Will regulators be the dark horse superheroes of 2020?
climate narratives: annotated #3
Photo by Sheri Hooley on Unsplash
Welcome to the third edition of climate narratives: annotated.
Public trust in governments has been battered by the pandemic, and we’ve seen central banks and regulators on both sides of the Atlantic stepping up to do new kinds of crisis response which were not previously part of their mandate.
What does this mean for sustainable finance and how banks address climate risk? Are regulators headed into a lose-lose cycle where by being more interventionist they squander their number one asset: the public trust which accrues to being above the fray of partisan politics?
The 2020 narrative on regulators - who command higher public trust than almost any other institution right now - is a kind of phase two, post Great Financial Crisis narrative. In 2008, central banks went from being an invisible, mysterious and powerful elite to one that was in the headlines everyday. Today they are seen as agile economic firefighters and credible crisis leaders.
French President Emmanuel Macron from his Bastille Day interview:
The idea has taken hold that governments can’t change anything, and along side that, an absolute anger.
Compare this with the Economist’s commentary on July 11 on how the US Federal Reserve Chairman, Jerome Powell, has handled the economic crisis kindled by COVID-19. “Amid America’s flailing institutions, however, Mr Powell’s Fed at times seemed uniquely competent.”
This week’s newsletter focuses on how regulators have broken new ground during the crisis, and two reports - one from the US and one from Europe - that illustrate the gulf that separates the two on how regulators should be addressing climate risk.
The first narrative that’s emerging is the central bank diving headfirst into emergency rescue of the real economy: this gives them a fast, hands-on, real world reputation which is new and unprecedented.
👉 The headline here is that they're taking more risk to shore up corporates.
Having learned from the last financial crisis of 2008 that incrementalism sends bad signals to markets and makes everything worse, central banks have been fast to act, and in the process have taken a lot more credit risk, especially towards the corporate, non-bank sector.
Let’s remind ourselves what central banks exist to do. Since the 1930s, their mandate has been to stabilize financial markets and avoid cascading bankruptcies and depression. They do this via monetary policy, the setting of interest rates, and insist on keeping politicians out of their playing field.
2008 changed the game: central bankers entered the public spotlight by taking on a new, much more interventionist role. As economist Thomas Piketty wrote:
Central banks helped prevent a complete shutdown of credit and a collapse in prices and economic activity. They reminded the world of their irreplaceable role.
This time its about taking on a "lender of last resort" function for the ailing corporate sector. The latest BIS Annual Report (Bank for International Settlements in Basel, Switzerland, the central bank for central banks) has an excellent section on the “evolving crisis playbook”.
Central banks found themselves pushing hard against traditional demarcations of their remit.
For many central banks, for example, a key boundary had been direct interventions in corporate bond markets, which could be perceived as engaging in credit allocation. Yet many did so in this crisis as part of a concerted policy effort to cushion the blow to firms which, through no fault of their own, had experienced a sudden liquidity squeeze
That report warns that this regulator superhero narrative could backfire.
There are limits to how far the boundaries between fiscal and monetary policies can be pushed without running the risk of undermining the central bank’s credibility. Trust and confidence in central banks are arguably their most important assets. It is precisely because of this hard-won trust and confidence that central banks have been able to cross a number of previous red lines to restore stability during this crisis.
Also noteworthy in July was the announcement from Christine Lagarde, President of the European Central Bank, that she was studying the possibilty of using the ECB’s €2.8tn asset purchase scheme to pursue green objectives. This would be the first time a central bank has used a flagship bond-buying programme to pursue green objectives.
The second narrative, which is closely connected to that trust and confidence that regulators command, concerns mounting pressure from civil society for regulators to step up on climate risk.
👉 What's interesting here is that the same trend plays out very differently on both sides of the Atlantic.
To find out what's happening in the US, I did a Q & A with Steven Rothstein, Managing Director of the Ceres Accelerator for Sustainable Capital Markets about a report "Climate Change as a Systemic Risk: A Call to Action for U.S. Financial Regulators".
It's worth noting that Ceres is a pioneer in the field of sustainable finance and business. The NGO was founded in response to the Exxon Valdez oil spill in 1989. They pioneered the so-called “Valdez principles” which are still at the heart of the debate about responsible capitalism and biosphere stewardship.
Perhaps then the most significant feature of the Valdez Principles is not what they have accomplished but the circumstances of their origin. A major disaster often engenders a social and political climate that is, at least temporarily, receptive to reform.
The call to action of that report is captured in a comment from US Senator Brian Schatz (D-HI) in a webinar discussion that Ceres hosted.
👉 Schatz cuts to the core of the problem when he says:
I'm not suggesting regulators become climate activists, I'm just asking them to do their job.
In your report, you note that the US is currently lagging other regulatory peers in Europe and elsewhere in acknowledging that climate change is a threat to financial stability, and acting on that fact. Could you explain why this is?
