Ario Advisory                            FSUK0021

Written evidence submitted by Ario Advisory


  1. Ario Advisory is pleased to submit evidence to the EAC for this inquiry. We believe this inquiry can have a significant effect on accelerating the changes needed across the financial sector (and beyond), and so contribute to the UK’s net zero transition. Given the world’s current climate trajectory, every sector, globally, needs to accelerate their activity. Whilst the Committee will naturally focus on the UK, the global connectivity of finance will require a certain global perspective.


  1. Ario Advisory is a responsible investment advisory firm. Its Founder Director, an actuary, Mike Clark FIA, was Specialist Adviser to the EAC for the Committee’s 2018 Green Finance inquiry. We continue to work across the finance sector (investment, insurance, banking) together with financial regulators and policymakers to accelerate change. We have a strong focus on the financial risks (and beyond risks, uncertainties) arising from climate change. We note we were part of the working group facilitated by Aviva that developed what became GFANZ.


  1. The over-arching perspective we offer the EAC is that the management of societal risk (including opportunity) by government, which can be viewed through the lens of the SDGs (Sustainable Development Goals), is significantly divorced from the finance sector’s much narrower view, and therefore management, of risk. A short piece we authored early last year Government and its Chief Risk Officer role: an assessment – Actuaries for Transformational Change explores this issue. On climate change, this point is quietly made in the Bank of England’s October 2021 Climate Change Adaptation report:

The Committee may wish to explore whether the government has unrealistic expectations of the contribution the finance sector can make to the transition. Certainly, there is much activity in the finance sector. But the 29th June 2022 CCC Progress Report to Parliament states starkly: Tangible progress is lagging the policy ambition.” This is concerning.

  1. In the Committee’s Call for Evidence, many of the “following actions” listed for inquiry are highly dependent on government policy, both that of the UK government and internationally. Finance tends towards a global risk theology based on money. Government policy and the signals it sends set the rules of risk and opportunity under which finance operates. A new Cumbrian coal field, development of Cambo and other oil fields, the trade agreement with Australia - all signal a government less committed to its climate ambition than its political rhetoric.


  1. We encourage the Committee to review the work of the Bank of England’s CBES, Climate Biennial Exploratory Scenarios. Whilst a good start, we contend that 30-year economic climate scenario modelling deals poorly with volatility, risk, uncertainty and other relevant issues. Ario Advisory is co-convener of the RWCS (Real World Climate Scenarios) initiative, and we would be pleased to share a Note from our first roundtable if desired. The work of New Zealand’s XRB, External Reporting Board, on scenarios may be relevant to the Committee’s work.


  1. The fundamental point here is that it is very easy for “scenario” to translate rapidly into “modelling”. Modelling is what the finance sector does. Modelling is of course useful. But if some key climate change drivers are hard to model, we need caution in interpreting the modelling results. Mass migration, the next US President, a potential Minsky Moment in capital markets – these and other uncertainties are highly relevant. Good scenario work is often a set of “narratives”. Narratives eat modelling for breakfast, it is said. For example, we are aware of some 2014 scenario work in the insurance sector which considered an invasion of Ukraine by Russia. It can be hard for organizations to consider change/risk drivers that would upset their stakeholders. Which bank with a global reach, carrying out narrative scenario work, would be comfortable stating the negative consequences for climate policy that could arise if the previous US President was re-elected? Yet in considering the future, it would be unwise to ignore such a possibility, and its effect.


  1. We commend the work of the BEIS-funded EEIST initiative (the Economics of Energy Innovation System Transition) to the Committee. Not yet widely known, their new concept of ROA, Risk and Opportunity Analysis, is powerful. It seems to lead to separating economics into the narrow discipline of Allocation Economics and the richer field of Formation Economics. Formation Economics is a helpful frame for better climate energy – and we believe wider - policy formulation. We are working on how this approach can be brought into finance. A better understanding of cascading risks, and cascading opportunities such as the S-curves of new technology adoption, should help to accelerate the financial decision-making so clearly needed. And in the policy sphere we should question the role of the Ramsey formula in HMT’s Green Book. How useful is a discount rate in the context of climate change? We recall the Stern/Nordhaus debate of the mid-2000s on this issue. Are new economic policy tools needed? We believe so.


  1. This leads us to the view that the recent speech by the PRA’s CEO following the launch of the CBES results could be described as unintentional regulatory greenwashing. Given all the uncertainties of climate science, we are troubled by the regulatory confidence exhibited in that speech.


  1. It is clear to us that the excellent work of GFANZ needs to be supported by significant stimulus for accelerated action by its seven “children”: NZAOA, NZAMI, NZBA, NZIA etc. Each of these seven alliances is doing good work. But what processes can be built to assess each member of each of these alliances on that member’s progress against its pledges?

We recommend the Committee explores the existing assessment work and how this might accelerate and be formalised. Some assessments are carried out by third sector bodies, but these gain little traction. Unsurprisingly, they tend to identify slow progress. Generally, the public interest is but weakly represented at this point.



