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What Jamie Dimon’s letter says about Wall Street and climate risk

April 7, 2022

The JP Morgan chief’s annual missive sheds light on bank attitudes to transition risk, the low-carbon transition, and financial regulation

Two influential papers grabbed headlines this week. The first was, unsurprisingly, the latest installment of the Intergovernmental Panel on Climate Change’s (IPCC) sixth assessment report. The second was JP Morgan chief executive Jamie Dimon’s annual letter to shareholders.

The IPCC report provides an exhaustive account of current efforts to reduce emissions and stop global warming from spiraling beyond 1.5°C. It includes a whole chapter on the role of investment and finance in these efforts, and the implications for financial stability if an orderly low-carbon transition doesn’t take place. 

Dimon’s letter, meanwhile, offers a window into the mind of the leader of an institution that is both the largest member of the Net-Zero Banking Alliance (NZBA)and the biggest financier of the fossil fuel industry.

Reading them side-by-side reveals where climate scientists and Wall Street disagree on climate change and its associated risks, but also — somewhat surprisingly — where they share consensus.

Dimon’s letter covers a wide range of global issues, but touches on climate change a number of times. One particularly revealing section concerns the balancing of JP Morgan’s commitment to sustainability with the West’s need for energy security. Here, he makes clear that the bank will not be exiting fossil fuels anytime soon, even though it will be changing the mix of energy it supports:

“Constraining the flow of capital needed to produce and move fuels, especially as the war in Ukraine rages on, is a bad idea. The world still needs oil and natural gas today, but not all hydrocarbons are equal when it comes to their carbon footprint. We should be directing more capital toward less carbon-intensive fuel sources and investing in innovations, such as carbon capture and sequestration, as we look to transition to green technologies delivered at scale for society. Our company is firmly committed to helping finance these kinds of investments and expediting the use of lower-carbon fuels”

Earlier in the letter, Dimon says there needs to be “immediate approval for additional oil leases and gas pipelines” alongside support of green energy projects as part of this drive for energy security.

Contrast this to the IPCC report, which states that in order to avoid locking in emissions that are “incompatible with remaining carbon budgets” there has to be “a rapid scaling down of new fossil fuel-related investments, combined with a scaling up of financing to allow energy and infrastructure systems to transition.”

It goes on to say that by continuing to finance fossil fuels in contradiction of Paris Agreement-aligned emission pathways, financial institutions are exposing investors and asset owners “to the risk of standard assets” which could result from the “potential sharp strengthening [of] climate public policies.” 

This risk is clearly not front-of-mind for Dimon, or JP Morgan. Recent data from sustainability nonprofit Rainforest Action Network (RAN) shows that the bank provided $15.8 billion in financing to oil and gas companies that are expanding production, and $61.7 billion to fossil fuel companies overall, in 2021.

In fact, Dimon alludes to increased fossil fuel financing in a paragraph about efforts to cut emissions in the short term, for example by “minimizing fugitive methane emissions” and halting the flaring of natural gas:

“Immediately actionable opportunities like these might require more financing, not less, to reduce the short-term rate of climate change and prepare companies to thrive in a lower-carbon future” 

True, in the context of a science-based portfolio emissions reduction plan, there is room for targeted financing of fossil fuel companies. Recent guidance on transition plans published by the Climate Safe Lending Network (CSLN), a group of lenders and nonprofits focused on decarbonizing the banking sector, said firms should engage with those entities that have clear strategies aligned with 1.5°C pathways — but in the broader context of phasing out their overall financing of the fossil fuel industry. 

That Dimon does not say that his bank will phase out fossil fuels shows he’s not on the same page as the IPCC authors. Nor are JP Morgan’s oil and gas portfolio targets, which are based on the outdated Sustainable Development Scenario (SDS) from the International Energy Agency (IEA). This was effectively superseded by the IEA’s more stringent Net Zero by 2050 (NZE) pathway, published last year, which says that no investments in new fossil fuel projects are compatible with a 1.5°C pathway. Tellingly, under the SDS scenario, demand for natural gas increases in the 2020s. JP Morgan can therefore expand fossil fuel financing while claiming alignment with a Paris-aligned pathway by cleaving to this scenario.

