Chapter 15 Investing for Value(s)

Key Takeaways

Based on Beeple’s artwork, modified by Professor Nerdster, free to distribute:-)

The short-summary is:

It’s the transition, stupid!
More detail:

Capitalism must solve the climate crisis, obviously, according to Carney. In this chapter, Carney is making a push to show how ESG ought to be used which aligns with his Glasgow COP26 work. This chapter is very much advocacy as he is the special envoy to the UN on climate finance.

The Rise and Rise of ESG

Carney lays out the trajectory for ESG. Just as GAAP (in the wake of crash of 1929) and as IFRS (following the 2008 credit crisis) imposed new standards in accounting, we now see increased pressure for companies to set out their sustainable development goals. Carney identifies a key challenge however, that there is a wide variety in methodologies in environmental, social and governance (ESG) and subjectivity is more prominent then in absolutes typical in accounting. Noting of course that accounting, too is subject to managerial influence. Hence, to shore up standardization, Carney is working on Glasgow COP26 ie. re-assert global standards for ESG. Glasgow COP26 is the next global conference, Paris 2015 was the last major conference. For Carney, the providers of capital such as pensions, banks and insurers will increasingly need more transparency, stipulate their investment horizons and clarify where they sit on the continuum of maximizing value for shareholders versus doing the same for stakeholders (who as stakeholders provide a positive feedback loop back to increased shareholder value in many instances anyway, according to Carney).

The Rise of ESG Historically:

It started with SRI (Socially Responsible Investing) in the 1960s. SRI screened for tobacco companies and apartheid in South Africa. ESG has broadened considerations:

Environmental Impacts

Climate change and Greenhouse Gas emissions
Air and water pollution
Biodiversity
Deforestation
Water scarcity
Waste management
Energy efficiency

Social Contributions

Customer satisfaction
Labour standards
Data protection and privacy
Human rights
Gender and diversity
Community Relations
Employee engagement

Governance and Management

Board composition
Whistleblower schemes
Audit committee structure
Political contributions
Bribery and corruption
Executive compensation
Lobbying

The Surge of Interest in Separating the Good Motives from Bad Execution

Modern ESG involves analyzing and investing in purpose-driven companies. In short, ESG is about having credible strategies while avoiding those that are part of the problem (gambling, firearms, deforestation, tobacco, fossil fuels) but also supporting “bad” companies and industries that are actually part of the solution, not just green washing (fronting that they care). Sustainably managed assets totaled $30 trillion at the start of 2018 and is now already at $100 trillion in 2020 according to Morningstar’s Hortense Bioy in August 2020. In addition, the UN’s Principal for Responsible Invest (PRI) have now been more widely supported which mandated ejecting member who don’t follow ESG principles. So there are now more serious consequences for green washing / fronting that they care.

How ESG can Guide Stakeholder Value Creation

a massive amount of ink in this chapter is dedicated to the technical deployment of a more rigorous version of ESG. The details are as follows:

Carney insists on looking at finance first impact investing, that is to say, “seeking to do well by doing good” (Value(s), 421) using ESG criteria to identify common factors that assist risk management and value creation BUT ALSO delivering superior financial returns;
‘Do well by doing good’ is about positive social or environmental benefits AND accretive financial returns;
With mandatory pensions, you can’t ‘vote with your feet’ but beneficiaries on socially responsible resolutions are possible;
As the CFA (charter financial analyst exams) trains you to identify a client’s risk appetite, it should also train you to prioritize non-financial appetites ie. ESG; Again, think John Kay, who says that the purpose of living is not to breath anymore then the purpose of business is to make a profit. Breathing and profits are necessary but not the purpose…;
Carney supports attempts to evaluate wooly environmental and social outcomes as rigorously as financial returns;

As such, Carney points to the Impact Management Project’s approach as detailed here

· Carney advocates a broad alignment between stakeholders and shareholders which occurs when purpose and competitive advantage of a company both depend on achieving a specific social or environmental value which Carney calls “Shared Value”;

Trade-Off versus Divine Coincidence

Some will trade a degree of financial returns to gain greater social returns while other seek divine coincidence which is what Carney is more interested in exploring in this chapter. Divine coincidence is a central bank / new Keynesian terms that suggests there is zero-tradeoff between stabilization of inflation and the stabilization of the welfare output gap. Divine coincidence approach of environmental outcomes and accretive returns that increase together. But what Carney is referring to regarding divine coincidence is more likely that doing well on ESG just so happens to mean doing well in terms of financial performance for factors obvious as well as less tangible (hard to draw causal links given complexity). Said another way, Carney’s thesis is that stakeholder values have a feedback loop that fuels the maximization of shareholder values. Carney wants explicitly calculated, reported and tracked social and environmental goods to be embedded in financial reporting…and its finally starting to happen through various international bodies: TCFD, FSB, Glasgow COP26, IFRS…..

Why ESG is so Lucrative or At Least Will Be…

Carney’s big persuasion push in this chapter is that purpose-driven companies tend to score on ESG metrics and also tend to outperform those that do not score well on ESG. Why? Possible explanations have to consider:

Superior management = superior ESG adherence = superior financial returns. Some ESG factors are more helpful financially than other ESG factors, the ones that are short-term could be overweighted and thus deliver shareholder value sooner, for example Wal-Mart has a logistics competency at its core and their carbon footprint is reduced which would align with divine coincidence;

Some ESG factors are more long-term. Some ESG factors are indirect contributors of competitiveness such as brand, social license which improve a company’s ability to attract and retain talent. For example, opposite to Wal-Mart, a company that protects endangered species but receives no direct reward might receive more or better job applicants as is the case with Patagonia for example;
The prospect of strong cashflows could explain why a ESG company trade at a premium in the case of Wal-Mart (controlling for other factors which is difficult empirically) and on social license in the case of Tesla (i.e investors and institutions bias towards cashflow metrics, managing what they can measure as Peter Drucker famously points out but social media darlings and rocket launches play into an aspiration mix that communicates both “it’s the transition, stupid!” and stock momentum)
Carney admits that ESG performance will not automatically translate into higher cash flows and that society’s values should not be determined exclusively by whether the stock market gives a company credit for helping achieve those ESG goals.
Somethings…money can’t buy but companies have massive impacts such as species loss or inequality according to Carney. The value in those cannot be captured by the firm and thus not translated into the price of the company.
As Albert Einstein said “not everything that counts can be counted, and not everything that can be counted counts.” Carney notes that there is are a lot of different methodologies to decide what should count, and determine what society believes should be counted…..

Performance….Further Arguments for ESG

Sustainable investment strategies (divine coincidence) outperform traditional strategies, according to Carney. He points to a study by Causeway Capital’s Mozaffar Khan, George Serafeim of Harvard and Aason Yoon of Northwestern University which shows that activities that enforce better and material social and environmental value get you ‘Alpha’ ie outperformance relative to the market median of 3 to 6 percent annually.
Again, Carney references Divine Coincidence here. The researchers found that this may be a function of the positive ESG sentiment such as public sentiment momentum (ie. Tesla is the top example).
Public sentiment influences the value of corporate sustainability activities therefore the price paid for corporate sustainability and the investment returns of portfolios that consider ESG data is boosted by those sentiments.
Again, Carney acknowledges that ESG does not equal Alpha automatically. The formulaic application of ESG ratings or kitemarks are not enough. Also, that as more firms use ESG… “if ESG mainstreams, then overall market performance, risk-adjusted returns, should improve, but relative performance will not.” (Value(s), 427)
Broad societal improvements to workforce diversity and inclusion across the board won’t differentiate specific companies that have helped make it happen, except during the transition to a more equal and inclusive society. “These shifts will create ‘social alpha’ , or what people would colloquially refer to as progress.” (Value(s), 427).

Fiduciary Duty

Carney is making an appeal here to the idea that CFA (chartered financial analysts turned portfolio managers) should really include calculations and inputs on ESG. Investors must weight ESG factors to fulfil their fiduciary duty to those whom the money is being managed. To do that investors need:

1) clear objectives of an investment…ie. that we knew the value that our capital is bringing in terms of ESG.

2) understanding the divine coincidence between stakeholder and shareholder value….i.e what’s good for the abstract other will have intangible benefits for the investor and the client.

Carney argues that investors must consider maximizing their client’s welfare not simply financial results…Recent polls show that owners of capital care more than simply about profit and want ESG to be a factor to some degree. 50% of those surveyed by FCDO (Foreign, Commonwealth & Development Office) were interested in sustainable investment today or in the future….33% were willing to accept LOWER returns if they knew their investment made a difference to something they cared about. In pensions, OTPP (Ontario Teacher’s Pension Plan) and UK cancer researches want to exclude things like children in cages, tobacco companies even if these firms are very profitable

Carney proposes changing the definition of what constitutes fiduciary duty.

Also notes the success of Make My Money Matter in the UK which aims to get individual investors to express their views.

FSB – TCFD

Effective in June, 2021, 1,500 firms with a market cap of $17 trillion are now reporting against TCFD (Task Force on Climate-related Financial Disclosure from the Financial Stability Board of the G20) which was launched only 3 years ago. How do we get this to be accretive is being researched and more people are moving into ESG roles to support that analysis.

The Investing Ecosystem for Stakeholder Value Creation

Carney is basically saying, we need climate disclosure. This investment ecosystem is rapidly developing, evolving and confusing according to Carney. Here are the main actors to explain what the information they need is:

Companies that receive investments and put it to work on green initiatives or social projects get a weighting;
Investors that provide that capital to those companies to support these activities, they can pursue investment strategies that are traditional or ones that systematically do take into account ESG facotrs;
Stakeholders including employees, suppliers, customers and communities are wanting more transparency;
Governments and regulators that oversee the system, set the rules and address the systemic consequences of actions that companies and investors take. It is a superior solution IF the consequences are independent of any single human actor’s will; if the consequences and punishment are autonomous and objective then those punished will not seek to punish the regulator themselves. This is particularly applicable to good parenting, autonomous punishment works much better.

Problems with Disclosure

Obviously, investors have different weighting on each ESG factor because they may care about different factors differently to others, I might like fire arms for example. Reducing exposure to tail risks and improving returns are part of solution, but companies may shift away from social license and resilience to systematic shocks as memories fade (think about how SARS memories faded in the run-up to Covid). We just don’t know when the next pandemic, climate Minsky-moment or decline in social license (catastrophic global war perhaps) will or might happen.

Carney is betting that the stakeholders are going to push investors over time as these ideas that Carney is espousing are mainstreamed.

Trying to understand if he’s late to the party: this has been tried. Companies don’t do this. Impact accounting and ESG needs to be more transparent in their investment goals.

ESG seems to be a differentiator…but there will be push-back.

Information and Disclosure:

IASB and FASB and securities regulators will likely oversee disclosures.
There is the IAS39 for valuation of financial instruments and the IAS9 for expected losses on loans.
But sustainability reporting has the following:
GRI (Global Reporting Initiative),
SASB (Sustainability Accounting Standards Board),
And as mentioned prior, the TCFD (https://www.fsb-tcfd.org/) the Task Force on Climate-Related Disclosures…is another group pushing for ESG disclosures as mandatory.
Social media to scientific analysis informs the view of public expectations…in the case of social media I hope not considering social media is not representative of public opinion.
There are competing interests per topic and opinion will vary over time but those opinions all should matter, according to Carney.

There has been a major attempt to consolidate by the big four (Deloitte, PwC, EY and KPMG) to develop a corporate reporting framework that has agreed standards with the GRI, SASB and TCFD metrics. The metrics are as follows:

1) Core metrics: 22 well-established metrics and reporting requirements, there are quantitative and obtained with some effort and time;

2) Expanded metrics: 34 metrics which are less well established which convey a wider supply chain scope. These metrics are more advanced ways of communicating sustainable value creation.

Impact Management Project (IMP): is building a framework on: What is already reflected in financial accounts (IASB);

§ Information material for enterprise value creation (SASB);

§ Information for sustainable development (GRI);

Integrated Reporting: developed in 2013 to explain the value creation incrementally of human, intellectual, manufacturer, social and natural capital.

