Introduction to the Tragedy of the Horizons
The "Tragedy of the Horizons" speech, given by Mark Carney 10 years ago, is a landmark address in the realm of sustainable finance. It notably features the most cited line in all of sustainable finance and remains one of the clearest expositions on the materiality of climate change for the insurance and finance sector. Carney’s speech anticipated the emerging stresses from climate change to economies and financial markets, including the threat of insurance gaps, social risks from climate change, food security, and political shocks.
A Decade Later: The Horizon Has Arrived
A decade after the speech, it is striking to see how accurately it predicted the challenges we face today. The horizon Carney spoke of has arrived, and as he predicted, it is indeed a tragedy. The meekness of the proposed solutions in the face of such a significant issue is what stands out when reading the speech again. The speech introduced the concept of the Task Force on Climate-Related Financial Disclosures (TCFD) and suggested the need for climate stress tests. The core idea was to "manage what you measure," indicating that by measuring and disclosing climate-related risks, we could overcome the tragedy of the horizons.
The Limitations of Disclosure
While the TCFD and subsequent disclosure regimes have been steps in the right direction, the critique lies not with the idea of disclosure itself but with the limitation of focusing primarily on measurement. Disclosure is crucial, but it does not inherently change the behavior of financial institutions or companies. The data landscape has improved significantly, with more companies disclosing their climate-related risks. However, the problem persists because disclosure alone does not address the root issue of myopic financial sector behavior that prioritizes short-term gains over long-term sustainability.
Beyond Disclosure
To truly address the tragedy of the horizons, we need to look beyond disclosure. This requires a more profound transformation of the financial sector, including changes in incentives and regulatory frameworks. The vision should include building more systemic financial resilience in the private sector. There are several regulatory options and ideas that could help, such as mandatory climate business interruption insurance, rules limiting share buybacks, and mandating corporate rainy day funds. Additionally, financial incentives, like the reform of collateral requirements to take into account climate factors, could encourage more long-term investments.
Driving Long-Term Behavior
For the financial sector to become more long-term oriented, asset owners must drive this change. One potential approach is to break away from market-cap weighted benchmarks in favor of long-term benchmarks that consider heterogenous discount functions and different definitions of the "market." This could help reduce short-term incentives that currently dominate financial decision-making. Adjusting mandates to require minimum long-term investment research budgets is another mechanism to drive more long-term thinking.
Conclusion
The "Tragedy of the Horizons" speech was a call to action, highlighting the critical need for the financial sector to integrate long-term risks, particularly those associated with climate change. While progress has been made, especially in terms of disclosure, the underlying issue of myopia in the financial sector remains. To overcome this tragedy, we need a bolder vision that goes beyond measurement and disclosure, focusing on systemic changes that incentivize long-term behavior and resilience. This includes regulatory initiatives, changes in financial incentives, and a shift in how asset owners approach investments. Only through such comprehensive changes can we hope to mitigate the impacts of the tragedy of the horizons and build a more sustainable financial future.
