Central banks and supervisors need to start right away to actively tackle climate-related risks in the financial system in a practical manner, according to speakers at a Network for Greening the Financial System (NGFS) meeting at the Banque de France on April 17.
The event’s host, Banque de France governor François Villeroy de Galhau, called on financial stability policy-makers around the world to implement “practical” steps to deal with climate risks before it is too late. “It is time to roll up our sleeves,” de Galhau said. The Bank for International Settlements deputy general manager Luiz Pereira da Silva echoed the immediacy of the problem, stressing the urgency by stating that climate change risks are “a clear and present danger”.
Central banks set up the NGFS to investigate climate change issues and promote best practice 16 months ago. At a meeting in Bali in October last year, de Galhau said “climate-related risks are the source of financial risk”. As a result it is “within the mandates of central banks and supervisors to ensure the financial system is resilient to this risk”, he added.
The NGFS released a its first comprehensive report on April 17, which recommended central banks and supervisors implement four specific measures to support the objectives of the Paris Agreement on climate change. These include integrating risks derived from climate change into their macro and micro supervision; adopting sustainability factors in central bank portfolio management; sharing data of relevance to climate risk assessment and making them publicly available in a data repository; and developing in-house capabilities to better understand climate change’s impact on the economy.
It is time to follow the path set by the TCFD on one side, on disclosure, and by the European Commission on the other, on taxonomy, to address all of these issues at the same time
François Villeroy de Galhau, Banque de France
The French central bank governor says the publication of the report brings to an end “season one” of the NGFS’s work and that it is now time to move on to “season two”, which will be packed with new initiatives being acted upon by policy-makers and financial institutions around the world. “Developing practical solutions now tops the agenda of what we will call the NGFS season two.”
De Galhau accepted policy-makers and the finance industry face some big challenges.
For example, he said integrating climate risk into micro-prudential measures is an “ambitious but complex task” – particularly in the areas of disclosures and taxonomies – but he insisted that “progress has been made”.
The challenge is to break a ‘chicken and egg dilemma’ – that is, to bridge climate change risk data gaps there is a need for enhanced disclosures, but these disclosures in turn need to be built on sound taxonomies that can only be constructed based on robust underlying data.
“It is time to follow the path set by the TCFD (Task Force on Climate-related Financial Disclosures) on one side, on disclosure, and by the European Commission on the other, on taxonomy, to address all of these issues at the same time.”
De Galhau also pressed for the industry to design a comprehensive set of stress tests.
The Banque de France governor also said existing efforts to highlight exposures in the financial system, an area where he said the Netherlands Bank, the Bank of England’s Prudential Regulatory Authority and French regulator APCR, have had some success. De Galhau pointed out that bank exposures to “transition risks” had fallen in the French financial system and now represents roughly 12% of credit risk exposures.
However, the granularity of disclosures is still fragmented in France and, more generally, there are large blind spots in risk management frameworks – for example, finding sufficient pools of reliable data to calibrate risk models in a statistically robust manner that can estimate climate change risks.
“We cannot effectively disclose risks for which there is no data,” said Sonja Gibbs, managing director of the global policy initiatives unit of the Institute of International Finance, a banking association.
Margarita Delgado, a deputy governor at the Bank of Spain, appeared less than sympathetic to the plight of banks and insurance companies. “We have been subject to transition risks for ages. The banks should be used to coping and dealing with risks. They are far smarter, have a lot of money and need to invest in these governance frameworks,” she said.
Reserve Bank of Australia deputy governor Guy Debelle said establishing a minimum level of disclosure would help. His counterpart at the Banque de France, Sylvie Goulard, added that the development of “concrete tools on stress-testing and disclosure” could be done through an interactive process, where one can “create tools and improve them”.
“The solution is to start doing it,” added Mario Navam, director for horizontal policies in the financial stability, financial services and capital markets union directorate at the European Commission. “We hope under the Finnish presidency by the end of this year to bring a taxonomy home.”
Mary Schapiro, the former head of the Securities and Futures Commission and Commodity Futures Trading Commission, who led work by the Financial Stability Board via the TCFD to establish disclosure requirements said the creation of a climate risk management handbook for financial institutions “would be of enormous benefit” and called for greater engagement with company boards.
The RBA’s Debelle said personal responsibility can be a powerful incentive.
He noted that legal opinion has now been issued in Australia highlighting that board directors may have personal exposure should they fail to tackle climate risks.
While Debelle stressed that the legal opinion was not the result of a direct effort by the RBA, the RBA deputy – who has also called for central banks to draw on climate change risks in relation to their core monetary policy mandates – said “it is a particularly effective way to focus the mind”.
From risk to returns
Bank of England governor Mark Carney said “a lot of time” currently is spent “talking about risk”, but he expects a shift “further along the horizon” to “return” – something the private sector would appreciate. Carney said improvements in data would inform better decisions that in future will be subject to highly sophisticated portfolio optimisation techniques using artificial intelligence.
As some point in the next 20 years, Carney predicts that portfolio managers will have moved from simple “exclusions strategies” to “tilt strategies”, where investors would invest more in companies with the prospect of making strong progress in the area of climate change.
US absent; no enforcement
Despite its early successes, the NGFS, which has 34 members and five observers, faces challenges itself.
One obvious problem and potential weakness is that is has no enforcement powers. It can only encourage central banks and supervisors to act.
Moreover, while the body had members that oversee two-thirds of the world’s global systemically important banks and insurers and represent countries that produce 44% of global GDP, the US – the world’s largest economy with the deepest capital markets – has yet to join the group.
Penetration is also low among African, Latin American and Asian central banks and supervisors, although the People’s Bank of China does sit on the NGFS’s steering committee. NGFS chair Frank Elderson, a board member at the Netherlands Bank, said the group expects to expand its membership in the months ahead.