How does this align with JP Morgan’s (and Dimon’s) commitment to the NZBA? Right now, the alliance does not demand that members phase out fossil fuel financing — it requires them to transition all their operational and financed emissions to net zero by 2050 instead. However, it also tells them to use “the best available scientific knowledge” to plot their transition. This should act as a ratchet mechanism that forces JP Morgan and its NZBA peers to periodically update their portfolio targets. Since the latest IPCC report (and through it the NZE pathway) unquestionably reflects “the best available scientific knowledge” today, Dimon may have to revise his support for new oil leases and pipelines, not to mention his bank’s growing fossil fuel portfolio, to stay true to the NZBA commitment.

Sprinkled throughout the IPCC report’s finance chapter are references to financial regulation. In one section, the authors explain that the “significant misalignment of investment and financing compared to pathways compatible with the Paris Agreement” is due to “misaligned policies” in several areas, including financial regulation. In another, they say that regulation could act as a “policy signal” that prompts investors to reallocate capital in support of climate goals.

Dimon’s letter also discusses regulation, albeit not in the context of climate change. He agrees that regulation can act as a policy signal, but often an incorrect one:

“Regulations have consequences, both intended and unintended — but many regulations are crafted with little regard for their interplay with other policies and their cumulative effect. As a result, regulations often are disconnected from their likely outcomes. This is particularly true when trying to determine what products and services will remain inside the regulatory system as opposed to those likely to move outside of it”

This suggests Dimon considers financial regulation to be a blunt instrument, and that attempts to use it to stamp out climate transition risks — for example, by discouraging banks from making fossil fuel investments — are unlikely to have the desired effect.

Indeed, Dimon believes regulators’ ability to affect lending and investing activities at all is overblown:

“Keep in mind that markets, not regulators, set capital requirements. If regulators set capital standards that are too high for banks to hold loans, then the markets will drive those loans outside of the banking system. There are also non-capital regulatory standards that can force activities out of the regulatory system, such as excessive reporting and social requirements, among others”

Dimon therefore presumably believes that hiking capital requirements for fossil fuel exposures would push oil, gas, and coal firms into the arms of unregulated shadow banks. Such entities would have no incentive to make their borrowers cut emissions, ultimately frustrating the low-carbon transition.

But Dimon’s doctrine is flawed. Markets may be amoral, but they are not always efficient. Nor do they always operate with perfect information. These axioms underpin the Task Force on Climate-related Financial Disclosures (TCFD), which was established to surface climate-related information that may have been hidden from the market before. The problem is the TCFD is voluntary. As the IPCC report explains: “disclosure requirements of risks and information in private settings remain mostly voluntary and difficult to implement.” 

This means that if markets do set capital requirements, then when it comes to climate risks these requirements are likely set too low, because they are operating with incomplete information. In the long run, this could lead to financial crashes and crises that wreak regulated and unregulated institutions alike. 

As mandatory climate disclosure requirements gather steam (as they are in the US through the Securities and Exchange Commission) this underpricing of climate risks may change. But this could take time — something the anthropocene is running out of. If it takes until the mid-2030s for markets to fully reflect the risks of ongoing fossil fuel investments, it will be too late to avert catastrophic warming.

In this context, it makes sense for financial regulation to step in and essentially ‘front-run’ the future, fully-informed pricing of climate risk. The alternative could be financial disaster. As the IPCC report notes:

“Indeed, if many enough financial actors have an incentive to downplay climate-related financial risk, then systemic risk builds up in the financial system eventually materialising for tax payers … While such type or risk may go undetected to standard market indicators for a while, it can materialise with a time delay, similarly to the developments observed in the run up of the 2008 financial crisis” 

Climate-related capital requirements that raise the price of climate risk today could do much to prevent this build-up. Such requirements can be put in place without knowing the exact financial toll climate risks could inflict, too. As the report states, the “challenges in quantifying the extent of climate risk … especially if risk is systemic, raise the question whether a combination of quantitative and qualitative restrictions on banks’ portfolios could be put in place to limit the build-up of climate risks.” Put another way, a ‘precautionary approach’ to climate-related financial regulation is justifiable given the scale of climate risk.