  1. We recommend the Committee forms a view on whether the insurance industry, in particular the members of NZIA, is dealing adequately with the tipping points of climate science (e.g. ice melt). It is naïve, in our view, to put too great reliance on the annual repricing practice in the general insurance industry. Insureds may become unable to pay the escalating premiums, and insurers to pay re-insurers those escalating premiums. That will lead to a growing proportion of assets being uninsured. Alternatively, government may decide to cap premiums. So the state, citizens, will subsidise private sector insurance contracts. Private sector capital will increasingly withdraw from underwriting commercially unattractive risks. This is not sustainable. Further, we need to ask if insurance underwriting relies too heavily on past data and the resulting modelling. Future climate tipping points will not be present in past data. EIOPA, the European Insurance and Occupational Pensions Authority, produced a helpful report on this issue last year entitled Impact Underwriting.


  1. Turning to banks, the Committee may wish to consider the following issue. The Treasury, we assume, is relying on the Bank of England (PRA) supervision of climate risks in the banking sector. However, it seems quite likely that in the coming years capital markets may experience a climate Minsky Moment, a market collapse brought about by a sudden realisation that climate risk was widely mispriced. Such a scenario may cause other risks to be viewed more cautiously, and repriced. In our view, there is a disconnect between what the science and political commitments (through UNFCCC/COPs) are telling us about the evolution of the earth’s temperature, and capital market pricing of climate risk. Should markets suddenly react to the reality of the environmental science, banks may decide, and herding, to reduce their balance sheet exposure to climate risk. However, they would likely find that market prices have “gapped” (experienced a discontinuity) and balance sheet resilience may be in doubt. The Treasury could find itself with a crisis that it had hoped BoE/PRA regulation and supervision would prevent. We remember 2008/09.


  1. Finally, we would like to draw attention to some recent work, and other issues, which may be relevant to the Committee’s work:


12.1 TPR (The Pensions Regulator) has recently completed some climate risk work with the IMF. TPR assisted the IMF in gathering data from UK pension funds as part of the IMF’s FSAP (Financial Sector Assessment Program). The IMF recently presented its findings at a TPR event, and the concept of a Minsky Moment was included as part of its findings.


12.2 DWP has considered whether the exercise of ownership rights by asset owners, such as pension funds, is inadequate. The DWP-sponsored TPSVI (Taskforce for Pension Scheme Voting Implementation) report spoke of investment managercomplacency” in this area. The Committee could consider the responses from investment management firms following the Minister for Pensions letter last year.

12.3 In our view, the fragmented nature of the UK pensions market hinders climate risk management. Whilst there are a good number of large schemes, there is a long tail of mid/smaller schemes. Some consolidation is occurring, but the modest amount of climate-competent executive resources is a worrying feature.

12.4 The Treasury’s Net Zero Review explicitly excluded the costs of adaptation from the Review’s terms of reference. This suggests a government that is not facing the reality of the fiscal challenge of climate change costs. We contributed to the OBR’s inclusion of climate change in the July 2021 Fiscal Risks Report.

12.5 The Committee might wish to go beyond mitigation (net zero) and adaptation (adjusting to the effects of climate change) and consider Loss and Damage, as defined by UNFCCC. Beyond the UK’s Net Zero commitment, the goals of the Paris Agreement recognise the need to meet the challenge of Loss and Damage. Can the finance sector, both in the UK and globally, make enough progress to help unblock the political logjam around Loss and Damage? The Glasgow Dialogue from COP26 is relevant here, and the Committee will be aware of the recent lack of progress at the Bonn Intersessional. At the June IFoA (Institute and Faculty of Actuaries) conference we presented: Loss and Damage – A Call to Action to Actuaries. That call can be extended to the whole finance sector, and we will be looking for opportunities to do that.


12.6 We encourage the Committee to be fully cognizant of the following issue. Decarbonization of investor portfolios may not be accompanied by a corresponding reduction in financed emissions. Decarbonization may indeed be very visible in some areas of investor portfolios. But financed emissions may still occur, having moved to areas under less scrutiny and assessment. Finance requires good public policy.

12.7 The Committee may wish to consider the political challenges around science-based guidelines. We hear of some pressure, for example, to include gas in the work of GTAG, the Green Taxonomy Advisory Group. More broadly, whilst the finance sector can make a major contribution to the transition, the Just Transition requires extensive government policy and its implementation to deliver the societal benefits.


  1. In conclusion, we encourage the Committee to inquire far and wide. As is well known, climate change is an existential threat to UK and indeed global citizens. The urgency we saw given to the crystallising risks of Covid and the Ukraine invasion is absent when it comes to climate action. Yet the risks of climate change dwarf both those. Finance can, and must, support the transition to net zero. Yet we must never forget that finance operates within the risk guardrails set by government, and non-financial regulation; finance takes the opportunities framed by government policy. Nature has been sending us climate invoices for years. Mostly, we have thrown them in the bin. Those unappealing costs have been incurred already. It is time to address how we share them equitably as we move forward.

We stand ready to support the Committee in any way we can in this important work.

Mike Clark

Founder Director

Ario Advisory

30 June 2022