This is the first of two articles.
Every morning Central Banks and financial players alike seem to be standing in front of the magic mirror and wondering, “Who is the greenest one of all?”
With a historic record reading of 421.21 ppm CO2 on April 3, 2021, the Anthropocene era reached a tipping point, triggering a planetary emergency. Hence, the beauty contest fervor is understandable and warrants praise for effort, but the jury is still out as to genuine intent, ambition, audacity, and impact.
All along, financial institutions have been committing more than $3.8 trillion to the fossil fuel industry since the signing of the 2015 Paris Agreement. These financial flows are largely facilitated with a heavy fossil fuel industry largesse at the bank board level. A recent study revealed that of 39 global banks reviewed, 368 board directors out of the 565-total, or 65% had climate-conflicted interests.
Central banks have been trying to be more virtuous. The U.K. government secured a historic scoop by putting climate change into the mandate for Bank of England’s Financial Policy and Monetary Policy Committees. The European Central Bank (ECB)’s Lagarde showcased the bank’s laudable climate change policy efforts in a recent response to E.U. Parliament. The disclosures fell short though of committing to full Climate Risk-related Financial Reporting (CRFR) of the ESB’s full balance sheet. In January, the Fed announced the creation of “Supervision Climate Committee,” more micro-focused, under the helm of Kevin Stiroh, also co-chair of the Task Force on Climate-related Financial Risks of the Basel Committee. At the March Ceres conference, San Francisco Fed governor Lael Brainard initiated that the Fed was also establishing a “Financial Stability Climate Committee (FSCC),” more macro-centric, to identify, assess, and address climate-related risks to financial stability.
To top it all, the Network for Greening the Financial System (NGFS), a coalition of central banks and supervisors promoting climate change attuned to prudential supervision and monetary policies, released its first dashboard last month. The “Scaling up Green Finance” infographic is a formidable inaugural initiative. With a bit more rigor, a subsequent iteration might include more visualized aids of the average daily CO2 ppm observations at the Mauna Loa Observatory, Hawaii, and the remaining carbon reserve to stay below the 1,5 degrees Celsius increase. With further ambition, the quarterly bank loan amount advanced and underwritten to the fossil fuel industry could be surveyed in overlay with the geo-location of fossil fuel extraction sites and climate change endangered zones. The follow up slides might involve bank loans advanced to sectors prone to eroding biodiversity in overlay with the spatial location of biodiversity-challenged areas.
The CO2 measures should become key targets to steer and accelerate global monetary and prudential supervision action. The fossil fuel and biodiversity endangering loan additions, all readily available data, should avoid overlooking the elephants in the room. NGFS could become the beacon of reference for each of the national central banks seeking net zero commitment policy and supervision guidance. NGFS’ contributions might be centered around clearly articulated policies and methodologies, inclusive of Basel’s climate related financial risk recommendations. More importantly, NGFS should recommend pre-emptive action if climate-sensitive reported trendlines are not impacted.
This year three crucial international gatherings will take place covering the interlinked universes of financial stability, biodiversity, and global food supply: the U.N. Climate Summit (COP26) in Glasgow, U.K.; the U.N. Convention on Biological Diversity meeting in Kunming, China; and the U.N. Food Systems Summit in Rome.
Given the planetary emergency, timebound ambitions and resolutions become crucial. Let’s review how Central Banks and financial institutions could contribute to positive outcomes for each of the summits.
U.N. Climate Summit (COP26) in Glasgow, U.K.
The 26th Conference Of Parties (COP26) will be the most significant climate event since the 2015 Paris Agreement. Treaty signatories will be reporting back in November on progress since the Paris Agreement. The most awaited decisions center around the nations’ voluntary Nationally Determined Contributions (NDCs), intent on curbing carbon emissions to stay below 1,5 degrees Celsius increase, and Art. 6. This article is a treaty provision detailing a new international carbon market for the trading of carbon emissions offsets created anywhere in the world.
The countries’ NDC and financial institutions’ net zero commitment narrative lack precise template guidance and acuity. Mark Carney, speaking in his capacity as Vice-chair of Brookfield Asset Management, added further confusion with comments on the company’s avoided-emission offsets in the absence of a science-based target setting.
There is a need for a more audacious agenda and more stern stewardship of ambitions. A recent UNFI Thought Leadership research article, “Financial Stability in a burning world,” authored by James Vaccaro and David Barmes, and praised by Ali Zaidi, Deputy White House National Climate Advisor, advances ten solutions.
The top-ranked solutions can be summarized as follows:
- Regulators should articulate and enforce science-based, 1.5-degree Celsius aligned net-zero targets, including consequences of falling short. This should instigate more consistency and accountability regarding the various net-zero claims. The LSE Grantham Institute identified recommendations to make net-zero a reality across Central Bank and prudential practice.
- An increased solvency weighting to reflect the asset’s embedded climate risk, per the Finance Watch-issued “Breaking the Climate-Finance Doom Loop” research, could stymie systemic risk contribution. For example, the risk weight for bank exposures to new fossil fuel reserves could be set at 1250%. At such levy, every single dollar of the bank loan would have to be entirely equity-financed, reflecting and pricing for the embedded micro-and macro-prudential risks of further oil extraction.
- Mandatory rules would require Central Banks and financial institutions to collect clients’ climate and environmental data in an initiative to expand KYC to KYCO2. Recent announcements by the Biden administration and the comprehensive SEC climate disclosure consultation, under the commanding interim leadership of Allison Herren Lee, concur with this recommendation. There is urgency, as of yet, not one single U.S. company currently details climate risks in their financial statements.
Furthermore, the paper challenges the neutrality concept of the finance sector. Klaas Knot of the Dutch Central Bank posited similar arguments in a recent BIS paper. The neutrality argument leads to the absence of the polluter pays principle, effectively allowing freeloading on the global risk-carrying capacity of Central banks, governments, and ultimately citizens. This sophism needs to be removed from the capital allocation narrative to avoid that climate change-caused disruption is overlooked and under priced. It is a fundamental premise when envisioning sustainable financial stability and attempting to protect the asset integrity of citizens’ pension assets at large.
This is the end of the first article. You may find the second article here.
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Planetary Emergency, Central Banks And The Financial System (1/2) - Forbes
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