The Low Carbon Transition and Financial System Stability
The agreement of the climate negotiating parties in Paris in December 2015 (COP21) signaled the world's intent to decarbonize over the coming decades in order to keep the earth's average temperature increase below 2 degrees Celsius by mid century. A timely and smooth transition to a low carbon economy may be accomplished if businesses routinely disclose and manage carbon dioxide emissions subject to science based targets along with climate related financial risks and financial performance. Existing capital budgeting techniques can help create value sustainably by focusing on the opportunity costs of both financial capital and carbon dioxide thus improving the allocations of both financial and atmospheric capital. Business efforts in this area will be most effective if guided by supportive government policy. If the voluntary responses from businesses, consumers, investors and local policy makers fail to meet the science based deadline for carbon dioxide emission reduction, aggressive and globally enforced carbon pricing mechanisms and emissions restrictions may become necessary. To the extent the business community is unprepared for broad based climate policy intervention individual firm balance sheets may become impaired. In this case the greater likelihood of financial insolvencies in carbon intensive and related industries will challenge the stability of the global financial system. It is therefore imperative that the problem of financial institutions that are "too big to fail" be addressed expeditiously by reducing financial firms' holdings of high carbon assets.