Despite recent, clear warnings of the devastating impacts of climate change above 1.5°C, current National government pledges still put the world on track for around 3°C of global warming this century.
Such a rise would mean major risks to societies across the world, to business and to the global economy.
More must be done, especially in the financial sector given no sector can operate without financial backing. Yet to date, there has been a historical under-appreciation of the impacts climate change will have on the financial system and how the financial system can actually support the climate agenda.
This is starting to change. Asset managers, insurers, banks and pension funds increasingly see environmental factors as material and are incorporating this information into their decision making. However, this will not be enough on its own.
We need to see unprecedented action at all levels of the economy and a substantial transformation of the financial system if we are to have any chance of meeting our ambitious but necessary goal of 1.5°C.
Transforming the financial system
There are two things that need to happen in the global financial system if we are to enable a low-carbon transition that is sustainable.
First, financial stability and asset pricing must be strengthened. The mobilization of financial flows from dirty to green activities offers significant opportunities, but also exposes potential risks to financial institutions and the financial system as a whole. Long-term material risks must be better assessed and managed, while less tangible factors of value creation related to environmental, social and governance (ESG) issues must also be considered.
Second, the financial sector must improve its contribution to sustainable and inclusive growth over the long term. It must finance long term needs such as innovation and infrastructure, as well as accelerate the shift to a low-carbon and resource-efficient economy.
This is no mean feat. It requires a fundamental transformation of our economy, to re-align it with the realities and risks of climate change.
And any roadmap for sustainable finance has to be multi-faceted, reflecting the complexity of the global system as well as the diversity of needs, risks, challenges, and capabilities that exist in different types of financial organizations.
It is also vital that we don’t wait until the last moment to act. While climate change has the potential to wipe out trillions of dollars’ worth of assets, an abrupt and disorderly transition could also damage the economy. Indeed, too rapid a shift could materially damage financial stability, as massive reassessment of assets destabilize markets, spark losses and lead to a tightening of financial conditions.
Collaboration is key
All players: central banks, supervisors, financial centers and individual financial institutions - banks, insurers, asset managers - have a significant role to play, and they must work together to enable sustainable and inclusive growth.
Sustainable finance is not a zero-sum game and the potential for dialogue and knowledge-sharing is considerable. By joining forces, these institutions can make a real difference and ensure that the transition is cheaper, safer, smoother and faster.
In terms of their remit, public and private financial institutions and centers should be working together to raise awareness of climate change issues, upskilling and building knowledge, while strengthening and promoting market good practice. They should be promoting, endorsing and implementing key standards such as the Task Force on Climate-related Financial Disclosures (TCFD). They should bring clarity to definitions, taxonomies, and methodologies to build fair, liquid, transparent, climate-friendly markets. And they should be encouraging financial innovation and providing guidance on issues such as green loans and green fintech.
The role of central banks, supervisors and regulators
As climate-related threats - both physical and transitional - are a source of financial risk, it is within the mandates of central banks and supervisors to ensure the financial system is resilient to these threats. At the same time, the commercial institutions regulated by them must be climate resilient themselves if they are to contribute to the transition.
Therefore, central banks, supervisors and regulators need to develop practices, methods and modelling techniques to integrate environmental risks into their supervisory roles and measure the financial impact of climate risks on micro and macro prudential objectives. This could include stress testing, scenario analysis and data issues.
These institutions also have a key role in scaling up green finance, both in their roles as actors involved in the management of the public good, and as corporates, using their own funds to lead by example. They should be providing information on what is needed to ensure the sound scaling up of green finance, on how they can support in identifying market barriers and dysfunctionalities on the supply and demand side, as well as the best ways to overcome these barriers.
They are also well-placed to monitor and understand market developments, and if needed, intervene.
A mix of legislative, non-legislative and standard-setting actions are needed to fill gaps, add clarity and address inconsistences in order to make real progress on the road to a sustainable financial system.
The Network for Greening the Financial System
Some central banks and supervisors are already making moves in in this regard. So far, the Bank of England, De Nederlandsche Bank, Banque de France and People’s Bank of China have been the most active in making banks and insurers take climate risks seriously. They are conducting thematic reviews on the climate-related risks that could affect the financial sector, building strategies and guidelines on how to tackle the risks and promote green financial development.
At the same time, the launch of the Central Bank and Supervisors Network for Greening the Financial System in 2017 (NGFS) signals a more widespread step in this direction. The exact roles of central banks and supervisors on climate change has been undefined so far, but this network should make it clearer.
The NGFS is a group of central banks that aims to help strengthen the global response required to meet the goals of the Paris Agreement and enhance the role of the financial system in managing risks and mobilizing capital for low-carbon investments. They work on the roles and responsibilities of different financial sector stakeholders, on challenges in greening the financial sector, and financial risks arising from climate change. On April 17th the group will be publishing their first comprehensive report and CDP is engaging to bridge knowledge and expertise about climate-related disclosure and action.
It can no longer be denied that climate change poses a systemic threat to our planet and global economy, and this isn’t a challenge that can be dealt with by one group. All parts of society must step up.
And as the urgency of the climate challenge increases, the collaboration, leadership and support of central banks and supervisors is more needed now than ever.