The European Union has been leading on non-financial through something imaginatively called “Non-Financial Reporting Directive” (NFRD)

There are three major approaches to using ESG by investors

1. Ratings based Approach
2. Fundamental value where raw ESG data is analyzed in an integrated assessment;
Or
3. Impact assessments

[1] Ratings Based Approach

in this approach the investor outsources the assessments to ESG data providers how have their own methodologies for objective and subjective data and then create a comprehensive indices.

There is a lot of self-reporting and surveys can be gamed;
Ratings system data may vary and therefore data vendors will have wildly different scores;
The correlation between 6 different ESG rating companies was only 0.46 in other words only about half the time did they get close to the same rating;
The more profitable a firm the lower the ESG discrepancy so there is hope that energy and time can avoid inaccurate ESG reporting;
Governance metrics were the weakest at 0.19. In other words only about 1/5 of the time did the 6 different rating firms score similarly;
Disagreement are increasing in 2019. Berg, Koelbel and Rigobon showed that there are three primary drivers of difference in reporting: 1) measurement (what metrics are being used), 2) differences in scope (what attributes are being used), 3) weighting (the level of materiality the ratings vendor ascribes to a given attribute).
Different ESG outcomes mean ultimately different values.
Carney argues the rating approach is simply too subjective. It is not straightforward to value the outcomes that a given investor values. Improvements will come but ultimately, this is subjective.
Carney reiterates that sustained practice of a virtuous goal of value creation is essential.

[2] Fundamental Sustainable Value

in this approach, rather then ratings based approaches, investors have access to the raw tools. The data is usually publicly available data (social media, NGOs, company website, company filings) and then disseminated systematically. Examples are:

HIS Markit;
Refinitiv;
Bloomberg.

The end user determines the materiality. This approach is akin to fundamental analysis in the Equity Research field in which the expert is providing a final investment decision by analyzing company performance, building a financial model that provides a homebrewed answer to the company’s intrinsic value…..and then trading accordingly.

As part of fundamental sustainable value, there is a growing emphasis on Shared-Value. Shared-Value reinforces:

(1) creating innovative products that solve a social need,
(2) enhancing productivity in supply and value chains,
(3) investing to improve the industry cluster where the business is based…

Carney is supportive of this approach because of the complex changes and having someone at the wheel. However, companies are the leaders at conveying their ESG strategy and this is still going to lead to a lack of standardization. Carney admits that there is a significant risk that this is about branding over substance….

[3] Impact, Monetization and Value

This approach looks at the financial AND social contributions. They seek to measure social impact. This approach uses:

IFC Operating Principles,
Impact Management Project Dimensions of Impact,
And Global Impact Investing Network’s GIIN’s IRIS+ metrics,
1/3 of FTSE100 companies already do this IMV….

Impact monetization puts prices on the impacts. The calculations are sometimes easy like: how many solar panels sold minus production costs? While it’s social impact includes solar arrays installed in a house and the array is known to replace CO2 emissions by $17 therefore the monetary impact of this solar panel company is X. But some investors might place a higher value on CO2 creation averted or that the value factor of CO2 will rise which is a value judgement in and of itself. For example, Canada uses it’s carbon price path of $170CAD per ton….

The Serafiem/Cohen Impact Measurement Model asks that you compare the total environmental cost of 1,800 company. You could find 2 chemical companies with sales of $12B each but one created environmental damage of $17B and the other only $4B.

These are the same problems with having to calculate the value of Amazon.com and the actual Amazon. There are some many factors that aren’t measured.
Calculating the impact value of moving from fossil fuels to renewable power generation requires looking at the different estimates of the diminishing marginal utility of impact….
Ranges and sensitivity analysis are useful here but Carney warns that false precision could set in.
The danger in Impact, Monetization Analysis is that the analysts will become disconnected from the raw data and develop a sense of false precision that cannot be validated since it is subjectively derived.
Aggregating the nuance, it will basically create an obsession with that one number much like a stock price itself.

Securing Climate Impact

The Transition to Net Zero…Carney believes that the evidence points to a need to shift toward green solutions in order to prevent exceeding the 2 degrees Celcius consensus from the Paris agreement which will unleash a feedback loop that is irrevocable.
Since climate transition is an imperative of climate physics and chemistry, it’s obvious that this demand for change is going to go mainstream, therefore jump on the wagon. Engineers and politicians see it.
Companies are increasingly being as whether they are doing their part or whether they will be crushed and become “climate roadkill” (Value(s), 449).
25 countries already of a Net Zero plan….Carney believes that harnessing finance is critical to make this happen. Every financial decision- should take climate change into account in that decision-making.

There are ways to evaluate the providers of capital:

What percentage of companies we invest in have a net-zero transition plan in mind?
What percentage of the portfolio is net-zero aligned?
What percentage deviation from the target is a given company?
What degree of the portfolio is actually warming: how much emissions is this particular company generating? GPIF, AXA and Allianz volunteer this information

Carney works at Brookfields to try to create net-zero as an asset class….

Social Purposes of Investing:

William Blake “Know your values rather than be enslaved by those of another.” Carney concludes that we ought to measure if the impact is achieved! Carney does not believe that investor should able to put companies into ethical blind pools of ESG collateral….. Creating value for all means measuring that value. That is what this chapter has been about.

Previous Chapter

Next Chapter

Introduction: Humanity Distilled	Chapter 1 Objective Value
Chapter 2 Subjective Value	Chapter 3 Money & Gold
Chapter 4 Magna Carta	Chapter 5 Future of Money
Chapter 6 Market Society	Chapter 7 Financial Crisis
Chapter 8 Safer Finance	Chapter 9 Covid Crisis
Chapter 10 Covid Recovery	Chapter 11 Climate Crisis
Chapter 12 Climate Horizon	Chapter 13 Your Values
Chapter 14 Values in Companies	Chapter 15 ESG

Analysis Part 3 Chapter 15

Ø Theory (8/10) versus practice (6/10). In theory, something works but in practice, operationally, that something might not work. Executives are interested in the next 2 to 5 years. As Tetlock showed in his master work Superforecasting, our predictions get very hazy past 5 years. Therefore, executives and others will continue to ignore climate physics in the short-run and point to correlative speculation when weather events are more and more extreme. It’s sad but true. Shareholders are wolves too! Carney does not address the counter-arguments sufficiently here.

Ø AMEE.co.uk in the 2000s and mid-2010s attempted to create a systematic ESG metric that is more than a value add but is mainstream, but then they pivoted to supply chain risk because of the greenwashing effect. Self reporting is one problem, there is the tacit consent challenge. The classic criticism of anyone who supports climate change initiatives is that their intentions are conspiratorial and self-interested at a proportion nearing 100%. I don’t think Mark Carney is looking to enrich himself because climate change is not in fact a serious threat, he may enrich himself somewhat because he is creating value by raising climate finance into the mainstream and it is the right thing to do.

Ø Carney says the investing ecosystem is rapidly evolving, but what is the massive sample size data on that? I’m not talking about a survey which is about as reliable as polling data about Donald Trump. “Yes of course I care about the environment!” Yes, this topic is trending because it aligns capital with solutions to climate change, but the financial sector still has a streak of strategic gambling and as such there will be a strong counter-argument / hedge against ESG as not that accretive after-all. Hard to predict the future but Carney is making an aspiration case, this is how it WILL play out which he’s betting will have a self-fulfilling impact. But as I have argued, I don’t think most people will be reading Value(s) in the way he entirely wants. It’s too lengthy, too academic and should be distilled further to connect with the audience, hence I have provided these summaries….

Ø Carney thinks the Edmonton Oilers have the greatest player in the world and that cognitive error matters because there is no I in team. And his prediction that the Oilers would go all the way to the Stanley Cup in 2020-21 was dashed in the first round by the Winnipeg Jets! Now, you could read into Carney’s enthusiasm that he a) loves the Oilers which is fine, b) places to much emphasis on heroes and individual leaders…it takes a village to achieve great things: you have to lead with good talent of course, but also good strategy, supporters and meeting people where they are at to move them into the light. I think Carney does tend to invite people into his ivory tower and then expect to totally persuade by telling people the way he sees the world (based on being well cited).

Ø Carney may be violating his principal that the four most dangerous words in the English language (actually five words) “this time it is different” in this chapter. With ESG, he’s saying “this time it is different”. Social license has been around and doesn’t figure that prominently in the MBA programs of the world, unfortunately. I support the aspiration but measurement is going to be your Achilles heel as well as what motivates financiers who are an exclusive group regardless of some democratization of stock trading in recent years. Few bankers will agree with John Kay that breathing is to living as profit is to business…for bankers the only thing that matters is money and right now. They discount the value of money in the future for this reason.

Ø If Carney had more experience in the private sector, then he’d be aware that every detail that is public-facing is designed to present the firm in the best possible light….managerial accounting shows that A/R (accounts receivable) and A/P (accounts payable) accounting can and may be manipulated if there is shareholder pressure or the executives are playing to analysts.

Ø It’s interesting that Carney believes ratings vendors will never get rid of subjectivity. It’s self-evidently true but what if the ratings firms were rated as well. And that the consequences of their poor ratings were made clearer to the end users….or is the rating process too far removed from the companies themselves while the employees are loyal to their firm and thus consulting firms ought to march in there to provide this oversight?

Ø If Wealthsimple has an ESG ETF, then let’s see what GoodInvesting has to say about it. Tim Nash’s views.

Ø Carney has shown it is the crisis that triggers re-evaluations and gets political and social change. Therefore, climate events are a series of relatively small crises which are correlated to Greenhouse gas emissions but there are counter-narratives that dispute the causal link of the increases in the hurricane season in part to absolve polluting sectors of the economy (most of the product components). Known as “De nile” from Al Gore’s An Inconvenient Truth.

Ø Machievelli says that presenting to the public that you are lovable is better, but it is also essential that you be ruthless and feared. Does sustainable impact investing draw both actual supporters of the environment/human stability as well as self-interested posers? Yes. The ruthless and feared VW executives figured they could game the system…they are merely the folks that got caught…..

Ø G7 Finance Minister summit in June 2021 was unprecedented as they came together to commit to a 15% corporate tax minimum in all those jurisdictions UK, Canada, France, UK, Germany, Italy, EU, Japan. But of course, where there is a will, there is a consulting firm that will help these corporations maximize their after-tax profit (PwC, Deloitte, KPMG, EY).

Ø Carbon off-setting in theory is cool. In practice, it might be a bit challenging to imagine that the “books balance” in the intended manner of having 1 ton of carbon generated and corresponding additional tree that reduced 1 ton of carbon. The key is the additional tree planted wouldn’t have otherwise been planted, for example…because it was going to be planted anyway, then a carbon off-set, in this case, could be attributed to more then one off-setting attempt.

Ø Carney is advocating more people skill up for ESG. There were Masters degrees in environmental science (a decade ago while I was at LSE) that basically created an army of advocates without any significant job and career opportunities over the last decade (perhaps the economy was also screwed up…but…my point is well known). Just as those who studied Middle-Eastern politics in the wake of the Iraq war, those who studied environmentalism found that their skill is still not really taken seriously on its own. You need to be well-rounded, have strong fundamental understanding of things like accounting, finance, marketing, sales, mathematics, engineering or another marketable skills. That talent stack would, as a whole, get you in the doorway of a desired industry. Often, environmentalists I know would ironically become lawyers defending corporations in ways that padded their ESG optics, for example. So being jaded about ESG is informed by practical experience.

Ø Carney enters the political frame by stating that what society believes should be valued is X. He makes not systematic effort to evaluate what society wants himself. Hence, he needs to consider how citizens engage their own options and preferences.

Ø Carney doesn’t necessarily call out who the polluters are…he doesn’t put pen to paper to say that fossil fuel companies are the problem and could be part of the solution. And what to do about Alberta’s transition? Carney doesn’t talk about a way to help Albertans who have driven the Canadian economy forward in terms of GDP should be compensated…and or supported in retaining economic development locally against the back drop of the Rookie Mountains. Think about how Britain settled the slavery questions in 1834 by compensating the owners of slaves? Then think about how the US settled the slavery question between 1861 – 65? Oil is like slavery in some ways as I argued a decade ago.

