Municipal Markets

BY Chris Hamel, Senior Fellow, Municipal Market Analytics

Financial Markets Transition to Carbon-Free Economy Because “The Equation Doesn’t Work”

“As the race to net zero emissions accelerates, banks, insurers, and asset managers will need to ramp up climate risk assessments and set clear goals for reaching net zero in their financial emissions. A delayed and disorderly carbon transition would pose the greatest risk to financial firms, while a rapid, well-communicated and measurable transition would keep risks lower.”
BY Moody’s Investor Service, October 12, 2021
The nail in the coffin of the carbon economy will result less from left-wing activists, and more from the money center institutions that understand, or are forced to understand by regulator insistence, that their current long-term investment profile leaves them owning the uncertainty of climate change risk unless the world pivots to a more stable energy footing.
The US municipal market would be advised to make careful note of this market trend and Moody’s guidance.
Given municipal debt is secured by a tax or fee, albeit typically a very secure and enforceable one, on private economic activity, the reality of unabated climate change consequence and the transition away from the current carbon-based economy may meaningfully affect its performance.
Yet despite indications of a US economy in transition, analysis by MMA partner, risQ, data experts that model climate risk tied to CUSIP, concluded in a recent report covering a period of years and hundreds of thousands of municipal securities that there is “no evidence that event-based physical climate risk is being systematically ‘priced into’ the interest rate cost of debt for issuers.” (Note that risQ was recently acquired by Intercontinental Exchange Inc.)
Multiple recent news items provide specificity of the challenge to and transition of the private economy that Moody’s references and on which the performance of the municipal market depends:
  • From a report of Munich Re, the global insurance provider, The New York Times relayed that the industry tab last year for natural disasters related to climate change was $82 billion.
  • Some insurers have had enough of this-type risk and corresponding cost. The Times continued that AXA, the French insurance company, is organizing its competitors into a group called Net-Zero Insurance Alliance with the goal of collectively transitioning their insurance portfolios to net zero greenhouse gas emissions by 2050.
  • In a survey of 103 US mayors conducted by the US Conference of Mayors and reported by Bloomberg, over half consider electric vehicles the “most promising technology for reducing energy and carbon,” with similar support for the importance of technology relating to “low-energy buildings.”
  • Also, according to Bloomberg, Arc Boat Co, a California start-up electric boat manufacturer “trying to do for watercraft what Tesla did for sedans,” has raised its initial capital with buyers already identified for the first of 25 models at a price tag of $300,000.
  • The State of California has had to create its California Fair Access to Insurance Requirements Plan to provide home fire insurance in the increasing instances where private insurers have ceased to provide the product given heightened fire risk, at least in part, a result of climate change.
  • Most recently, S&P Global announced its acquisition of a climate risk analytics firm with the tool that “quantifies climate risk” that delivers “outputs, including modeled transition risk and physical risk analysis presented in financial terms, … aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).”
Returning to Moody’s analysis, it estimates that “across the G-20, financial firms hold $22 trillion in loans and investments subject to carbon transfer risk. Green lending and investments will bring major commercial opportunities, to financial firms, but the credit impact of carbon transition will begin to hit home in the second half of this decade when scrutiny of their interim climate goals is likely to intensify.”
Moody’s take underpins the recent prediction by Bill Gates speaking at COP26 as reported by Axios that “30 years from now, some of those oil companies will be worth very little.”
The AXA CEO, Thomas Buberl, explained in his interview with The Times his strategic decision of moving away from insuring coal producers: “…as an insurer, you basically have two perspectives: ...the investment perspective and the underwriting perspective…the claims. Yes, investment in coal, …seems to be quite an isolated and attractive investment—but when you blend in the claims side, …the equation doesn’t work.”
“The equation doesn’t work.”
The US municipal market will encounter its form of this uncertainty and risk, and must prepare accordingly.
Christopher Hamel is a Senior Fellow with Municipal Market Analytics, Inc. A form of this article first appeared in an MMA publication.
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