as risk-off assets – they’re not going to generate much return on investment, and these days you might even have to pay a little for the privilege of holding them. But they don’t require adult supervision. They just sit there, stewing in a tiny puddle of interest, while house prices, the sharemarket and futures contracts on oil are flying in every direction.

You can maybe squeeze a few droplets of excitement out of government bonds by thinking about all the flavours of ennui they come in. There are different term periods, coupon rates and frequencies attached, which contribute to determining whether the yield is 1 per cent or 0.1 per cent. There are lots of varieties, including “notes” and “bills”, and the relatively freewheeling “semi-government bonds”, and occasionally some exotic terminology such as “gilts” or “bunds”, but truthfully, when you take a step back these are all just tweaks on a theme.

Australian government bonds are, naturally, backed by the Australian government, which to credit-ratings agencies means they’re among the safest places in the world, in any asset class, to park your cash. Unless the nation goes belly-up and starts defaulting on its debt, your bonds are going to behave themselves.

Katta O’Donnell has been thinking about government bonds a lot recently, which is unusual because she’s 23 years old and because government bonds are boring. But O’Donnell thinks Australian government bonds might have a provocative undercoat of riskiness when you peel back the paper.

“They’re one of the largest financial tools around and it’s really important that people understand them. Most Australians will be investing in government bonds through their superannuation fund,” O’Donnell says.

“It’s really important that people are aware that government bonds are at risk from climate change. And that all through our economy, we’re going to be hit hard from climate change. Physical impacts, transition impacts… our government is seemingly not doing anything to prepare for what we know is coming.

“And I think that’s really, really dangerous, and they’re not performing their legal duties.”

O’Donnell, who is finishing her final semester as a law student, has launched a suit against the Commonwealth in the Federal Court, arguing that the government must be honest with investors in government bonds about the risks that climate change presents to Australia’s economy and sovereign credit rating, and therefore to the value of their investments. Also named in the suit are the Treasury secretary, and the chief executive of the Australian Office of Financial Management, the agency that issues government securities.

The link between extreme weather and macroeconomic distortion is clear. In 2011, for example, Cyclone Yasi contributed to a spike in inflation of 0.7 percentage points, thanks to massive crop losses and subsequent tightening of the banana market (or “the banana price episode”, as the Reserve Bank calls it). And, lest it bear repeating, the link between climate change and the increased frequency and magnitude of extreme weather events is not in doubt.

What’s missing is a clear acknowledgement that the costs of climate-related disasters, and the failure to address them, present material and growing risks to investors in Australia’s financial products.

O’Donnell’s statement of claim asks for an injunction on promoting or issuing bonds to retail investors until that condition is met, as well as declarations that failure to disclose those risks is in breach of statutory obligations under the Australian Securities and Investments Commission Act (something in the nature of “misleading or deceptive conduct” in promoting a financial product) as well as the duties of care and diligence required under the Public Governance, Performance and Accountability Act (“a reasonable person … would not have neglected, failed or refused to disclose the information necessary”).

That’s a roundabout way of saying that O’Donnell wants the government to tell the truth.

“It’s a fairly basic ask,” she says. “And it baffles me, really, that I even have to be in this position.

“Government has to be there to protect the public. And at the moment, it’s like they’re just creating a bigger problem by lying to us and pretending that this catastrophe doesn’t even exist yet.

“One legal case is definitely not going to fix the climate crisis. But it’s changing the narrative at the moment. And we need to be talking about this on every level, and the financial aspect is a huge driving factor to [addressing] climate change.”

O’Donnell is represented by David Barnden, an environmental lawyer who works at the nexus between climate change and finance. Barnden thinks a case that digs into government bonds is essential in a country where not only are the impacts of climate change likely to be particularly severe, but mismanagement of the inevitable decarbonisation of the economy is likely to cause financial harm to everyone with a stake in the country.

But he can’t really explain why it’s been left to O’Donnell to bring the case, rather than institutional investors or older retail investors.

“Historically there’s been a culture of groupthink in financial circles,” Barnden says. “Pension funds, for example, weren’t overly keen to rock the boat.

“And younger investors, like Katta, who are investing over decades, either personally or through their superannuation funds, you see them more exposed to climate change. You see them being, quite rightly, angry about what people in power are doing or not doing to mitigate the risks.”

Barnden is having a red-hot moment – he has another case under way that pits eight children and a nun against the federal minister for the environment, in an effort to block an expansion of Whitehaven’s Vickery coalmine in New South Wales. And in late 2020, he closed out a suit on behalf of Mark McVeigh, a 25-year-old ecologist who had sued his super fund (the Retail Employees Superannuation Trust, or Rest) for failing to monitor, disclose and address climate risk in its investment portfolios. After a two-year battle leading up to a trial, Rest settled on the first day in court.