Ø Carney as well as other advocates struggle with the fact that profit motives are the metric for success for companies (“you can’t [unfortunately for civil servants etc] manage what you can’t measure”} – Peter Drucker, therefore the creation of value and that the capture of that value in the form of money is THE primary driver. Whether it is the only driver is another matter. But I think a critic can be forgiven for thinking that it is naïve to think that this generation of C-suite decision-makers are mostly pre-occupied with the long-term impacts of the company at which they have climbed the ‘greasy hole’ to the top of. Really lucky and foolish CEOs have been incredibly successful merely because the things that we can measure about them keep appreciating in value…they keep hitting their targets. With ESG, you asking CEOs who may actually be hindering their business but are lucky that what is being measured is working (despite their own bad decision-making which can not be untangled for company performance)…you are asking the CEOs to stake their remaining career on something that cannot be measured in profit terms…

Ø Just because you can find a poll that shows ESG factors are valued by consumers of large asset managers, doesn’t mean you aren’t leading the witness. The question is will we all buy in to the sacrifice and the benefits of the grand transition? I think that more and more people are making decisions with the environment being a variable, but we are poor systems-thinkers. Typically, you and I are going to spend our days being mindful (in the moment) which means we like the dopamine hit of doing carbon off-setting things but not if it gets in the way of amygdala. Also there is a wide spectrum of preferences. To assume that they all care about profits and or all care about ESG, why would that happen? Surely it’s a mix of incentives and motives. And even if there was a major climate catastrophe, it is not clear that polluters would stop polluting considering (they would certainly argue) that the damage has now been done (absolutism abound!), they would argue that the feedback loop of hyper temperature increases that Carney warns about is probably wrong because predicting the future even in climate physics is difficult and they would continue to burn energy to build things they were building just before said catastrophe just as post-Covid, we’re returning to offices because there are rents on that commercial real-estate and C-suite wants to get more value of the capital expenditure on the company’s income statement.

Ø IF THE INVESTOR SEES the consequence of their preferences then they will be shaped for the better. If Quebec felt the consequences of shutting down the oil sands directly then their behaviour would be modified. If the consequences of your behaviours are imposed by an autonomous system it is much better than if the consequences are imposed by other people (Ottawa, bureaucrats, etc); in that latter case, it will fell like a game: As per How to talk so little kids will listen.

Citations Worth Noting for Part 3: Chapter 15

Ø Tidal Wave of ESG, from David Beatty at Rotman.

Ø Hortense Bioy, ‘Sustainable Fund Flows Hit Record in Q2’, Morningstar, 4 August 2020.

Ø Hortense Bioy, ‘Do Sustainable Funds Beat their Rivals?’, Morningstar (June 2020).

Ø Michael E Porter, Goerge Serafeim and Mark Kramer, ‘Where ESG Fails’, Institutional Investor, 16 October 2019.

Ø Robert G Eccles and Svetlana Klimenko, ‘The Investor Revolution’, Harvard Business Review (May – June 2019), ‘The True Faces of Sustainable Investing: Busting Myths Around ESG Investors’, Morningstar (April 2019).

Ø UK Department for International Development, ‘Investing in a Better World: result of UK survey on Financing the SDGs’ (September 2019).

Ø Sarah Boseley, ‘Revealed: cancer scientists’ pensions invested in tobacco’, Guardian, 30 May 2016.

Ø Oliver Hart and Luigi Zingales, ‘Companies Should Maximize Shareholder Welfare Not Market value’, Journal of Law, Finance, and Accounting 2(2) (2017).

Ø ‘Dynamic Materiality: Measuring What Matters’, Truvalue Labs (January 2020).

Ø Dane Christensen, George Serafeim and Anwhere Sikochi.

Ø PwC, ‘Purpose and Impact in Sustainability Reporting’ (November 2019).

Ø ‘Fiduciary Duty in the 21^st: Final Report’, United Nations Environmental Programme Finance Initiative (2019).

Ø Florian Berg, Julian F. Kolbel and Roberto Rigobon, ‘Aggregated Confusion: The Divergence of ESG Ratings’, MIT Sloan School of Management Working Paper 5822-19 (May 2020).Ø https://yanalytics.org/research-insights/monetizing-impact

Business, Finance, Politics, Strategy

Citations

June 13, 2021 Professor Nerdster Leave a comment

Chapter 14: Values in Companies

Key Takeaways

Carney starts out with the history of companies as a concept and asks what is the purpose of companies? It is not simply to make a profit, but rather to create value which is only partly quantified in the form of profit. For Carney, purpose requires balancing dynamism, fairness(?), solidarity (with employees and community), sustainability (across generations) and responsibility.

As John Kay put it…“Profit is no more the purpose of business than breathing is the purpose of living.” And while you need to make a profit to operate just as you need to breath, it is not the purpose of business.

Who owns the company? Shareholders do not own the companies to which they hold stock, Carney argues.

Wedgwood as the Model of a Modern Major Capitalist:

What is the company for? Carney suggests it’s more than profits. Josiah Wedgwood is the example of a capitalist that made life better for customers by democratizing.
He was born as the industrial revolution was taking off.
He tracked 5,000 changes in experimentation to understand how to make the perfect pottery.
He was an abolitionist icon (ie. against slavery).
He built a town with amenities to support his growing factory.
He was an ardent economic nationalist, admits Ricardian Carney.

Five things that change us in a crisis;

1) Triggers a revaluation of what we value…

2) Triggers a shift in what we value…

3) Triggers an improvement in reporting…

4) Triggers cause resilience…

5) Triggers embed responsibility…

1^st for Carney, a crisis triggers a reevaluation of what we value. In prior chapters, Carney showed that the crisis was caused partly by:

· the underpricing in risk and the lack of supervising and off-loading responsibility to the wisdom of the market in Chapter 7’s breakdown of the Financial Crisis;

· the years of undervaluing resilience, with states failing to protect citizens despite ample warnings in Chapter 9’s breakdown during Covid;

· the tragedy of the commons where we aren’t pricing pollution as the producers problem (externality)

2^nd for Carney, a crisis changes our appraisal of value and values. Who benefits from these shifts? Shareholder, stakeholders are disrupted through change….

The Covid crisis caused:

· a reappraisal of value and values

· a reset by companies

· a social reset by countries

· accelerated move to e-commerce,

· accelerated shift to e-learning

· accelerated shift to e-health

· a reorientation of supply chains from ‘just-in-time’ to ‘just-in-case’

· greater consumer caution

· widespread financial restructuring (sees a stretched)

3^rd for Carney, crises are a catalyst for new reporting of systematic risk.

· 1929 Wall Street Crash (crazy speculation by everyday people using loan money) + Roosevelt’s New Deal = creation of the Securities and Exchange Commission to protect the investors and efficient markets. The SEC then also triggered the creation in 1936 of GAAP (generally accepted accounting principles) which became the global standard to ensure financial data could be reliably counted on.

· 2008 Financial Crisis = reporting for OTC derivatives, reduce the influence of shadow banking, new rules for securitization, accounting standards such as IFRS 9 was developed. IRFS includes what the expected losses are which provides more clarity.

· The Climate Crisis, Carney is (hoping?) to bring about TCFD for consistent, standardized disclosures on climate-related financial risk.

4^th for Carney, crises increased resilience, they make us tougher. Global banks have a buffer 10x the size prior. Trading has been reduced 1/2, interbank leading is declined 1/3^rd and cloistering of divisions within banks, with deep separation aims to prevent a systematic collapse.

Again, Carney argues the Climate Crisis has a valid target of net-zero. ¾ of the world’s coal reserves…

5^th for Carney, embedding responsibility. Having purpose, Carney suggests might have prevented the financial crisis. In the aftermath, regulations, rules and compensation provide the teeth for a better future.

The Firm As A Series of Contracts versus A Purpose-Driven Entity at the Heart of an Ecosystem:

Carney goes through the history of company formation. The coordination of employees, investors, suppliers, buyers. He notes that corporations are indeed people both legally and in reality. For Carney, the company is not the sum of a bunch of contracts, however.

Shareholder & Purpose:

East India Company (the 1^st publicly traded company in the UK) was incorporated with the purpose of protecting a monopoly in Asia. The concept of the shareholder was buy shares of a company with the agreement that that capital would be used to advance the purpose of the firm, a larger goal. But during the industrial revolution, in 1844, the UK government passed a law that allowed firms to be incorporated without an express purpose and it made registration much easier. By the 19^th century, the focus on public purpose shifted to private purpose.

Shareholder Primacy:

Ford Motor Company challenged the idea further when in 1916, there was a $112 million surplus on their balance sheet. Shareholders wanted a dividend but Henry Ford wanted to direct those profits into creating more innovation and to democratize cars for more people. The Michigan Supreme Court sided with shareholders but the amount doled out was much smaller through managerial discretion. This case Dodge v. Ford is central to the idea that shareholders own the company to which they hold shares. The UK Companies Act in 2006 and the Delaware Supreme Court in 2015 re-asserted that the purpose of ‘directors must make stockholder welfare their sole end.’ So, in the UK and the US, it is to maximize shareholder value. But there is disagreement, Wachtell, Lipton, Rosen & Katz LLP (WLRK) says shareholder primacy is not exactly what is going on….

Carney shows through legal examples in Canada and France that shareholder aren’t even owners of the company and thus the maxim of maximizing shareholder value is flawed. It is true that shareholders do get paid after everyone else: creditors, bond holders, employees, suppliers and governments via taxation both in the UK and the US. But employees cannot diversify their risk to a company as Martin Wolf has argued so shareholders may not really be taking the most risk, aren’t really owners and certainly a poor shareholder who put their life-savings in it is taking more risk than Warren Buffett in the owning of a given share of any company. Shareholders do not have much downside risk either. So, for Carney shareholder primacy is flawed.

The Agency Problem:

The separation of ownership of shareholders and control via the management which have their own self-interest (perks, pet projects, empire building) mixed in with meeting shareholder interests, triggered the Milton Friedman doctrine that:

a) an executive is an employee of the owners of the business;

b) the executive is responsible for maximizing shareholder value;

c) shareholders (probably want) profits therefore that is the value in question;

d) as long as the firm conforms to rules of society in terms of customs and law, they are good.

Carney sees Friedman’s ideas as useful but deeply flawed. Shareholder primacy is problematic and the proof is that Friedman gives himself an out in two ways:

1) saying that money making should conform to customers and laws of their day. As Carney has shown, values are subject to their time therefore, Friedman has an out when there is disembodiment between the market and shareholder. Friedman claims any charity to employees is merely window-dressing. But Carney has shown in this book that there are times where there is deep corrosion in financial markets.

2) saying that shareholders have primacy is flawed because shareholders merely have a ownership of the shares in a limited legal way. There is strain in how the wealthy treat the poor for example.

Companies have Command and Control Dynamics so Models from an Economist is a Matter of Degrees:

For Coase in The Nature of the Firm, the firm is defined by costs difference of providing goods and services through the market. Transactions in the market hold the costs of gathering information, bargaining and enforcement. These transactions bear costs that the firm saves but the expense is the span of control, complexity and diseconomies of scale. The activities performed more efficiently in a Command and Control system within the firm with the rest completed through the market.

Stakeholder Value:

Carney argues that instead of Shareholder Value there ought to be Stakeholder Value, which also happens to be the latest trend in business school literature. Profit is essential but it is not the only thing. Many CEOs reject the notion that there is a single purpose to a firm. For Carney, a successful firm must deliver a balance of competing interests amongst stakeholders (which Carney neglects to define), but this is analogue to the individual who pursues the good life. Competitive advantage, for Carney includes, having an attractive purpose as Chapter 15 will show.

Other Thoughts from Chapter 14:

· For a better tomorrow, we need companies that are motivated by profit and empowered through purpose;

· Profit and purpose are both necessary and re-enforce each other;

· Firms should embed purpose in what they do;

· Corporate purpose reduces risks, inspires employees, provides guidance in uncertainty and attracts and drives innovation;

· Non-financial metrics should matter even if they are notoriously hard to measure;

· The challenge falls with turning a purpose into practice (actions, outputs);

· Maximizing shareholder value (short-term) is not the sole aim of corporations, full stop;

· Environmental, Social and Governance (ESG) can contribute to profits and also purpose;

· The make-up of boards and their focus on purpose is critical;

· Board-level reforms need to include purpose-oriented reform;

· Patagonia, Unilever have institutionalized purpose;

· B Corp certification reward companies that meet social and environmental metrics;

· Danone is a company that embraces a enterprise a mission designation;

· Executive level compensation needs to be connected to ESG factors and needs to be re-configured to align incentives that are longer term;

· Companies need to consider future generations;

· Companies should be engaged in improving communities;

· Reporting is Key: two-way flow of information between stakeholders, shareholders and companies;

· Good and bad ideas need to be tested and then good ideas scaled, and bad thrown away;

· There is more and more evidence that suggest that companies that perform well on ESG also tend to have better financial performance, 63% report a positive co-variation, increased ESG leads to increased financial performance, Chapter 15 will address the counter-arguments.

