The Stern Review: Mitigation

Carbon pricing could totally change the way companies operate. Nick Robbins ask if the city is ready to make the leap

After eight years of haggling, endless meetings, U-turns and broken promises, the Companies Act became law on 8 November 2006. Billed as the most important reform of corporate regulation for 150 years, the new Act is symbolic of the decline and fall of Tony Blair’s ‘third way’ approach to modern capitalism.

Rejecting the twin poles of state-controlled communism and untrammelled free markets, the early Blair had promoted a ‘stakeholder economy’ in which the private firm would cease to be ‘a mere vehicle for the capital market to be traded, bought and sold as a commodity’. Instead – as he told an assembly of Singapore business executives in January 1996 – the company would become ‘a community of partnership’, in which ‘each employee has a stake’ and where a company’s responsibilities would be ‘more clearly delineated’.

An in-depth review of company law was duly launched when Blair took office. But under pressure from the corporate establishment, the fuzzy logic of stakeholding was replaced by the even fuzzier notion of ‘enlightened shareholder value’, catchily known as ESV. In a wonderful piece of wishful thinking, the government now argued that the interests of shareholders and society were as one – and all that was needed to realise this Utopia was a bit of extra reporting by business.

Meanwhile, under the banner of the Corporate Responsibility Coalition, a broad-based alliance of environment, development and labour organisations nobly tried to expose the flimsy foundations of ESV. Yet even the most cynical campaigners hadn’t foreseen the next act of the tragedy. In November 2005, after years of laborious consultation, Blair’s nemesis, Gordon Brown, contemptuously announced that the modest proposal to require companies to produce an annual operating and financial review was far too burdensome and would have to go.

The final bill that limped through Parliament a year later pointedly reaffirmed the primary obligation of company directors to their shareholders, offering a crumb of comfort that in the pursuit of profit maximisation, directors should ‘have regard to’ the interests of employees, the community and the wider environment. In a classic British formulation, directors were hereby given a duty to consider the interests of others, but without any obligation to act. Brown’s fellow native of Kirkcaldy, economist Adam Smith, would have scoffed at this evasion of justice. Long seen as an unthinking champion of free enterprise, Smith actually identified inherent flaws in the shareholder corporation, arguing for strict controls to curb the ‘negligence and profusion’ both of executives and investors.

Whether enlightened or not, shareholders have emerged intact – if not strengthened – from this sorry affair, retaining the privileges of limited liability without any corresponding delineation of responsibility. A quick look at today’s capital markets would expose the hollowness of this conclusion. The City is a smart place, and many who work within it are well aware of the severe social and ecological faultlines in the global economy. But this awareness has little bearing on actual behaviour in a market increasingly obsessed with absolute financial returns over ever-shorter periods of time. Socially responsible investors strive to act with integrity against the odds. But financial markets as a whole continue to deny the ecological truth.

Nowhere is this more embarrassingly evident than with global warming. Nicholas Stern’s recent report on the economics of climate change once again trumpeted the imperative of putting a price on carbon. Indeed, Stern estimated that each tonne of carbon dioxide equivalent (CO2e) emitted into the atmosphere does $85 of damage to the environment – an amount many times higher than the prevailing carbon price in the EU Emissions Trading Scheme.

For the stock market, the implications are potentially devastating. Take BP, one of Britain’s largest firms. If BP had to pay $85 for every tonne of CO2e emitted from its operations, the bill would account for over a third of its annual profits. More profound still would be the impact on BP’s bottom line if it also had to pay the costs of the carbon dioxide released by its goods and services – a not unreasonable assumption, given the established environmental principle of ‘extended producer responsibility’. The estimated 570 million tonnes of CO ²e from its products would land BP with an annual requirement to find $48 billion, more than twice its yearly profit – and this is likely to be an underestimate. But the cost of its carbon dioxide would also corrode the company’s balance sheet, transforming its reserves of oil and gas into immense carbon liabilities.

In all of this, however, the operative word is ‘if’. Stern’s $85 remains an estimate, and markets largely continue to allocate capital as if climate change did not exist. There is no obligation on companies to account for the cost of carbon, or on investors to take climate change into account. Equally, there is no requirement for new companies coming to the London stock market to disclose their carbon risks to potential investors.
City eyebrows were certainly raised when the Russian oil giant, Rosneft, was listed on the London Stock Exchange in 2006, with concerns focusing on its dubious acquisition of Yukos’ reserves. But not one line of the extensive prospectus analysed how this intrinsically carbon-polluting company could be affected by steps to reduce emissions in the years ahead.

If Stern’s grand agenda for driving down greenhouse gases is to be realised, then the oxygen of capital for carbon intensive activities will need to be progressively closed off. This will mean tightening the financial regulation of accounting standards, stock market listing rules and corporate disclosure so that it becomes fit for purpose for the oncoming low carbon age. For if you want to change capitalism, it makes sense to start with capital.

Nick Robins works in the City of London to promote sustainable and responsible investment. He is also author of The Corporation that Changed the World: How the East India Company Shaped the Modern Multinational (Pluto Press, 2006).

This article first appeared in the Ecologist December 2006