“Rest acknowledges that climate change could lead to catastrophic economic and social consequences and is an important concern of Rest’s members,” the fund said in a statement.

“The superannuation industry is a cornerstone of the Australian economy – an economy that is exposed to the financial, physical and transition impacts associated with climate change.”

Although the suit ended in settlement rather than a judgement, it’s still a remarkable if not legally enforceable precedent. A big institutional investor (Rest manages something in the order of $60 billion on behalf of its members) has agreed to change its investment strategy, acknowledging that climate change is a material risk that it had been ignoring, rather than square off in front of a judge. That sends a message to other fund managers that climate change probably has relevance to statutory and fiduciary duties, or at least that it might not be a great idea to be the one to test that in court.

Barnden says climate litigation is a powerful tool: it can “crystallise risk” that, while obvious, might otherwise be ignored.

“Societies are built on the rule of law, so when courts identify misconduct, or direct individuals or companies to do certain things, the market would need to follow. [Litigation] is one of the tools available – it’s certainly not the only tool and it’s certainly not the complete answer,” Barnden says.

Sarah Barker, a partner at MinterEllison who specialises in climate-risk governance, says that Barnden’s approach sidesteps the difficulties associated with climate cases based on human rights, which have had success in other jurisdictions but are tricky to pull off under Australian law. But there’s a healthy menu of strategies available to potential climate litigants.

“Climate change litigation, as a category, is really quite unique in its breadth of cause of action,” Barker says. “We’ve got human rights cases, we’ve got planning and environment cases and administrative cases. But we’ve also got tort cases, negligence and nuisance. We’ve got misleading disclosure cases, we’ve got breach of company director and pension fund trustee cases under corporate and securities law.”

But when it comes to the limits of liability, there’s still “radical uncertainty” over what risk disclosure entails. It’s not clear whether simply acknowledging risks alone is enough to fulfil the duty to disclose. It might also be necessary to explore the alternatives, draw out the variables, stick caveats on all the moving parts. To have an earnest go at ameliorating the risk, in other words.

Barker worked on the briefs that fed into an influential opinion issued by Noel Hutley SC in 2016, and updated in 2019, looking at the issue of company directors’ liability for climate risks under the Corporations Act. The Hutley opinion argued that directors have a duty to “inform themselves, disclose the [climate] risks as part of financial reporting frameworks, and take such steps as they may see fit to take, with due regard to matters such as the gravity of the harm, the probability of the risk, and the burden and practicality of available steps in mitigation”.

Hutley’s argument has been much mooted by legal thinkers – everyone’s got an opinion on it – but it hasn’t yet had an opportunity to be tested in the courtroom. Its conclusions, however, have been endorsed by Australia’s financial regulators, which have warned that company directors should be wary about their liability for climate-related harms, and pushed recommendations from the internationally recognised Task Force on Climate-related Financial Disclosures as an appropriate framework for disclosure (albeit without mandating them).

Barker describes the TCFD framework as “volandatory”; public companies aren’t required to follow it, but the nudges in that direction, from shareholders as well as regulators, are not as gentle as they once were. And that has compounding effects. With more and more investors looking for TCFD reporting, it increasingly fits the description of being “useful to a reasonable investor”, which makes it material information and therefore relevant to disclosure.

“It’s becoming close to impossible to argue that information in that form is not decision-useful to an investor,” Barker says.

Emma Herd, chief executive of industry association the Investor Group on Climate Change, represents large institutional investors, asset managers and other financial players who are working to understand risk and reporting frameworks such as those outlined by the TCFD, and scenario analysis in particular.

“When we first started looking at this 15, 20 years ago, we had one big bucket of risk called ‘climate risk’,” Herd says. That is now separated into more discretely defined considerations such as “transition risk” and “physical risk”.

“Transition risk is really about the financial and investment implications of decarbonising the economy – reducing emissions and transitioning away from carbon-intensive activities and commodities,” Herd says. “How vulnerable is a particular company – or a particular asset, a piece of infrastructure, a whole industry sector or even a national economy – to the financial risks associated with those trends? And how well are they being managed or mitigated?

“Physical risk is the actual financial and investment costs associated with climate change itself: increasing extreme weather conditions – heat is a big one in Australia – coastal inundation, water availability, all of the costs associated with the actual effects of climate change. And then what you can do about it to increase the resilience of your investments to these effects.”

Herd says that to understand the risks at an economy-wide level, each element of the financial system will have to reconnoitre its own pockets. “We need to understand what [the climate-related risks] are for our future retirement savings … The banks need to understand it from a credit-risk perspective. Financial regulators need to understand it from the perspective of both corporate disclosure requirements, and also meeting their own prudential oversight responsibilities for managing systemic risks.”