· Employees who know their employers purpose also have better financial performance;

· Patagonia give 1% of its revenue and they get 9000 applicants per post as a result….;

Previous Chapter

Next Chapter

Introduction: Humanity Distilled	Chapter 1 Objective Value
Chapter 2 Subjective Value	Chapter 3 Money & Gold
Chapter 4 Magna Carta	Chapter 5 Future of Money
Chapter 6 Market Society	Chapter 7 Financial Crisis
Chapter 8 Safer Finance	Chapter 9 Covid Crisis
Chapter 10 Covid Recovery	Chapter 11 Climate Crisis
Chapter 12 Climate Horizon	Chapter 13 Your Values
Chapter 14 Values in Companies	Chapter 15 ESG

Analysis Part 3 Chapter 14

Ø Chapter’s message in a nutshell: You get more with honey then you do with vinegar, be nice and have better outcomes in good and bad times.

Ø The Covid crisis has accelerated a shift, but for how long? What is the reasonable band-width for which human’s recalibrate? Carney seems to be have a view that change is more permanent than might be believed by myself or others.

Ø “During the [Covid] crisis, we have acted as interdependent communities not independent individuals, with the values of economic dynamism and efficiency, joined by those of solidarity, fairness, responsibility and compassion.” (386, Value(s). This is not quite what is happening or happened or has it? Hard to measure? Are media stories representative of reality? How does Carney know from publications, statistical research or the people he hangs out with? People aren’t, pre-determined. There is speculation and sales in his statement; persuasive as it is.

Ø If Carney is so certain of the benefits of a crisis, then logically should triggering a crisis not be an aim of effecting change? From 9/11 to detonating a nuclear weapon in the Antarctic, causing a crisis is perhaps a logically implication of his breakdown of how the financial crisis has progressed financial technology forward. Carney seems to imply that all the Dodd-Frank legislation was a major success, whatever has been implemented deserves a thumbs up, however the process of providing new safe-guards was very contentious and as Obama points out in my blog post, it wasn’t always that great.

Ø An inverted view might be that the financial crisis brought on regulations that are a mixed bag of efficacy and punishment. Instead of weeding out the incompetent, regulations have caused a retrenchment of those most passionate about finance.

Ø Perhaps this will be addressed in Chapter 15, but how do you really objectively measure ESG performance? If the measures are game-able, they will be gamed, just a fun fact of human nature. Humans are cunning. Get used to it.

Ø Carney took the Patagonia “9,000” applications example in two funny ways. 1) that Patagonia didn’t plant this story as a PR stunt, 2) that Patagonia has those high number of applicants because of their purpose (single causation is flawed thinking or perhaps Carney is simply trying to persuade).

Ø Senator Elizabeth Warren’s 2018 proposed Accountable Capitalism Act requires directors in firms making more than $1 billion to ‘consider’ stakeholders, not simply shareholders, when making choices.

Citations Worth Noting for Part 3: Chapter 14:

v Andrea Sella, ‘Wedgwood’s Pyrometer’ Chemistry World, 19 December 2012.

v Derek Lidow, ‘How Steve Jobs Scores on Wedgwood Innovation Scale’, Forbes, 3 June 2019.

v US Securities and Exchange Commission, ‘What We Do’, 10 June 2013.

v John Kay, ‘Shareholders Think They Own the Company – They Are Wrong’, Financial Times, 11 November 2015.

v Martin Wolf, ‘Shareholders Alone Should Not Decide on AstraZeneca’, Financial Times, 9 May 2014.

v Lynn A Stout, ‘The Shareholder Value Myth’, Cornell Law Faculty Publications, Paper 771 (2013).

v John Kay, The Truth About markets: Their Genius, their Limits, their Follies (London: Penguin, 2003).

v https://bcorporation.net/

v https://www.blackrock.com/corporate/investors-relations/2018-larry-fink-ceo-letter

v Bank of England, HM Treasury and Financial Conduct Authority ‘Fiar and Effective Markets Review: Final Report’ (June 2015).

v Nell Derick Debevoise, ‘Why Patagonia Gets 9,000 Applications for an Opportunity to Join their Team’, Fortune, 25 February 2020.

v ‘The Business Case for Purpose’, Harvard Business Review Analytic Services Report (2015).v Marc Andreesen, ‘It’s Time to Build’, Andreessen Horowitz, 18 April 2020, https://a16z.com/2020/04/18/its-time-to-build/

Business

Value(s) by Mark Carney: Part 3 Reclaiming Your Values Chapter 13 Values-based Leadership: Key Takeaways / Analysis / Citations

June 13, 2021 Professor Nerdster Leave a comment

Part 3 Reclaiming Your Values

Chapter 13 Values-based Leadership

Key Takeaways

Talking about leadership is risky for Carney as a prospective Prime Minister-in-waiting in Canada. It opens him up to any gap between preaching and practicing in the future. There have been a lot of fools in finance that preached the “Great Moderation” who were proven rather wrong in 2008…Allan Greenspan who was Carney’s idol of sorts for example. Carney’s view is that values can be reasserted by describing what is required for leadership.

This time, things are different = the five most expensive words in the English language.

Leadership Models:

Carney walks us through the different leadership models. Max Weber (1864 – 1920), the grandfather of sociology and much of modern social science breaks leadership down into three discrete types

Charismatic
Traditional and
Legal-bureaucratic

And that’s a fine framework but not really important.

Other Points on Leadership

Authority is not leadership + institutional authority is not good enough over time without social approval from co-workers.
No one will accuse central bankers of being charismatic, Carney jokes. They are technocratic and exhibit legal-bureaucratic leadership.
Great Person theory ie. born with charisma and intelligence from Thomas Carlysle is bunk according to Carney.

Carney is an advocate of behavioural theories of leaders: leadership is a process not a gift. It is usually through observation and teaching.
Carney advocated participative leadership: encouraging experts to contribute to the decision-making. This enables tasks to connect to the group that must own the decision. If group members can see how their own actions connect to a higher purposes of the organization, employees will have more skin in the game.
For Carney, effective leadership is situational. The right person isn’t always there for the right time. Good leaders take stock of their followers.

Transactional versus Transformational Leaders:

Transactional leaders:

use rewards and punishments. This approach is most effective when the tasks are clear, repeatable and there is no ‘vision’ required.

Transformational leaders:

Achieve goals that both the leaders and followers are motivated to achieve as described by James MacGregor Burns (1918 – 2014). Bernard Bass (1925 – 2007) and Ronald Riggio build on Burns’ ideas with four components to transformational leadership:

Transformational leaders support intellectual stimulation that not only challenging the status quo but ask colleagues to be creative;
Transformation leaders support individualized consideration that keep communication open and feel free to share ideas, receive direct recognition for their contributions;
Transformational leaders have and share a clear vision for fulfill their goals.
Transformational leaders are a role-model that colleagues should emulate and support the leader’s ideals. They need to have EQ (popularized by Daniel Goleman) and IQ.

Carney talks about Machine Learning (ML) and Artificial Intelligence (ML). Machine Learning being useful for credit cards and anti-money laundering operations and many other applications and typically good if the future is expected to behave as the past (which includes the biases of the dataset). AI being “general purpose technology with widespread applications, whose productivity benefits depends on re-engineering processes to achieve a common purpose.” (349, Value(s)). For Carney, as well as University of Toronto scholars, AI is most useful as prediction machines that are better at modelling future events then any individual human might but it has many flaws. For example, hard to untangle how an AI model came to its conclusion on a particular circumstance which is not good for auditing purposes.

Leadership and the Crisis of Trust. Consent requires values-based leadership:

The crisis of trust is a crisis of leadership.
People have lost trust in experts.
Trust has declined in the government and journalism.
Shift of trust in family and friends over CEOs and bankers. EU was seen as a bureaucratic expert-led infrastructure…therefore, not to be trusted.
The MMR vaccine was falsely linked to autism in the Lancet which contributed to a mumps epidemic in 2005 in the UK.
Counterfactuals (which by definition do not happen) about preventable deaths during the COVID crisis, were taken as fact.
Focus on building critical thinking skills is increasingly important. News is increasingly acquired through social media which is driven by what can keep the user most addicted to staying social media.
Carney notes that Michael Gove went from the people ‘have had enough of experts’ to ‘follow the science’ as a minister in the Tory government.

Better trust = Better leadership. As Carney has stated several times now in this book that trust takes ages to build, moments to destroy and a long time to rebuild. Here is how it gets created:

1) Trust through Transparency:

Helps colleagues or citizens to see how and why a decision has been made. But Carney notes that transparency is an easy default with the risk of becoming white noise, or hard to understand with out a dictionary (academic language barriers creation) etc.

2) Trust through Factfulness:

Establishing the facts is critical as US Senator Moynihan famously said “You are entitled to your own opinion, you are not entitled to your own facts.” Fact checking is a new industry and distinguishing between marketing rhetoric and facts has also been hard to parse. Carney supports Facebook’s oversight board which is made up of Nobel laureate, constitutional law experts, a former prime minister of Denmark: And the board publishes the decisions, notably the media still interprets the decisions for clicks….

3) Trust through Acknowledging the Reality of Uncertainty:

Andre Gide famous saying “Trust those who seek the truth but doubt those who say they have found it.” Carney found it annoying that the Bank of England forecasts were being treated as facts by journalists even if it was explained that forecasts are cognitive exercises multiple times. The general public want certainty in their information, seek perfection, however the reality is that there is uncertainty, that scientists don’t actually have all the answers automatically and categorically on day one about COVID, for example. Carney advocated NOT professing false certainty but supporting a probabilistic approach such as the Bank of England’s MPC (Monetary Policy Committee). Carney believes that planning for Brexit was what established him as a solid leader: “we are prepared for this.”

4) Trust through Better Communication:

Carney believes in multiple layers of explanation as a critical tool at the Bank of England. They measure their communication with Flesch scores. Talking “jobs and prices” is more approachable for the general public than “inflation and employment”…too bad speaking clearly can remove the nuance. Value(s) the book would be much shorter but not as insightful, for example.

5) Trust through Staying in Your Lane:

Be comfortable delegating expertise, no all experts are leaders and follow your remit. With the Scottish referendum, Carney was obligated to provide some information regarding financial stability and fundamentals on the sovereignty question. Carney was very careful not to tread on the political side. The UK market expect Remain would win at 4/5^th 80%, Leave 1/5^th There are trade-offs in monetary policy particularly inflation controls that dampen employment. For Carney, it would have been political to not disclose that preparations were made for Brexit. There is merit in explaining limits to your expertise.

6) Trust through Listening to All Sides:

Even with all the facts laid out, there can be differences of opinion, of course. Engaging the wider community is key. As the chair of the FSB, Financial Stability Board, Carney was able to drive towards consensus even if there were competing views on where financial policy should be directed. He plans to provide that at the Glasgow Climate negotiations with 195 countries…

If you take the decision, people will love their best decisions and orphan their bad ones.

What Leaders Do:

Finding the right people
Setting the right priorities
Catalyze action.

First, finding the right people:

Christine Lagarde told Carney that as the head of the IMF, there was diversity geographically but that they had all had PhDs in economics from MIT. Bank of England to overhaul their hiring policy. Remote working like Stripe. Developing the right leaders, manage those who have different backgrounds, rigorous people. Create a culture of open debate, wide range of leaders so that when you have to make major decisions like in early March 2008, where Carney met other central bankers at the top of Basel, Switzerland’s BIS Tower, he was read to support the President of the ECB, Jean-Claude Trichet in providing liquidity $200 Billion in liquidity to the market…

Second, setting the right priorities:

You need to look at global and technological developments. Ambition must be for our own self-esteem, we need to be ambitious and seek to solve clients biggest problems.

