If nations around the world follow through on commitments to limit climate change, fossil fuel companies could find themselves with a lot of "stranded assets" on their balance sheets.
Oil, gas and coal companies have pledged to spend trillions developing new fields and deposits in the next two decades. However, staying within a two-degree Celsius threshold for global warming means that we can burn only about a third of known reserves, various analyses have shown.
This mismatch between investment and official policy—what is meant by stranded assets—could spell trouble for both companies and markets alike according to a former senior official at the Bank of England. Paul Fisher, until recently deputy head of the U.K.’s Prudential Regulation Authority, says a sudden repricing of assets potentially creates "a systemic risk" and "could be the trigger for the next financial crisis."
The Bank of England set up the Prudential Regulation Authority in 2012 following the last financial crisis. Some market-watchers compare a mis-pricing of climate risks now with the mis-pricing of risk in the housing market in the run-up to the 2007/2008 meltdown. In that case, failing to appreciate that houses were less valuable if people couldn't pay their mortgages created a bubble that popped suddenly and violently.
Fisher compared the effect of climate change with the impact of Britain leaving the European Union, which has caused the pound to plummet in value recently. "That is exactly the sort of event you might get with climate change," he told an audience in Sydney, Australia.
Government policy is not the only risk climate change poses to financial markets, according to a report from Financial Stability Board (FSB), which oversees the integrity of the international financial system. First, extreme weather events could damage property and disrupt trade. Second, those harmed by climate change could seek compensation from companies that fail to properly outline climate risks to investors (the Securities and Exchange Commission has been pressurizing public companies to be more forthcoming). And finally, the transition to a lower-carbon economy could itself upset markets by altering the value of insurers and other companies.
"Once climate change becomes a defining issue for financial stability, it may already be too late," said Mark Carney, governor of the Bank of England, and chair of the FSB, in a speech last year.