Steven Rothstein: There are myriad differences in the regulatory environment between the U.S. and Europe, but the primary factor here is the unfortunate politicization of climate change in the US. Some leaders in the regulatory community see climate as something that needs to have a policy solution - and is therefore dependent on politics. They’re not wrong, but there is also a critical financial dimension. The systemic impacts of this financial risk are playing out in real time, and regulators can’t wait for policymakers to act.
Which countries today are really leading the way on the main thrust of your recommendations - on integrating climate change into prudential supervision and mandating climate disclosure?
Steven: We’ve been encouraged by the leadership of the Bank of England, which has announced plans to ask banks, insurers, and asset managers to regularly conduct stress tests for climate resilience. Other central banks including France and, more recently Australia, have followed suit. The central bank of The Netherlands has conducted climate stress tests on certain aspects of their economy, and Norway’s central bank issued a statement saying that climate risks “must be integrated in the risk assessment and hence in the overall assessment of the capitalization and funding of financial institutions.”
Here in North America, Canada recently announced that companies would be required to commit to publishing annual climate-related disclosure reports consistent with the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, including how their future operations will support sustainability and national climate goals.
Additionally, 66 Central Banks and Supervisors from around the world belong to The Central Banks and Supervisors Network for Greening the Financial System, which is acting on these issues as well. The U.S. is conspicuously absent.
US regulators are ignoring this major system-wide vulnerability - aside from the political context in the US where climate change continues to be a contested debate - is it also because that vulnerability is difficult to quantify?
Steven: The old trope here is true: What gets measured, gets managed. In our report, Addressing Climate Change as a Systemic Risk: A Call to Action for U.S. Financial Regulators, we call on financial regulators to affirm that climate change is a systemic risk and begin the research to understand how climate risk affects their mandates on market oversight. But regulators cannot do the needed macro-economic research without the right firm level information. While the volume of corporate climate change disclosure has improved tremendously over the past decade, disclosure is mostly being provided by large companies - and what is provided is still not sufficiently comparable, rigorous or “decision useful”. That’s why we’re calling on regulators to coordinate with each other to mandate climate change disclosure - so that regulators and investors get the data they need.
Is this ultimately a philosophical debate about the definition of the public interest and the mandate of the regulator?
Steven: I think it’s more of an awakening that needs to happen than a debate that needs to be won. Financial regulators are responsible for safeguarding markets from systemic threats. Climate change poses a clear systemic threat to markets. There needs to be an awakening, both in and outside the halls of these agencies, to the reality that this is coming for our financial markets, and that protecting them from it falls well within their job description.
Photo by Mauro Sbicego on Unsplash
👉 In contrast, European regulators for the most part don't dispute that climate risk is part of their job, the question is more focused on the "how".
To answer that question, a Brussels-based NGO called Finance Watch pushed out a report called "Breaking the Climate Finance doom loop" last month - I mentioned it in the previous newsletter.
Since then, I had a chance to talk with the report's author, Thierry Philipponat. The full episode will be published next week, but here’s a little teaser of what you can expect from that conversation as we examined the origins of the report and where we’re falling behind when it comes to mitigating the impact of climate change on financial institutions:
all experts, including most central bankers recognize that the task of quantifying the impact of climate change on financial stability is somewhere between extremely difficult and impossible.
Regulators are supposed to be keeping the banking sector healthy, to protect society from collapses of the sort we saw in 2008. And yet, the report points out that lending to the fossil fuel sector is not treated by regulators as a high-risk activity. That situation is over-due for change in a world where we are seeing companies like BP and Shell writing down billions of dollars worth of assets.
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Beyond the recording
This is a regular feature where we will share unaired pieces of tape and highlight the resources and readings that informed our understanding of the topics covered in our New Climate Capitalism podcast.
Extra content from episode #4:
Climate shareholder activism is on the move, and our latest episode narrates the playbook of a recent campaign as a play in five acts. I talked to Wolfgang Kuhn, Director of Financial Sector Strategies for the UK NGO ShareAction and he took us into the war room of the recent ShareAction campaign to bring a climate shareholder resolution to Barclays bank.
In the interview, Wolfgang gives many valuable insights which are important from both the investor and the management perspective. How to navigate the tension between listening to your stakeholders and aligning your corporate strategy with public opinion is a major boardroom challenge of the next decade.
When we talk to investors [they are] mostly saying, 'we don't want to be too prescriptive. We don't want to step on management's toes because it's their job to set strategy.' And we are saying, 'that is true, but when it comes to systemic issues of the magnitude of climate change or biodiversity laws if, by now in 2020, the board isn't fully engaged with this and has a proper strategy and has in place proper mechanisms to deal with it" then something's wrong.
More resources and articles from all guests are available via the website climate narratives.co.
From the Gers, France,
Denise