Third, catalyze action:

Amazon’s approach of building and feeding a flywheel makes sense. Keep up the momentum which allows the leaders to get out of the way. Amazon had a structured decision making: focus, how does Amazon make decisions.

Amazon Meeting Structure:

A) Defining the purpose of the meeting…is it to make a decision, to brainstorm or to be debriefed? Should include who has to be informed at the end of the meeting, try to be as inclusive as possible.

B) Ensure that everyone who needs to have read the memo before hand has read it and take the 15 minutes to read it at the start of the meeting if necessary.

C) The memo ought to be no longer than 6 pages. Simple is harder than complex in writing a six-page note. Tell a linear story in the memo, do not be repetitive.

D) If you are the decision-maker take clear decisions and ensure follow-up.

E) The BoE had a problem that they pushed this approach. They wanted to improve the communication and be more inclusive.

People want to be empowered and they were practicing leadership. So allow followers and leaders to not be mutually exclusive.

Attributes of Values-Based Leadership:

Purpose: mission statements are helpful to bring on support. The Bank of England’s motto is “Promote the good of the people of the United Kingdom by maintaining monetary and financial stability.” The Bundesbank’s mission is “to protect the integrity of the Deutschmark.” Purpose is essential because it is strongly correlated with better performance. People want to work in a meaningful organization. You also need trust and integrity: if your stated purpose does not align with your actions then you will be in trouble as a leader. Leadership is “about acceptance of responsibility rather the assumption of power” (370, Value(s)).
Perspective: be able to see the periphery, the poorest people’s perspective is a very important standpoint. Leaders think of the marginalized: a) during the 2008 financial crisis, working poor lost their savings, b) the climate crisis will hit the current generation of children and their grandchildren the hardest, c) COVID hit the elderly, vulnerable and essential workers most. During the financial crisis, there were concerns that allowing reckless behavior would ensure future reckless behavior. The moral question of Ben Bernanke: “do you let the man who smoked in his bed die to teach him a lesson, or do you save him and put out the fire that could have spread to his neighbours’ houses and then reprimand him?”
Clarity: you need clarity of mind, meditation should be a daily activity for anyone who is serious about leadership according to Carney. You should seek to simplify the complicated. Speak with clarity as much as possible. Narratives / Story telling is the best way to means of connecting with audiences. Tim Geitner’s “Plan beats no plan” is coupled with Napolean “march towards the sound of gunfire.” Carney adds that “what beats a plan?…a plan that is well executed.” Macron’s zinger “make no mistake, there is no plan b because we do not have a planet b.”
Competence: Carney put the premium on making the right call: good judgement. Strategy is important but execution is paramount. You need to be adaptive. Leaders have to know when to shut-up as well…Kennedy read The Guns of August by Barbara Tuchman which explains why European nations were too focused on supply chains leading to the First World War and used that insight to resolve the Cuban missile crisis.
Humility: Mark Carney was the 118^th governor of the Bank of England. Westminster Abbey has many historical figures, Chaucer, Newton, Darwin, Pitt the Younger, Clement Atlee. There are no central bankers and few capitalists buried at Westminster Abbey. There are no ‘economists’ except Sidney and Beatrice Webb of LSE fame. There will be many governors of the Bank of England after Carney is gone. Good leaders have an ability to learn, don’t turn to writing books. It’s important to admit that you don’t understand something. Carney was more interested in US dollar than the subprime mortgages. He didn’t imagine different possibilities. We should be building an anti-fragile system rather than trying to prevent all major financial crises. A growth attitude is essential.

Key is to have purpose, perspective, clarity, competence. And humility.
Humility and confidence are needed. Don’t be constantly humble.
Real human progress is moral progress.
Virtues grow with muscles.

Ed Brooks at Oxford also says moral leadership:

1. Humility: intellectual limits

2. Humanity: solidarity.

3. Hope: our ambitions for our future.

Previous Chapter

Next Chapter

Introduction: Humanity Distilled	Chapter 1 Objective Value
Chapter 2 Subjective Value	Chapter 3 Money & Gold
Chapter 4 Magna Carta	Chapter 5 Future of Money
Chapter 6 Market Society	Chapter 7 Financial Crisis
Chapter 8 Safer Finance	Chapter 9 Covid Crisis
Chapter 10 Covid Recovery	Chapter 11 Climate Crisis
Chapter 12 Climate Horizon	Chapter 13 Your Values
Chapter 14 Values in Companies	Chapter 15 ESG

Analysis of Part 3: Chapter 13

Artificial Intelligence and Machine Learning discussions are noteworthy for the fact that they are pretty lossy goosey. Carney seems to conflate the two concepts and there is a lot of evidence to suggest that AI and ML are misconstrued marketing concepts in practice with very focused use cases. And that AI has seen a surge in discussion because it is a counter-argument against the then US president who was attempting economic nationalism to re-trench labour jobs that “AI would be wiping out anyway.” Carney does not distinguish but should between General AI and Narrow AI.
Carney spends very little time talking about how to quantify preferences and or when to lead and when to follow.
If critical thinking skills are so important, then why is university so expensive? Why not train high schools kids for the SAT, LSAT and GMAT tests which require logical reasoning and math?
Note that Carney points out Michael Gove’s about face regarding ‘following the science’ versus his rhetoric that the people ‘have had enough of experts’ (such as Mark Carney) in the campaign to leave the EU. First of all, follow the science has a spectrum of validity. Science is never truly settled on a topic because the pursuit of truth shows that theory can be over-turned. You can have scientists disagree vigorously precisely because there is no single scientific answer, but reasonably speaking IF the vast majority of scientists agree then it is de facto a law or settled science. Second of all, Carney shows his marketing short-comings, a catchy meme can travel far and wide, the people ‘ have had enough of experts’ was a marketing enticement to allocate votes to the Leave campaign when Carney was saying Brexit would have negative short-term financial effects.
Carney believes in listening to the wider community, but you do see that he is less beholden to them.
JFK questioned the advice of his team during the Cuban Missile Crisis…maybe because the Bay of Pigs was the most embarrassing military campaign ever.

Citations Worth Noting for Part 3: Chapter 13:

Ajay Agrawal, Joshua Gans and Avi Goldfarb, ‘The Simple Economics of Machine Intelligence’, Harvard Business Review (November 2016).
Philip V. Hodgson and Randall P. Whie, ‘Leadership, Learning, Ambiguity and Uncertainty and Their Significance to Dynamic Organizations’
Max Weber, The Theory of Social and Economic Organization (New York: Oxford University Press, 1947).
St Thomas University, ‘What is transactional leadership? Structure leads to results’, 25 November 2014.
Daniel Goleman, Emotional Intelligence: Why It Can Matter More than IQ (London: Bloomsbury, 1996).
Ronald E. Riggio, ‘Are You’re a Transformational Leader?’, Psychology Today, 24 March 2009.
Mark Carney, Opening Statement to the House of Lords Economics Affairs Committee. 19 April 2016.
Andre Gide, Ainsi soit-it ou Les jeux sont faits (Paris: Gallimard, 1952).
John C. Maxwell, The 21 Irrefutable Laws of Leadership (Nashville: Thomas Nelson Publishers, 1998).

Business, Finance, Politics

Value(s) by Mark Carney: Chapter 12 Breaking the Tragedy of the Horizon: Key Takeaways / Analysis / Citations

June 13, 2021 Professor Nerdster Leave a comment

Chapter 12 Breaking the Tragedy of the Horizon

Key Takeaways

One of James Carville’s Clinton ‘92 campaign slogans was “It’s the economy, stupid”. For Carney is “it’s the transition, stupid!” If you can get private financial institutions to truly back the transition then you can contribute to being a good custodian for generations to come. Carney’s work for Glasgow COP26 centres on organizing the plumbing for these financial institutions. In chapter 15, “Investing for Values” Carney explored this further. In this chapter, Carney argues that there are three technologies: 1) engineering, 2) political and 3) financial that need to be marshalled to address climate change.

Engineering Technology

Driving Scale and Innovation: There will need to be major improvements to these hard to change sectors. Very hard to outlaw fossil fuels (ie. decarbonize) which are cheap and do not have a large upfront CAPEX:

Zero-carbon economy, electricity today is 20% green and is projected to be 60% by 2060;

Energy creation needs to be moved to a 90% market share with a mix of wind and solar. To what extent do we electrify everything and do it with green electricity depends on storage and loading challenges since solar and wind are intermittent. And we need to look at power efficiency in products we use;
Global electricity has to increase 5x by 2050 and needs to be generated by renewables according to Carney;
In the UK, off-shore wind farms were expected to generate £140/MWh by 2025 back in 2013 but then in 2014, they revised the number to £107/MWh, in 2016 they revised it down to £57/MWh; In the US, $59/MWh is the cost of coal and now onshore wind-farms are at $26/MWh and solar is $37/MWh….cheaper then coal!

Electric Vehicles (EV)

Hard to reduce dependency on fossil fuels (again, the euphemism is “decarbonize”);
Use hydrogen for public transport;
Tax breaks for EV;
Build the infrastructure for electrical and hybrid vehicles;
Car companies build vehicles in 3 year cycles from planning to off the factory floor so planning for more EV now is critical, even if batteries and charging stations are a problem;
EV is not appropriate for long-haul trucks according to Carney;

Aviation and Shipping

Going to be very challenging to reduce dependence on fossil fuels (i.e. decarbonize);
Nothing is currently commercially viable according to Carney;
The cost of not using fossil fuels is $115 – $230 USD per ton in aviation and $150 – $350 USD per ton in shipping;

Industrial Sectors

Currently responsible for 32% or 17 GtCO2e annually, cement manufacturing, plastic, aluminum, chemical, fashion, furniture and home appliances. The consumption of energy is massive;

A lot of the green technology does not really exist yet;
There are four ways to reduce: use hydrogen (the product being H2O), electrifying processes, using biomass and carbon capture technology.

Carney places a lot of reliance on carbon capture and sequestration at the point of production which involved pumping CO2 emissions into a saline solution deep underground, which is theoretical since the cost of pumping CO2 under every factory around the world has not been fully explored or whether there would be a centralized CO2 pumping station for a given geography;
Carbon capture, use and storage (CCUS) are currently about 1% of renewable investments so this is not a hot market;
Direct air carbon capture and storage (DACCS) involves sucking CO2 out of the sky where CO2 is much more diffuse then at the point of production, and therefore the economics right now are between $40 – $400/ton if extrapolated from the small test plants currently testing this technology.

Political Technology

Setting the Right Goals. Carney argues that we need to understand the consequences of our preferences. But he also wants to convince you that his preferences are the best and you should follow him:

SDGs He isn’t talking about new means of engagement with the polity but rather focuses on the fact that nations will fall short by the end of the century, hence the need for Sustainable Development Goals (SDGs) which are part of the UN’s collaborative framework. There are 17 goals with 169 targets as part of the SDGs.
Nationally Determined Contributions (NDCs) are determined by each country and easily fall victim of the tragedy of the commons. At the Paris COP 15, the target that was agreed to was actually 2.8 degrees Celsius above pre-industrial levels by the end of the century.

Greta Thunberg and the societal response: Carney was impressed by her. He showed her the Bank of England’s gold reserves. At the UN Climate Action Summit in September 2019….
Thunberg said “You have stolen my dreams and my childhood with your empty words and yet I’m one of the lucky ones. People are suffering. People are dying. Entire ecosystems are collapsing. We are in the beginning of a mass extinction and all you can talk about is money and fairytales of eternal economic growth. How dare you!….We will not let you get away with this. Right here, right now is where we draw the line. The world is waking up and change is coming, whether you like it or not.”
There was a Global Climate Strike in 2019 with 7.6 million people in attendance in 185 countries…the media struggled to tall a compelling narrative, but the 6^th Mass Extinction is coming according to Carney.
Carney argues that revolutions happen abruptly as Cass Sunstein argues, when a tipping point is met, when it becomes socially acceptable (like wearing masks for example).
Values depend on consumer focuses.

Financial Technology to Ensure That Every Financial Decision Takes Climate Change Into Account

Carney argues that companies must take the race to net-zero seriously. For Carney, the financial system needs to take climate change into account, because that’s where the smart money is headed already. Firms can report their own climate disclosures. COP 26 in Glasgow is going to focus on the financial approach. There is money to be made in the transition. And Mark Carney argues that the smart money is turning green.

