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The future of finance is distributed, multiscale, and resilience-building
Geophysical and market-driven risks require active integration of complex non-financial value considerations into mainstream financial decision-making.
The future of finance will be less exploitative and better designed to generate sustainable value, inclusively. It will be distributed, multiscale, and resilience-building. We know this, because the raw math shows it must be so. Already the number of catastrophically costly events driven by climate destabilization has proliferated wildly. Most regions are now experiencing multiple overlapping major climate impacts on any given day.
In 2020, the U.S. Commodity Futures Trading Commission found that unchecked climate change would destabilize the financial system and undermine its ability to support the wider economy. In other words: climate change could cause the U.S. economy to fail in unprecedented, and possibly unrecoverable ways.
In 2021, the U.S. Financial Stability Oversight Council issued a similar finding. The report identified two broad categories of major risk to the financial system: physical risks and transition risks. It also mapped out a cycle of accelerating risk, in which:
Climate-related physical and transition risks have impacts on economic sectors and the macroeconomy, affecting everyday life and the ability of society to respond to shocks;
Those economic impacts filter through the financial system, affecting markets and financial institutions;
The resulting financial difficulties then create further negative economic impacts, and risks and costs begin to spiral;
While climate impacts continue to feed more risk and cost into the overall system of geophysical and economic interactions, affecting human wellbeing and the ability of the financial system to function day to day.
The report goes on to detail international cooperative efforts, through the Financial Stability Board, securities and insurance bodies, the International Monetary Fund, and convenings of central bankers, to get ahead of and reduce these risks. The future of sustainable value-creation must include vulnerability-sensitive debt relief and financial innovation, and new cooperative financing mechanisms to deliver best-case investment support to best-future food systems.
In the summer of 2023, we are seeing what happens when climate impacts outpace the ability of systems to respond. More than 200 million Americans have lived under extreme heat conditions so far, just halfway through the northern summer, while Arctic and Antarctic signals show worrying signs of losing their climate-regulating force, jet streams are fragmenting, and ocean currents may be moving toward catastrophic breakdown as soon as 2025. U.S. electricity grids have largely held, so far, but failure in a prolonged heat-dome situation could result in an extreme heat event as catastrophic as Hurricane Katrina, with horrific harm to public health and safety.
There is now serious discussion about how the world would respond to the simultaneous failure of more than one major food-exporting region to produce enough food, due to devastating, and possibly multi-year climate impacts. Right now, there is no institution that is funded, staffed, or equipped at the levels needed to respond to hundreds of millions of climate refugees fleeing food system failure in a short period of a few months. Yet markets, as they operate today, may shorten the timeline for emergency response even further, exacerbating risk of widespread destabilization.
In 2022, global food insecurity reached three times pre-pandemic levels, with 828 million people going to bed hungry every day. 50 million people in 45 countries were “teetering on the edge of famine”, and 90 countries were facing debt difficulty or distress. The 2023 State of Food Security and Nutrition report, from the U.N. Food and Agriculture Organization, finds that:
“In 2022, 2.4 billion people, comprising relatively more women and people living in rural areas, did not have access to nutritious, safe and sufficient food all year round. The persisting impact of the pandemic on people’s disposable income, the rising cost of a healthy diet and the overall rise in inflation also continued to leave billions without access to an affordable healthy diet.”
Inequality has exploded in recent years, with the vast economic middle losing income relative to the wealthiest, who hold far greater financial assets and have enjoyed far greater income growth. Without a financially capable middle class, overall consumer support for sustained economic prosperity will be limited. Worsening income inequality is a worsening threat to future financial stability.
The 2021 FSOC report on Climate-Related Financial Risks (PDF) also identified operational challenges facing its member institutions—U.S. financial regulators:
Data limitations – the need for better connections between financial and non-financial data;
Time horizons – impacts extending beyond financial forecasts, and acting through overlapping timescales;
Complexity and uncertainty of climate risk – including the lack of historically tested methodologies for attaching that risk to financial analysis and regulation;
Policy and economic uncertainty – political opposition to climate forecasting, risk reduction, and related investment decision-making tools, adds to financial stability risk;
Trade-offs – some actions to improve overall financial system dynamics could limit financial benefits to vulnerable communities.
These challenges can and must be resolved. Better data can only arise from better data systems integration. Financial data that decision-makers trust and utilize every day need to learn how to take in, make sense of, and align decision insights with data describing Earth systems science observations and geophysical risk dynamics. Early warning systems should not only inform emergency response planning, but also how the financial system allocates resources to sectors and actors that help or hinder future climate resilience and overall sustainability.
This kind of intelligent, cross-factor integration, across overlapping timescales, can produce decision insights that actively minimize financial risk from physical and market shocks, while supporting resilient operations that can play a priority role—attracting more financial opportunity—in a situation of climate-related or secondary market disruption. There is no political reasoning that would support reducing the opportunity for such improved financial outcomes—especially considering they would be linked to the resilience of the everyday economy.
The raw math says the only prosperous future possible for the financial system is one in which non-financial returns are not only sustainable, but measurably and reliably risk-reducing and resilience-building. Clear evidence from everyday experience and from financial sector risk analysis shows macrocritical resilience is already a market imperative, today, but systems and institutions need new tools to be able to make the best possible judgments about financial commitments linked to non-financial returns.
To minimize trade-offs that can harm vulnerable communities, and which might also undermine overall readiness and responsiveness to systemic shocks, it will be vital to engineer and deploy systems that connect to and support resilience measures at the micro-scale. Large-scale capital flows will be more resilient when the data supporting their risk-reduction and resilience-building efforts are more granular and detailed, while supporting better outcomes at local, national, and international scales. Local observers, local actors, and scalable localized innovation will all be critical for testing and discovering the most effective new operating models.
If we wait too long to get our financial house in order, in line with real-world insight into non-financial returns, the opportunity costs could be deep enough, and pervasive enough, to render the system nonviable. The work of developing distributed, multi-scale, resilience-building finance may well determine whether we have enough food for everyone, whether nation-states can be sustained or not, and whether our collective climate future is at all livable.