The formulations that make up scenarios under analysis are opaque. Everyone’s got their own secret sauce, and it’s plausible that some companies are conducting what Herd calls “adaptation arbitrage”, under which they disclose their least-painful climate-risk scenario, rather than the most likely one.

In January, the Climate Council released a report on “The Compounding Costs of Climate Inaction”, which suggested that the dollar figure associated with extreme weather disasters in Australia reached $35 billion for the decade 2010–19, more than double the (inflation-adjusted) losses of the 1970s, but dwarfed by the estimated damages of $100 billion annually by 2038.

Those figures primarily look at the more easily accountable immediate harms, but there are also downstream effects to be quantified. The health impacts of the 2019–20 bushfires, for example, include almost $2 billion associated with smoke inhalation alone (hospital admissions, emergency callouts for asthma attacks, and an estimated 429 premature deaths). But the productivity losses, reduced quality of life and increased risks of disease don’t have a dollar figure – yet.

Insured property losses from the bushfires are around $2 billion, but that’s a fraction of the total. Several estimates of the bushfires’ final bill stretch to more than $100 billion when you include the likes of job and wage losses, firefighting costs, agricultural losses, business hit by power outages, reduced value of real estate and long-term health effects. For that kind of money, you could order an NBN with six months of JobKeeper on the side. But even these sums don’t factor in the shrinking industries, stranded assets and broader costs to the economy associated with disappearing markets for fossil fuels.

A Deloitte Access Economics report from November 2020 (“A new choice: Australia’s climate for growth”) rolls together all the risks it can find and suggests that the current trajectory of climate warming will result in losses across the economy of $1.1 trillion by 2050, which will then triple by 2070.

Conversely, investing in a transition pathway now will result in a $680 billion windfall and an additional 250,000 jobs by 2070. “The economic costs of climate change are the baseline,” the report says, adding, in what you might describe as a bit of Zen economics, “While doing nothing is a choice, it is not costless”.

“By 2070, we’ll be having a COVID-size disruption pretty well every year,” says Nicki Hutley.

Hutley is a Climate Councillor and former senior partner at Deloitte (although she’s not an author on either report above). Like Herd, she believes that quantifying risk and harm is not yet an exercise in precision. At this stage, trying to put a price tag on climate change requires a bit of divination.

“Economists argue over some of the technical aspects of the models. We get bogged down in questions about what’s an appropriate discount rate, or should you use a social price of carbon or a market price of carbon,” she says.

“It’s kind of putting a finger in the air and saying, ‘Well, you know, we’ll add a slight risk premium, because we know that there are parts of this portfolio exposed to extreme weather.’ I doubt whether anybody’s properly pricing it, to be honest.”

But regardless of the assumptions and choices built into quantifying climate-related risk, Hutley says that the debate has irrevocably shifted from the costs of addressing climate change to the costs of a failure to do so.

“There is no model that doesn’t tell you that we are now in for a very difficult time if we do not do something about climate action … If governments don’t act now, then we will get much higher unemployment and we will have higher energy costs because they haven’t managed the transition properly. And obviously both of those things contribute to sovereign risk and downward pressure on bond prices.”

There are mechanisms to intervene if the invisible hand isn’t laying bond prices down where they’re meant to be. In November 2020, the Reserve Bank announced a new quantitative easing program and began buying bonds from the secondary market at an unprecedented rate. Pulling government securities out of circulation (and replacing them with fresh new cash) can be used to juggle all kinds of economic settings – liquidity, inflation, interest rates. In this case, the RBA has stated that the program it aimed at increasing demand for bonds, and therefore lowering bond yields, should produce “lower borrowing costs, a lower exchange rate than otherwise and higher asset prices”.

But, perhaps counterintuitively, “lower borrowing costs” and “higher asset prices” aren’t universally beneficial. Assets that are already looking overvalued don’t necessarily need to be propped up any further, and lower savings rates are also likely. As RBA governor Philip Lowe pointed out when announcing the quantitative easing program, the RBA’s actions are “lowering the cost of finance for all other borrowers in Australia, whether they are a household buying a home or a business wanting to expand”. Mortgage rates – the cost of finance – may be lower, but if house prices are swollen that still won’t help those without existing equity in the housing market.

There’s nothing inherently wrong about a spot of quantitative easing now and again. Countries the world over are doing it. And it’s certainly not the only horse the RBA has running. But it’s explicitly a tool for desperate circumstances, an emergency measure that doubles-up on the trickle-down bet, and therefore a mechanism that disproportionately benefits those with the most, who need it least.