Harnessing the power of economics to effect change is the most sensible force for good, in Carney’s eyes.
Carney points out that the amount of money needed for the low-carbon shift is about $3.5 trillion in the energy sector per year and twice the rate currently invested in the energy sector….
Climate-resilient systems are needed at a cost of $90 trillion;
Carney argues that the private sector is more then money, we need their innovative drive that is incentivized towards net-zero;

Carney’s 3Rs, these are the three areas needed to make this work: reporting, risk, returns

Reporting: TCFD network: a solution by the market for the market which Carney forcefully argued didn’t work in the 2008 financial crisis….at any rate, their total assets under management is over $170 trillion which includes the largest banks, pension funds asset managers and insurers. The largest AUMs are asking to disclose their carbon footprint in line with the TCFD.

The metrics used are

Disclosure of risk, governance and strategy for climate change;
Consistent metrics across sectors;
Scenario analysis typical in financial modelling and equity research.

The disclosures cannot be static! They should be dynamic such that they reveal financial risks/opportunities. Ask the company to explain how they will reach net zero….

Regulatory Reporting

financial regulators input climate-related financial reporting in their roles.

At the Bank of England, Carney says the Prudential Supervisory Authority are a division of the bank with advice on how insurers should address climate change.
Make the TCFD reporting mandatory at the Federal/National level! IFRS and IOSOCO (which regulate securities) have to agree to make reporting standardized.

Risk Management

As mentioned in chapter 11, there are physical and transition risks. Climate change differs from most other risks in that:

Climate change is unprecedented as they have not fully happened yet;
Climate change is massively impactful in every country and globally;
Climate change is foreseeable right now using the scientific method;
Climate change requires action today for horizons in the future that we cannot be predict accurately.

The Bank of England has stress-tested the UK financial system for various climate pathways, scenarios. Climate stress tests about engaging the developers of the model in the contingencies and factors at play.

Returns

The creation of green and transition bonds is an important catalyst. Carney believes that helping companies moving from brown to green is a consultative practice. The typical best plans are as follows:

Defining a net-zero objective based on scope 1 (all direct emissions: fuel combustion etc), scope 2 (indirect emissions: electricity purchases) and scope 3 emissions (all other indirect emissions: end products).
Outlining clear milestones and metrics for senior management;
Board of Directors level governance;
Executive compensation based on meeting these metrics……

Green bonds will not be sufficient to pay for the green future. Value will be in identifying the transition. ESG are focused on the s and the g. Investor should be able to calculate the e net present value. “We need 50 shades of green.” (325, Value(s)). Needs to be able to get a sense of how serious a given company is at the senior management level. Embedding metrics in the motivation. The efficacy of transition plans.

Mark Carney says the UK should lead the climate change strategy in Glasgow….hence he is advising Boris Johnson.
Decarbonization is going to be a financially viable source of investment; if you are pulling carbon out of the process then the investment will come to you as an additional value proposition.
Buying offsets is opaque and only 98 million tons of CO2 were traded at a total market value at $295 million, there is no central market. There are no uniform carbon credits and there is a lot of friction so Carney argues for standardization…
The cost of the green tech is high for developing countries but it makes sense to provide that do developing countries as a value added services….how to capture that value once the developing country firm has that technology is not so clear.
Climate policies suffer that same challenge that central banks deal with: the temptation to lower interest rates over long-term stability of inflation. We want to prevent short-termism in finance and now on climate.
Short term costs are hard for politicians, there is a lack of credibility.
Political parties need to get broad support across the spectrum.
Specific climate polities should be looking at the economics. More transparent tracking of climate policies.
Governments should have sustainable growth committees. Carney wants to provide tools for the Bank of Canada and England decision making and targets. The idea is that market will allocate capital and then break the tragedy of the horizon.
Continued growth is not a fairy tale as Thunberg argued.
Policies should be focused on technological innovation.
Clear and consistent communications.
More likely that investment and returns will be made clear.
Policy makers and future costs of doing business need to be calculated and part of the solution.

Previous Chapter

Next Chapter

Introduction: Humanity Distilled	Chapter 1 Objective Value
Chapter 2 Subjective Value	Chapter 3 Money & Gold
Chapter 4 Magna Carta	Chapter 5 Future of Money
Chapter 6 Market Society	Chapter 7 Financial Crisis
Chapter 8 Safer Finance	Chapter 9 Covid Crisis
Chapter 10 Covid Recovery	Chapter 11 Climate Crisis
Chapter 12 Climate Horizon	Chapter 13 Your Values
Chapter 14 Values in Companies	Chapter 15 ESG

Analysis of Part 2 Chapter 12

Not clear that the private sector would want to take on the opportunity to meet net-zero BEFORE a large global catastrophe that is clearly caused by human-made climate change such that customers demand either the private sector have targets in place or the public sector enforces such practices. It will be a train-wreck to check every single companies manufacturing to ensure they have the carbon capture pipes operating properly. It is so easy to pollute. The fines must mark the cost of violating the rules far more prominent.
Ironically, what caused the financial crisis are the individual actors being disassociated with the system level. What Carney hopes is that this be flipped around with climate change. Suddenly, decisions should be made at the system level with a simple boiled down abstraction of 42 +/- 3 GigaTons of CO2 per year must be our pollution cap. However, there is another disassociation that must occur here; namely financial experts in urban centres, far away from the oil fields are talking about transition as if the oil companies are going to just love this whole ‘climate-change agenda’. The consequences of the model make short-term harm very real for the oil industry workers who enjoy their work. I don’t mean we’re wrong about climate change because oil workers might stand to lose economic opportunities due to an imposed legislative or imposed financial capital re-allocation away from fossil fuels, but slave owners in the US lost their economic future because of the threat of legislative decision-making, they were willing to go to war and die in the name of a moral wrong. So, we, including Carney, need to get serious about “Oil Country”.

“When Abraham Lincoln wanted to curb slavery, he was battling the entrenched interests of the Southern US states. Slavery was a moral wrong, but slavery was also central to the Southern US economy. ” – Professor Nerdster

Efforts to have a global corporate tax neglects to acknowledge that the best situation is where every other country is paying that tax but you have a loop hole.
Just because you can build something doesn’t mean you should. Do people want self-driving cars? Do people want to charge their cars? This is where regulation forces the issue.
Carney’s really skates on thin ice in this chapter because industrial processes rely mostly on energy to melt and shape the products that we enjoy, most items in your house have a carbon footprint that you never see but enjoy the fruits of, the cost to create that same product without generating CO2 is likely significant today. Bill Gates’s How to Avoid a Climate Disaster is pretty much explanation of how this complex set of problems can be solved. Many companies would not exist if it was illegal to pollute….This issue is where the rubber hits the road, unless there is total control of the means of production by some over-arching legal body, there will be an incentive to use fuel…let me think about this further. This is where manufacturing products on the moon becomes more attractive as CO2 there is additive….impractical in my life time but, you know….fun to think about.
With what power can Carney achieve having his preferences reflected in the world? What Carney and others are missing is the way to show the end user the consequence of their preferences. While people do tend to seek out like-minded people, and shun polarization, running for public office would be his best route….. What funding model do we have?
Carney seems to fail to acknowledge that what Greta Thunberg is ignoring is that the transition could be very painful and as such not materialize as she extrapolates it ought to. She is also a child, probably should be in school. The consequences of climate change are heavy in her mind, the consequences of transition aren’t thought out. Both are subjective, terribly difficult to predict and forecast…even with climate physics firmly in the corner of “2 degrees Celcius is a big deal…”
The global climate strike didn’t really move the needle, did it? Is that really how we measure sentiment on climate change being a mainstream concern?
Reporting has been tried before, startups were created to create a global standard but then failed; Amee.com. Companies do want to participate in green-washing but not so much on their own accord anything that undermines stakeholder value is a threat to the CEO’s job.
TCFD network: a solution by the market for the market….which Carney forcefully argued didn’t work in the 2008 financial crisis….
Self-interest trumps the interest of others. That’s what COVID illustrated. The self-interest of profit generation is so strong that you would wonder if Carney lives in a fantasy land…no, he just happens to be correct about the climate physics at play, may need more salesmanship.
You start to wonder if Carney is a heavyweight with all the details, annotations and facts but a lightweight with bandwidth of human nature between self-interest and self-lessness . Maybe he’s got an overly focused vantage point on reality. For example, take a pan for your kitchen. How much did that pan cost? Is it anti stick? $25CAD pan. Now why is that pan so cheap? The material supplier doesn’t have a carbon pollution tax right now. If you impose a carbon pollution plan on that manufacturer because they are in your legislative geography then another kitchen pan producer who doesn’t have that constraint will. Game theory! Learn it a weep. And there are way to game the system further. The temptation to lie about emissions is massive as Volkswagen did it. OPEC oil producers do it. So let’s be serious about human nature too! We are cheeky monkeys!

Citations Worth Noting for Part 2: Chapter 12

Ezra Klein, ‘How to decarbonize America’, The Ezra Klein Show, 27 August 2020.
Department of Energy and Climate Change, ‘Electricity Generation Costs’ (July 2013).
Energy Transitions Roadmap report version 1.5 (2020)
Goldman Sachs, ‘Carbonomics: Innovation, Deflation and Affordable De-carbonization’, Equality Research (October 2020).
Climate Action Tracker, ‘Warming Projections Global Update’ (December 2019)
Cass Sunstein, ‘How Change Happens’ podcast. London School of Economics Public Lecturers and Events, 14 January 2020.
Cass Sunstein, How Change Happens (MIT Press: Cambridge, MA, 2019).
UN Environment Programme, ‘Emissions Gap Report, 2019’ (26 November 2019).

Business, Finance

Value(s) by Mark Carney: Chapter 11 The Climate Crisis: Key Takeaways / Analysis / Citations

June 13, 2021 Professor Nerdster Leave a comment

Chapter 11 The Climate Crisis

Key Takeaways

For 11,000 years, the stable Holocene era has afforded humanity the playground to thrive. Now we have created the Anthropocene which is driven by human impacts on the planet. Carney does not go into any counter-arguments to say that the impact of human activity on the planet is correlated 1% with climate change or 99%…for him the data is conclusive. In the 1850s, the Industrial Revolution drove up global temperature averages by 0.07 degrees Celsius per decade. The planet’s average temperature is up by 1 degree Celsius since the 19th century.

Other climate changes noted

The oceans are 30% more acidic since the Industrial Revolution;
Sea levels have risen 20 centimeters in the last 100 years;
The 5th mass extinction has shifted to the 6th with extinctions at a rate that is a hundred times higher than an average from millions of years;
There has been a 70% drop in mammals, fish, birds, amphibians and reptiles since 1965, assuming evolution is not at play, although how do you define evolution?;

Now, market prices of assets are being impacted. Climate change is likely creating:

a. a feedback loop of rising sea levels,
b. massive human migration away from rising coastal sea levels,
c. extreme weather events that are damaging insured property,
d. More impaired assets on the balance sheets of companies,
e. A reduction work productivity with the lethal heatwaves,
f. Global conflict over scares resources,
g. collapse of coral reefs destroying the livelihood of 500 Million people and ¼ of all biodiversity,
h. Increased regime change,
i. Increased citizen unrest,
j. Increased spread of disease

In Kiribati, an island republic in the Central Pacific, large parts of the village Eita (above) have succumbed to flooding from the sea.

What is the cause?

Causes: Emissions

The UN’s Intergovernmental Panel on Climate Change (IPCC) has argued that there is a 95% chance that human activity is CAUSING the global warming / climate change. The release of GhGs (Greenhouse Gases) with the most problematic being CO2 which, during rapid industrialization and growth has meant that over 250 years, humans have burned ½ trillion tons of carbon. Trends suggest another ½ trillion could be released in the next 40 years…¾ of the warming impact of emissions is CO2, with the remainder being methane, nitrous oxide and fluorinated gases. Trees cannot carbon capture to rebalance. Temperature and CO2 emission move roughly together, therefore we know what the carbon budget ie. the amount of carbon dioxide that be released into the atmosphere before temperature thresholds are surpassed.

