Central banks around the world have spent every day this week making major announcements regarding their efforts to address financial risks related to climate change. They have also provided perspective on what monetary policy and financial supervision can do....and what it cannot do....to create incentives that support if not accelerate the transition away from carbon-based energy.
Did you notice? Probably not.
Climate change media coverage mostly was dominated by the latest climate change summit and the new Biden/Harris Administration efforts to halt energy extraction from federal property in the United States. Climate advocates in the United States additional want to change regulatory standards created by the Trump Administration that require investment advisors for retirement/pension funds to only take into consideration financial/economic risks.
Consider this week's developments so far, captured by the PolicyScope Platform as they occurred:
Central Bank Reserves Management: The Bank for International Settlements has expanded its Green Investment Fund to include instruments denominated in EUR in addition to USD. The mobilization of central bank reserves in this space will create additional demand and liquidity for qualifying green bonds rated at least A- that meet existing high quality standards for sustainability disclosures.
Green Bond Issuance:
Hong Kong SAR, China has issued and placed privately $2.5bn in official sector green bonds, listed both in London and Hong Kong stock exchanges. The bonds were denominated in USD across the term structure (5 years, 10 years, 30 years) for the purpose of building a term structure for this asset class. Hong Kong reports a diversified buy side consisting of Asian (65%), European (20%) and US (15%) investors, with European and US investors preferring longer dated tenors. Institutional purchases were similarly diversified across banks (34%) and central banks, sovereign wealth funds and supranationals (20%) with the balance (46%) going to fund managers, private banks and insurance companies.
The European Banking Authority released detailed bank survey data showing the distribution of current and expected bank green lending and green bond issuance activities in Europe.
The European Commission and the European Parliament continue to expand European issuance of green bond assets.
Bank of England vs. Members of Parliament: Policymakers in London are squabbling about whether (or not) the central bank's corporate bond purchase program launched in response to the pandemic might be consistent with the Paris Accords
Corporate Disclosures/Financial Supervision:
The ECB is pressing for more detailed data than currently provided under the prevailing international standard articulated by the Task Force on Climate Disclosures a few years ago. In addition, the ECB is publicly pressing for "forward-looking measures that assess the extent to which both financial and non-financial firms are aligned with climate goals and net zero commitments (by sovereigns)."
The Autorite des Marches Financiers (AMF -- the French securities regulator) identified implementation of various climate-related EU regulations as a top priority for work during 2021, with an emphasis on disclosure requirements for ESG indices and defining benchmarks regarding both the EU Climate Transition Benchmark and the EU Paris-Aligned Benchmark standards.
Additional standardization is expected in Europe during 2021 as the European Commission, European Council, and European Parliament complete negotiations on a standardized taxonomy for climate-related disclosures.
Most expect to see the Securities and Exchange Commission in the United States propose climate-related disclosures for securities issuers after Gary Gensler has been confirmed as the new Chairman of the SEC.
Credit Ratings: The ECB is pressing for climate risks to be included in credit ratings. Implementing this recommendation will be no easy feat given that physical climate transition risks will take years to impact credit profiles. Not all supervisors and central banks agree that credit ratings should reflect exposure to carbon-based energy, preferring instead more direct mechanisms to increase carbon prices through emissions trading systems and formal taxes.
ECB Collateral Policy: The ECB now accepts as collateral bonds with coupons linked to sustainability performance targets.
ESG Investment Mandates for Central Banks:
The Monetary Authority of Singapore announced its continued intention to "mainstream sustainable financing" without providing specifics.
The European Council issued Conclusions concerning Climate & Energy Diplomacy in which Member States commit to "scale up the mobilization of international finance," accelerate the energy transition, and discourage investments in fossil fuel projects.
The Bank of England told Members of Parliament that it is "reviewing how to incorporate climate issues into our corporate bond purchase program."
Embedded Risk Concerns: Central banks in parallel are expressing concern that they could end up holding latent climate risks embedded in the securities they purchase and the securities they accept as collateral, particularly given the substantial increase in both activities in response to the pandemic. These concerns suggest strongly that central banks may end up driving strong demand for improved climate risk disclosures, pressuring securities regulators and markets to increase the rigor and consistency of disclosures quickly.
Stress Testing (Financial Institutions):
The Bank of England indicated to Members of Parliament that stress tests are underway with UK banks and insurance companies to assess their potential exposure to climate-related financial risks.
The ECB disclosed that it is undertaking a system-wide stress test that includes mapping bank physical assets to climate patterns with a 30-year time horizon. Bank-specific climate stress tests are expected in 2022.
New Institutional Structures
The International Monetary Fund announced that it will be unveiling during 2021 a Climate Change Dashboard designed to "mainstream climate indicators into macroeconomic data." The Dashboard will facilitate tracking the economic impact of climate change as well as mitigation measures taken by individual sovereigns.
The International Monetary Fund also announced what has been clear to IMF watchers for quite some time. Formal Article IV economic reviews now formally and systematically assess climate issues AND large emitters are subject to additional scrutiny focused on mitigation strategies. Related, the Financial Stability Assessment Program (FSAP) reviews assess disclosure, stress testing and supervisory oversight regarding climate-related risks at the national level. The purpose of these initiatives is to create subtle pressure for policymakers at the national level to address climate issues in the economic and financial system.
The ECB announced the creation of a Climate Change Centre at the central bank. Its purpose at least initially is to provide a center of competence and coordinating mechanism internally.
Some in Europe are advocating that a politically independent climate policymaker be created, using central banks as the template. Bundesbank President Weidmann this week argued against this proposal, expressing instead a preference for climate policies to be articulated by democratically elected politicians.
Monetary Policy: ECB President Lagarde, Deutsches Bundesbank President Weidmann, and ECB Executive Board Member Panetta in separate speeches have all explored the intersection of climate risks and monetary policy. Concepts include:
Inflation: extreme weather events are expected to generate short-term output volatility and short-term inflation dynamics which require active central bank management. The concern is that climate change may create a "durable divergence" between headline inflation and core inflation
Inflation Expectations: The ECB also frets that climate change may impact household and corporate inflation expectations.
Productivity Dynamics: Productivity and labor supply may both decrease due to increased temperatures. NOTE: while not referenced in President Lagarde's speech, the impact of increased heat will obviously have a disproportionate impact on economies where central air conditioning is not prevalent and/or where outdoor manual labor is a major contributor to local economic growth.
Interest Rate Transmission Mechanism: A growing proportion of "stranded assets and losses" at banks could impair monetary policy transmission mechanisms through the interest rate channel.
Policymakers are only just getting started.
Activity levels so far in January actually are below last year's aggregate activity for both the high level ESG issues
and the more detailed climate disclosure issue.
We expect 2021 will generate far more financial regulation and risk management oversight activity concerning the definition and disclosure of climate-related risks by financial institutions and securities issuers.
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