The pandemic and the responses to it have already been a great enabler of inequality. But it’s not just that the impacts have been felt most by the already disadvantaged. Wealth has actively been redistributed from the poor to the rich, and from the young to the old. The world’s 10 richest people have seen their net worth, on paper, increase by US$540 billion thanks to the pandemic, in large part thanks to the quantitative easing programs that central banks have been running.

According to Oxfam, the transfer of wealth to those 10 individuals amounts to enough “to prevent anyone on Earth from falling into poverty because of the virus”, with sufficient spare change to pay for a vaccine for every person on the planet.

If, as Nicki Hutley says, climate change will be creating a pandemic-sized disruption annually by the time Katta O’Donnell and her cohort are retiring, it seems inconceivable that the solution will be to rely on the central bank’s emergency reflexes: print dollars, buy bonds, and support share prices and house values. If you can see the risk coming, it should be possible to put other plans in place.


In this environment, you have your pick of explanations for the recent growth and volatility in asset valuations of zoomer and millennial darlings such as Bitcoin or Tesla. It’s price discovery of paradigm-shifting technologies; it’s scavenging for scraps of yield in Ponzi schemes; it’s “money printer go brrr”.

The advent of new share brokerage apps and platforms with lower barriers to entry, epitomised by Robinhood in the United States (and its Australian counterparts such as SelfWealth, Superhero and Stake), has also empowered traders with little nous or capital to muddle about in the markets.

In early 2021, a murmuration of Redditors grabbed the world’s attention with an attempt to topple some hedge funds, and hopefully get rich in the process. The resulting extreme volatility in their primary target, video-game retailer GameStop, triggered overnight bailouts of hedge funds on the other side of the trades, and concerns about contagion into other stocks and the broader financial system.

The process will probably have lasting regulatory impacts on the capitalisation requirements of the app-based brokers, and force a new understanding of the hedge funds’ strategy of shortselling (betting a stock’s price will fall). But it also revealed the surprising, if crude, heft that a flash mob of retail traders can command, and the potential for that power to warp how markets are meant to work.

Most of the Reddit traders were undoubtedly out for the gains, but a sizeable portion seemed to be motivated by a latent alienation from capitalism and an enduring resentment over the global financial crisis. At Bloomberg, commentator John Authers argued that the GameStop bubble was driven not by greed but by anger “about generational injustice, about what they see as the corruption and unfairness of the way banks were bailed out in 2008 without having to pay legal penalties later, and about lacerating poverty and inequality”.

One retail trader, Authers said, had warned him, “This isn’t a casino. This is a riot.”

Andrew Moore, chief executive of micro-investing platform Spaceship, says “there’s no doubt that there’s a real upswing” in new traders and investors entering financial markets. “And interest rates, for sure, are contributing to that. There’ll be a lot of young people with money sitting in savings accounts, who are looking at the sort of return that they’re getting and thinking, Wow, this is pretty unexciting. Safe, but unexciting.”

Spaceship, whose customers are aged around 32 on average, offers a relatively traditional managed investment product, though with a much prettier interface and some functionality overlaid that make it friendlier. But Spaceship is also keen to educate its userbase on the differences between saving, trading and investing. When the ASX crashed in March 2020, less than 20 per cent of Spaceship’s investment account customers made a withdrawal, with the majority taking the long-term view and riding out the turbulence.

“We want people to be able to invest in their financial future, and feel comfortable doing that, and learn in the process,” Moore says.

Spaceship is not encouraging in-and-out day trades; it says it’s helping customers invest long-term in climate-friendly tech stocks. It’s a fascinating blend of cool-uncle/daggy-uncle energy.

From Moore’s perspective, the use of equity as an act of political speech will probably continue to take the form of shareholders engaging with their companies, rather than a virtual Occupy Wall Street movement. The long-term impact of online activists attempting to hurl “buy/sell” orders through the market like bricks through shopfront windows is hard to assess; it may turn out to be just another blip in the system.

But what’s certain is that the ethical, and particularly environmental, bona fides of public companies are increasingly going to be tested.

“There is no doubt that the millennials – who in the not-too-distant future are going to be the biggest investors in the market – are going to be quite demanding,” says Moore.


Katta O’Donnell, of course, is already putting some of those demands forward.

“I don’t really see it as a radical idea, to have systematic change. If we’re going to tackle climate change, it needs to come from deep within the system. We need to have a complete overhaul,” she says.

O’Donnell acknowledges that there’s a lot going on and it’s hard to connect it all. “But that’s what climate change is. It’s a very broad concept and such a multifaceted issue. It’s so many things coming together. Maybe that’s why our government doesn’t even try, because it’s so challenging. But there are some really obvious steps that can be taken and that need to happen.

“It all starts with telling the truth. Once you acknowledge a problem, then you can start to face it.”

Patrick Lau

Patrick Lau is a Sydney-based journalist who covers business, the environment and culture.

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