The planet as a system would accelerate into a dangerous feedback loop if average global temperatures go past 1.5 degrees Celsius. The IPCC predicts that if temperatures reach 2 degrees Celsius above pre-industrial levels then 1) sea levels could risk 10 centimeters, 2) ¼ of all people could experience severe heat waves, 3) coral reefs will die off almost completely… 4) permafrost could further unlock CO2 and methane accelerating the trends would blow the budget wide open.

622-02757722 © Masterfile Royalty Free Model Release: No Property Release: No Green Number 0 on White Background

Net Zero

Carney advocates a stabilization of temperatures at 1.5 degrees Celsius. above pre-industrial levels. To do that:

Emissions have to fall by a minimum of 8 percent for the next 2 decades….
We release about 42 +/- GigaTons of CO2 per year,
Planetary budget is 420 GigaTons of CO2 remaining before we hit 1.5 degrees Celsius and 1500 GigaTons of CO2 before we hit 2 degrees Celsius..

Children born in 2021 will have to generate ⅛ the amount of CO2 emissions compared to baby boomers into order stay on carbon budget of 420 GigaTons of CO2 remaining before we hit 2 degrees Celcisu. We need to reduce excess carbon from:

Industrial processes are 30%
Buildings 18%
Cars 17%
Energy generation 17%
Agriculture 10%

To reduce GhG, the solutions must

Change how we create energy (fossil fuels must shift to renewables);
Change energy usage (decarbonizing industrial processes, increased energy efficiency for buildings);
Increase the carbon capture, use and storage (and maybe terra forming, although Carney doesn’t mention this)….

Basically, we need to convert the creation of all industrial process to electric and then shift the source of electric from fossil fuels to renewables. The first step may appear impossible considering the amount of energy needed to manufacturer most items in our homes, however that’s what has to happen. Bill Gates details the technologies needed in his book “How to Solve the Climate Crisis.”

Geography of Emissions

most pollution is from cities. By region its:

China 28%,
Asia – Other 16%
USA 15%
EU-28 10%
India 7%,
Russia 5%,
Japan 4%,
Europe – Other 3%,
Africa 3%, Canada 2%, Australia 1%

The Consequence of Climate Change

How much do we value the future? The estimates of the costs of climate change and value of the sustainability contain many uncertainties that enable doubters. The GDP, employment and wage impacts are one way (a 25% reduction in GDP at the tipping point of 3 degree Celsius), the net present value of all future cashflows. What we really value such as the lives of species, livelihood adaptation, birth rate drop aren’t easily monetized.

How central bankers view climate change? There are two types of risk

physical risks
transition risks

Risk Type 1: Physical risks =

increased rate of climate and weather related events (storms, fires, floods). The underwriting risk shows that the entire livelihoods buckle as inflation adjusted losses have increased over 8x over the last few years.

Insurers are in the front line of climate change, beach houses aren’t getting insured at the prices they were 10 years ago.
The insurance sector is adjusting and pricing-in some climate change using various projected models, subject to re-writes like any other model…Carney feels that coupling “sophisticated forecasting, forward-looking capital regime and business models built around short-term coverage has left insurers relatively well placed to manage physical risks” (277, Value(s)).
Carney argues that there areas of the economy that will need a public backstop because insurance companies will not insure those areas between $250 Billion and $500 Billion on the US coastal property by 2100.
Insurers and reinsurers are expecting trouble, Lloyd’s of London has a 20cm assumption which coupled with a hurricane would cause Manhattan damage that is 30% more severe than Hurricane Sandy.
Coastal flooding is projected to rise by 50% by the end of this century.
Lethal heatwaves are projected to effect 1.2 billion people annually by 2050;
The Network for Greening the Financial System (NGFS) is an 80 central bank strong group that have created representative scenarios to show climate risks may evolve affecting the real and financial economies:
Hothouse earth shows that at 3 degrees Celsius, sea levels rise x cm and extreme weather events result in a 25% GDP loss by the end of the century.

Risk Type 2: Transitional Risk

The second category of costs of risk. The costs and opportunities are more apparent as the crsis worsens and impositions become more overarching:

There will be stranded assets

Tropical deforestation of palm oil, soy, cattle and timber is for commercial use 70% of the time.
Automotive industry that will, in Carney’s mind, be disrupted by electric vehicles, driverless vehicles and car-sharing services.
Coal producers have gone bankrupt in the US.
Demand and Supply Shocks: demand shocks affect consumption, investment, government spending and net exports in the GDP = C + I + G +(X – M). Demand shocks are short-term usually and therefore don’t effect the productivity of the economy. Supply shocks effect growth, the growth of labour supply, physical capital, human capital and natural capital and the degree of innovation in the economy. So the impact of climate change on GDP is very tough because the sample of prior shocks also contained policy adjustments …

Calculating the Impact of Climate Change on GDP

Feedback loops amplify quickly and suddenly (ice melting off of the antartica rapidly) and the north pole, it’s dynamic and not inherently predictable even if there is no human variable in the atmosphere itself (all chemistry, geology and hard sciences):
The relationship between GDP and temperature is not linear;
Do physical climate events actually have a negative effect or simply impact growth (feedback loops and bad social impacts);
The degree of adaptation and innovation to mitigate the impact of climate change could be much more significant (i.e humans turn a disaster into a strength leading to more prosperity due to new opportunities that are created).
Factors like the mass climate refugees which could be over 200 million people, the poorest being dislocated.
The 6^th Mass Extinction: the biodiversity that provides natural capital from the Amazon to the coral reefs will be effected.

For Carney, it is a big deal that the CEO of Shell (Sir Mark Moody-Stuart) says that the probabilities of climate change’s negative impact on humanity is 75% and acknowledges that despite that uncertainty in predicting climate change, Moody-Stuart through the course of his career made larger strategic bets with much lower probabilities…

Causes Incentives

For Carney, climate change is a ‘tragedy of the horizon.’ The worst impacts are beyond the life-span of the decision-makers of today. The horizon is beyond: the business cycle, political cycle and central bank cycles.

The horizon of central banks is 2 to 3 years.
The horizon of financial stability is about 10 years.
The horizon of political decision-making is about 4 years.

The benefits of mitigating greenhouse gases which stay in the atmosphere for centuries is massive, but for the people who don’t vote today, because they don’t exist yet. “Halving emissions over 30 years is easier than halving them in a decade.” (285, Value(s)) The welfare of future generations should not be discounted as heavily as the financial calculations typically demand.

S-Curve:

The rate of adoption of new technology has three phases; 1) research and development, 2) mass adoption, 3) maturity. The rate of S-Curve over the years has been accelerating. James Watt who invested the stem and in 1769 did not see coal over take peatmoss until 120 years later in the 1900s (technically, Watt died before see that development). So, technology to tackle climate change is emerging at quicker paces. The S-Curve needs a nudge from the market as well as the public sources of capital investment.

Tragedy of the Commons

The original example is the unregulated grazing rights on the common lands of Ireland and England in the 19^th century there was a negative externality in which a decision is taken which then effects others who aren’t party or even benefit from that decision, is taken. We, the consumer, and we the producer don’t pay for the CO2 emitted to produce most goods. Other examples:

1) Overfishing to the point at which that stock of fish is depleted (Cod on East Coast of Canada);
2) Deforestation to the point where the forest is spoiled (Easter Island…);
3) Commons grazing to the point where the land was destroyed…

Three solutions to the Tragedy of the Commons:

Pricing the externality: putting a price on carbon. This has only worked well in theory. There is a price of $15 per ton but you would need $50 to $100 per ton to meet the Paris Accord target…
Privatization of the public spheres: Public grazing lands in the UK to privatization however this created a wealth transfer to those who had the right to charge a fee.
Supply management by the community to cooperate or regulate the scarce resources there in. Popularized by Elinor Ostrom (1933 – 2012) as economic governance. Get political consensus with shared management.

Carney goes on to draw the analogy that COVID is like climate change, it is a global problem. But climate change has no boundaries at all. Now, there are echoes of Bretton Woods style nationalist self-interest, huge debts and new institutions to tackle climate change:

1992 – Rio Earth Summit; a good start..
1997 – COP (conference of the parties) 1 and 3 the Kyoto Protocol: Kyoto was flawed, didn’t have teeth, a more serious call to action;
2009 – COP15 the Copenhagen Accord flawed, advanced countries pledge financial flows to reduce emission in poorer countries;
2015 – COP21 the Paris Accord, more stakeholders, financial firms, turning the agreement into legislative objectives as the UK did (already a low emitter, but limited recycle programs and lots of trash in the streets)

Our political systems don’t overcome these items. True leaders are stewards of the system. Leadership is about being custodians.

Current Financial Sector

Financial markets aren’t really pricing in a carbon price transaction. There is a low urgency effort that will lead to hot house earth, according to Carney. Most financial energy numbers don’t use a price test for their carbon stress test of capital investment They usually use a static price. Their prices are well below the medium to get to zero. BP has $100 per ton in its internals. Only 4% of banks and insurers think these climate risks are being priced accurately. Only 16% used a dynamic price.

Transition Pathway Initiative (TPI) is a consortium of thirteen + five asset owners/managers that are trying to better understand the transition to low-carbon impacts investment strategies. They also launched the FTSE TPI (Climate Transition Index) to articulate who is on the right side of history in Carney’s mind. Investors are shifting capital away from hydrocarbon investments incrementally suggesting that they are pricing in a transition. In other words, the markets are responding to something akin to inevitability about a low-carbon economy. But these are strategic bets, it doesn’t mean they are certain. Moody’s “recently identified sixteen sectors with $3.7 trillion in debt with the greatest exposure to transition risk” (297, Value(s)).

§ For the Goldman Sachs, capital expenditure in oil and gas is being hindered by this transition of asset manager value in oil and gas. Major projects have been mitigated by 60% over the last five years, big oil is moving to big energy.
§ Portfolio managers are engaging and pulling down their oil and gas investment incrementally. Also, in part due to the collapse of prices.
§ Transition bonds. In the fullness of time, climate change will incentivize brown companies to raise capital for green innovation.
§ Carney argues we cannot diversify away from climate change.
§ For Carney he argues that we need financial markets to build a virtuous cycle, better pricing for investors and smoother transition.
§ Sustainable financial systems are being built and the next chapter discusses this in more detail.

Previous Chapter

Next Chapter

Introduction: Humanity Distilled	Chapter 1 Objective Value
Chapter 2 Subjective Value	Chapter 3 Money & Gold
Chapter 4 Magna Carta	Chapter 5 Future of Money
Chapter 6 Market Society	Chapter 7 Financial Crisis
Chapter 8 Safer Finance	Chapter 9 Covid Crisis
Chapter 10 Covid Recovery	Chapter 11 Climate Crisis
Chapter 12 Climate Horizon	Chapter 13 Your Values
Chapter 14 Values in Companies	Chapter 15 ESG

Analysis of Part 2 Chapter 11:

Sea level a big deal? Just how bad is this going over 2 degrees Celsius? It’s a prediction that seems likely and would result in actually cooking-up Earth, with accelerated feedback loop, to the point where the Antarctic ice sheet completely melts and we’d all have to learn to swim…We might even develop gills…..okay, that’s a stretch…how much of this is probable? The emotional crescendo of Al Gore’s An Inconvenient Truth was, in my view, showing major cities around the world being flooded by rising sea levels. This was the easiest and therefore, best way to illustrate the problem(s) which are myriad as Carney has tabulated in Chapter 11. But…..