A final point of comparison between the IPCC and Dimon papers concerns the role of governments in spurring the low-carbon transition. Dimon calls for a new “Marshall Plan” to ensure energy security for the US and its allies, in which “governments should play a leadership role by enacting thoughtful policies that spur long-term and large-scale capital deployment for low-carbon solutions that create jobs and benefit the global economy.”

The IPCC report doesn’t disagree:

“In addition to indirect and direct subsidies, the public sector’s role in addressing market failures, barriers, provision of information, and risk sharing (equity, various forms of public guarantees) can encourage the efficient mobilisation of private sector finance”

This harmony of opinion reflects what Daniela Gabor, Professor of Economics and Macro-Finance at The University of the West of England, calls the hegemony of the “Wall Street Consensus” in climate finance. This consensus holds that global finance should be at the heart of the sustainable development process and should be driven by Wall Street virtues: fiscal discipline, central bank independence, and privatization. 

An essential policy tool of this consensus is the de-risking of climate-friendly investments by the public sector to insulate the private sector from losses.

Daniela Gabor @DanielaGaborthe latest @IPCC_CH report is out, and it provides new compelling evidence of the hegemony of #WallStreetConsensus Derisking paradigm in climate discussions April 4th 202251 Retweets118 Likes

From Dimon’s perch, it probably makes sense for governments to guarantee or insure some portion of private institutions’ investments if the goal is to have banks plow more finance into green projects. Lower the risk, and the public sector lowers the amount of capital firms like JP Morgan have to set aside against these investments. This in turn raises their return on equity and makes them attractive from a profitability standpoint.

This is the unspoken subtext of the NZBA and its sister organizations under the Glasgow Financial Alliance for Net Zero (GFANZ) too. In a statement published last November, GFANZ members said:

“To enable greater levels of private capital investment, countries need to create the right high-level, cross-cutting enabling environments. This will establish investment-friendly business environments; a replicable framework for deploying private capital investments; and pipelines of bankable investment opportunities. Private capital and investment will flow to these projects if governments and policymakers create the appropriate conditions”

However, for the public sector this may be a bad trade. Banks could pump funds into highly risky green projects — and ‘greenwashed’ projects — that then implode, saddling the taxpayer with losses. The de-risking approach could also make governments the arbiters of where the private sector focuses its firepower. If, say, the US government de-risks hydrogen-related projects but not wind power projects, then it’s likely more capital will flow to the former than the latter even accounting for their different economics and effectiveness supporting the low-carbon transition. 

What’s interesting is that the IPCC report recognizes the dangers of de-risking at the other side of the energy spectrum, in terms of the ongoing financing of fossil fuels:

“It is also the case that, even if at greater risk from stranded assets in the future, the large-scale financing of new fossil fuel projects by large global financial institutions rose significantly since 2016, because of perceived lower private risks and higher private returns in these investments and other factors than in alternative but perceived more risky low carbon investments”

One reason why fossil fuel projects are “perceived lower private risks”? Public subsidies. The authors assert with “high confidence” that: “Existing policy misalignments – for example in fossil fuel subsidies — undermine the credibility of public commitments, reduce perceived transition risks and limit financial sector action.”

It’s odd that the de-risking of green projects is presented as ‘good’ and the de-risking of fossil fuels as ‘bad’ in the IPCC report, when in both cases governments are subsidizing financial institutions and stoking moral hazard. It also exposes the contradictions in the “Wall Street Consensus”, which preaches market discipline while supporting the socialization of losses and privatization of profits.

Reading the two papers, it’s evident that the debate over climate-related financial risk remains a contested concept. But it also shows that in some areas, the financial sector and orthodox banking ideology have taken the reins.

As Gabor tweeted, “paragraph after paragraph, it [the IPCC report] deploys the language preferred by BlackRock and other carbon financiers”, of which JP Morgan — and Jamie Dimon — are a part.