The financial markets are double-edged swords in the battle against climate change. Until now, many commodities have been a huge part of the problem, but a new report shows that they can be part of the solution.
Fossil fuels have clearly contributed to global warming, but agricultural commodities such as palm oil, soybeans and livestock are major contributors, especially when produced in forests that have been slashed and burned. In a new report, federal regulators in the United States are recommending sweeping reforms on finance and production.
According to the authors, financial regulators, business leaders, and legislators around the world understand the urgency of global warming and climate change. The missing link, however, has been in the climate-related financial markets. Until the financial world stops subsidizing pollution, deforestation and inefficiency, climate action won’t reach critical mass fast enough.
It must be fair, but it must include all industries, and it must be effective in reducing emissions consistent with the Paris Agreement. This is the single most important step to manage climate risk through the appropriate allocation of capital.
That stark warning is the conclusion of a new report from the federal regulators in the United States. Managing Climate Risk In The U.S. Financial System is a new Report of the Climate-Related Market Risk Subcommittee, Market Risk Advisory Committee of the U.S. Commodity Futures Trading Commission. The powerful report will make it impossible for financial markets to ignore climate risks much longer. Embracing solutions, however, will not come fast enough.
According to the report, fair incentives encourage the efficient allocation of capital. Unfortunately, when it comes to financing climate risks, they are urgent and they are missing. Until this flaw is fixed, capital will flow in the wrong direction. This report reflects agreement around a set of fundamental principles beyond pricing carbon, such as the need for collaboration with international efforts to address climate-related financial market risk.
Agriculture, for example, is directly dependent on weather and uniquely exposed to weather risk. While farmers have coped with weather variability since the advent of agriculture, these changes have already begun to affect agriculture in the United States and globally and will continue to do so in proportion to the amount of warming experienced over the coming decades and centuries. There is a general consensus that crop yields are likely to decline unless improvements in agricultural technology can keep pace with weather-related stress, including drought, floods and extreme temperatures.
No discussion of climate-related financial risk management can begin without focusing on this market failure. Financial markets do an amazing job of allocating capital in the direction of the incentives that they are given. Appropriate incentives arise in these markets primarily from the prices that balance supply and demand for capital.
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