Sea level estimates are being re-evaluated: There is one issue with this description of coastal flooding…it is not so probable as once thought. Carney seems to have ignored the claim that water levels would rise 20 feet i.e. 6 meters for that reason….I wasn’t sure why his book doesn’t mention this often quoted climate catastrophe? He doesn’t address it. I mean, 6-meters-of-water! was probably the most obvious and emotionally powerful visualization as to why climate change should be a concern…. Well, it turns out that it is not as probable in the next 100 years as once thought. Read this page to get the down-low: https://en.wikipedia.org/wiki/Sea_level_rise. According to latest projections from the IPCC 6th Assessment Report (2021); the sea level is predicted to rise by 2 – 3 meters if global warming is limited to 1.5 degrees Celsius, 2 – 6 meters at 2 degree Celsius and 19 – 22 meters at 5 degrees Celsius and that’s over the next 2000 years…..Hmm…confused yet? 2000 years as in 4021?…yes….So by 2050, there “will” be 50 million people under the water line using 2010 populations as a benchmark….The prediction of mass migration (1/2 billion people) is slightly overstated….
New research suggests that sea levels substantially lag Earth temperature changes, so the probability that sea level rising is a massive problem is much less the central / easy-to-understand threat of climate than originally thought.
We don’t trust our audience to get a concept quickly enough therefore we skirt the concept: science is a process of contestation, not an absolute truth system. New information changes old scientific models. The mass migration narrative we thought 15 years ago is not quite the consensus view in 2021. Of course, scientific consensus can change with new research, why is that a problem? I’ve noticed that the default assumption is that the general public is incapable of understanding that nuance….and or the threat that an opponent will exploit “changing” scientific consensus to suggest “X is a hoax!”, X being whatever a partisan wants to discredit for the time being, is greater than the benefit of being honest with people. Carney talks about this with regard to Bank of Canada forecasts being both a ‘certainty’ and obviously ‘not a certainty’….
Trust but verify | Calculate the sea level rise yourself: If you do your own calculation of the how much ice needs to melt off of land masses such as land glaciers on North America etc, Greenland and Antarctica, then doing so will help strengthen your understanding. In the case of the total ocean, there is an area of 361 million square kilometers that the new water would have to be evenly distributed on top of. There is 1.338 billion cubic kilometers of total water in the ocean that has to occupy 361 million square kilometers of Earth’s surface. The Antarctic Ice Sheet is 30 million cubic kilometers of ice, which could be added for a total of 1.368 billion kilometers. Depth = volume / length x width i.e. 30 million cubic kilometers / 361 million square kilometers is 0.083 km or 83 meters of additional water across the 361 sq km of ocean. Add 2.9 million cubic kilometers from Greenland and about 170,000 cubic km from mountain and other glacier formations…if you like but that would be a modest increase.
83 meters = 100% of Antarctica’s ice sheet has to melt: So take the 83 meter increase described above…that describes ALL the ice in the Antarctic melting which is more likely if human beings are idiotic (nuclear war, smog everywhere etc) or an extraterrestrial species from a Venus like home world invades and terra forms Earth to a warmer clime…. Even so, there is no where near enough ice on land to get to Waterworld levels, 83 meters = 272 feet….so don’t believe Hollywood, folks.

The level of flooding depicted above is not supported by the math behind how much land-based ice is presently on glaciers, Greenland and Antarctica,. So, yes emotionally, Water World (1996) made you care about the environment, but there is not enough ice on earth to flood as above…unless more water is introduced to Earth.

Sense checking the 6 meters concept: So anyway, there are a bunch of assumptions that are required to get that original 6 meters prediction that Al Gore was shocking us with….And here is an example calculation. Basically, a small portion of Antarctic needs to melt for the 6 meter increase to occur, ie 83 meters = 100% therefore 6 meters = 13.8% of the ice sheet to drop into the ocean…but again, IPCC believes that 13.8% of 30 million cubic kms which is 4.14 million cubic kms will take a really long time to melt, the point is it will with our current policies but we’re also talking beyond 2100. So that’s assuming we do nothing which is obviously not the case. Humanity will reach a goal of carbon reduction because current companies will find a way to cost save and there are trillion dollar companies yet to be founded that charge a fee for solving climate change….probably.
Bottom line on sea level right now: So if the IPCC report suggests that 1) ice melting will take a lot longer to have an effect than original thought, and 2) the planet has to warm by 5 degrees Celsius over a longer period of time, then the 6 meters isn’t probable (in our lifetimes or the lifetimes of most children born in the 2020s…). And by 2100, there will be multiple generations worrying about climate change so (gov’t & private) solutions will emerge ($$$$$$$).
Magicians pivot your attention: So anyway, scientists don’t know for sure but it’s safe to say that the sea level story is no longer the central concern, hence Mark Carney does not lay into it at all in Value(s). Now, it seems plausible that he doesn’t discuss sea level much because he doesn’t want to admit that science is not static or that governor of central bank can’t accurately predict the future because then you won’t trust him or the institution to generally do what’s right… Instead of admitting the truth that science is a journey, in order to persuade us to make personal sacrifices, Carney and others have put more emphasis has been put on the fact that there will be more flooding as humans demand more single-dwelling homes in flood plains….which takes us back to the problem of personal preferences and how the consequences of those preferences are distributed.
Smart money / market argument: Over the decade after An Inconvenient Truth (2006), most of the emphasis was on awareness coupled with government intervention. Stephane Dion in Canada led the Liberal Party to massive defeat in 2009, a campaign built on a Green Shift. Of course a myriad of variables determined that election which is why blaming the Green Shift is a political statement that Canadians “don’t really care about climate change” which obviously varies as an opinion per Canadian. Such is our complex voter preferences… However, the lesson taken there is that the idea that government and by extension the civil service and regulation are primary means of driving punitive costs to polluters has consistently been deemed suspect by a significant portion of smart-money folks.
Obama was hands off for example because of the coalition he had backing him and the legislative strategy he needed to implement. And in his biography, his mother knew that jobs were more important then environment for poor Indonesians that she worked with for years. Now, financial institutions, which enable the allocation of scarce capital, in as optimal a manner as possible, are being marshalled (by the general investment customer base) to more seriously address climate change + the general investment. Carney does not put the most devastating case forward because it gets harder and harder to know how that would play out in a complex eco-system such as our planet. But basically, after the sea levels rise 10 cm….10 cm or 20cm? So what? We were talking about 20 feet in 2006. Some of the claim by Al Gore on ocean level has since been reevaluated (as mentioned above)….websites are disappearing that used to contain claims of 6 meter sea level rises “guarantee”. So he has to combine weather with flooding to say Hurricane Sandy would have been 30% worse than it was from an insurance perspective. I feel so bad for insurance companies having increase their rates….not!
Reparations: Another point is that the Alberta conversation needs a better answer around some support system, although historically when a sector struggles we do not necessarily intervene, but with climate change, government is intervening to accelerate the transition . There are no easy answers there because living in minus 40 conditions in Edmonton becomes hard to fathom if the human capital with a green tech breakthrough can migrate to Silicon Valley with no dis-incentives.
Another question is: what if the scientists are wrong, again? How much punishment should allocated to their grandchildren for the oil & gas careers that are hindered unjustly in this hypothetical? That would be absurd of course but the climate physics is rock solid until new research uncovers better techniques and models as part of the scientific method. It’s an important philosophical question: what is the consequence of getting it wrong? What commitment can Carney truly make if he is wrong? And if / when climate change is mitigated through a combination of human ingenuity and sacrifice, there will be naysayers who point of that it was never real in the first place because all the bad things that were suggested did not transpire! Such is the elephant in the room of all data science: there is not parallel version of Earth where we can control for different approaches to climate change.
The Yeah But…a lot of the public still can’t connect this slow moving crisis to their lives, most people see this is a transitionary problem over decades and decades, predictions have been wrong and continue to be wrong, if saving humanity was so lucrative then why haven’t we paid to terra form the planet to prevent sea level rising: there is a funding problem: no one wants to pick up the cheque, where is the global fund to pay for these changes, you are asking people to suffer for an abstraction that isn’t flawlessly defined…
Carney fails to address the command economy advocacy imbedded in prescribing with science what every person’s carbon footprint ought to be. Here, there is no invisible hand, the government of the world is most equipped with providing each citizen with their responsibility. The counter by Carney is of course, seatbelts wouldn’t have been imposed without political and regulatory force. It is the use of that force that can spur innovation in concentrated points throughout the economy.
Putting a price on pollution is like putting a price on negative social media comments, the state is imposing a costs for doing something that perceived as bad but has some positive value and making the recipient hopefully tougher for criticism of their instagram post of a really delicious meal.
A general rule in life is to identify that if someone is claiming that there is a single cause to a problem, they are trying to convince you of something or sell you something. You are being persuaded into conformity of some kind, like you need to buy X to resolve the Y. A lot of people don’t actually like being talked down to…I’ve found…. The language problem of inexactness of human communication system (language) is slowly being overcome with PowerPoint, Film etc. This problem of debating cause versus correlation is best exemplified with climate change discussions. Human activity has caused climate change immediately sounds misleading because the “climate is always changing” and how does one know to what degree “human activity” is causing climate change. Humans could be contributing 1% or 99% of the factors driving climate change, but some goof will point out that volcano contribution to disrupt the argument. For example, the counter argument that human activity is not causing climate change conflates causing with contributing. If someone says human activity is not contributing to climate change then that’s a sniff test for an intellectual dilettante. To prove that humanity is contributing to changes in the environment simply apply the counterfactual of the no-humans version of Earth. In that version of Earth, on this day, you would now be outside rather than in your home or office where you are reading this article. There would be no roads, etc etc. The very fact that this is obvious, proves that humans impact Earth in a significant way. And secondly, all those human tools and technology that we have been using requires heat energy to produce. That heat energy generates CO2 amongst other gases. So if any one says that humans do not contribute to climate change, they necessarily have to deny that absent humans there would be roads, houses mysteriously populating this no-humans version of Earth. In other words, it’s absurd.
Carney neglects to acknowledge that the research cited is subject to grants. If someone is obsessed with derivatives, then they will likely think derivatives are really important. They will have biases that warp their world to the point where their own brain notices patterns elsewhere that relate back to derivatives: this is selection bias. To not acknowledge that any human being, regardless of credentials is subject to the same confirmation and selection bias should they study climate change, is intellectually controlling. I suspect Carney knows there should be some doubt but he may not trust readers with this nuance.
Another interesting sense from this chapter is that Carney doesn’t have an entrepreneurial spirit really, if he did he would understand that extinction is a necessarily part of evolution. If the cause is human habitat encroachments which by definition is going to continue to happen, then we should be sympathetic. However, extinction is not by definition bad. Does anyone miss Pan-American Airlines? Does anyone miss the Dodo Bird? Of course, we all miss these things or would like to see them in the wild but such is life…Dodo Birds were definitely eaten to extinction but they also did not produce enough offspring. Life is cruel and unfair.
Measuring the acidity of the oceans: a 30% increase in acidity is significant if the acidity of the acid content is 1 -> 1.3 part per 100 but not if it is 1 0> 1.3 part per 1M….
Carney does not mention that there is an increase in human habitats such that extreme weather events like flash flooding are on the rise…in geographies where the events are newsworthy. An analogy might be that coverage of gun violence is only newsworthy when a random citizen is the victim rather than a gang related victim.
Carney does not address terra forming solutions accept for the socially accepted one: carbon capture which involves sucking carbon out of the air or releasing CO2 into the ground.
Carney basically tells readers to read Bill Gate’s How to Avoid A Climate Disaster. In other words, friends help friends.
Anyway, here are some of my wacky but fun ideas to address the most extreme consequences (such as the 6 meters ocean rise) which as I mentioned above is not that likely in the next 100 years:

Notice how any terra forming suggestions are met with derision as they are not a complete solution, not costed and/or seemingly enable current practices? People forget that things do take a long time to implement. People also tend to want a single causal variable to solve all the underlying problems because our brains organized to address single cause circumstances…..there is rarely a single bullet, and change is incremental (we can’t cram for solutions). We tend to need a business case as well.
If the 6 meters sea level rise is increasingly less likely, then we will continue to put off any wacky terra-forming ideas, and that’s less fun for me, but definitely not a major loss.

Citations Worth Noting for Part 2: Chapter 11:

‘What is Ocean Acidification’, PMEL Carbon Program.
IPCC, Special Report: Global Warming of 1.5 degree Celsius (2018).
Saul Griffith, Rewiring America, e-book (2020).
Stockholm Environment Institute, ‘Framing stranded asset risks in an age of disruption’ (March 2018).
Norman Myers, ‘Environmental Refugees: An Emergent Security Issue’, Oxford University (May 2005).
Sandra Batten, ‘Climate Change and the Macro-Economy – A Critical Review’, Bank of England Staff Working Paper No. 706 (January 2018).
IMF, ‘The Economics of Climate’ (December 2019).
Ryan Avent, ‘Greed is good isn’t it?’, American Spirit, 18 April 2020.

https://www.transitionpathwayinitiative.org/