England expects — but how much?

The Bank of England will steer banks and insurers to think seriously about climate change. This is great news in itself. But what will count is how far the Bank is willing to push them.

  • By Jon Hay
  • 16 Oct 2018
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Banks in the UK will have to start talking about climate change at board level. Well, they won’t absolutely have to — but they will in practice, because the Bank of England has said it wants them to.

A classic example of British governance is going on in the area of greening the financial system.

In March, the UK’s official Green Finance Taskforce published the results of a far-reaching inquiry. It was one of the boldest sets of policy proposals so far in this field.

The government should produce a Green Capital Raising Plan and climate change resilience strategy; set up a green finance institute, green fintech hub, local development finance fund, clean growth regeneration zones, a Centre for Climate Analytics, a Green Investment Accelerator, a green venture capital fund…

The group also recommended that the Task Force on Climate-Related Financial Disclosures’ (TCFD) approach to planning for climate change should be integrated into UK corporate governance norms; banks should take energy efficiency into account when offering mortgages; investors’ fiduciary duty should clearly state the importance of environmental, social and governance issues.

The Taskforce’s plan is more ambitious even than the European Commission’s Sustainable Finance Action Plan, released a few weeks earlier. Yet while the EC is now steaming ahead with the first raft of legislation under its plan, the UK proposals have been lying on ministers’ desks, buried under a foot high pile of dossiers marked ‘Brexit’.

This week is Green GB Week — a week of activities to celebrate “clean growth”. Did you know? At last, the government took the opportunity to announce that it would take up some of the Taskforce's proposals, and publish a more detailed response in the spring.

Meanwhile, Cuadrilla began fracking at its Preston New Road site on Monday, after a long battle to defeat protests from environmentalists and local authorities, which had refused permission.

Raising the bar

While Cuadrilla’s employees were beginning to pump water, sand and chemicals underground, the Bank of England was releasing its most advanced statement yet on climate change.

The Bank’s Prudential Regulation Authority, which oversees the soundness of banks, building societies and insurance companies, is seeking comment from the market on a draft Supervisory Statement.

If this is adopted — which is likely — it will say that all financial firms should consider climate change as an important source of potential risk. Threat could come from physical events, such as floods damaging buildings, or the economic transition — governments acting to cut carbon emissions and making some business models obsolete, including companies financial firms are exposed to.

The climate may not pose direct risk to every firm, but every firm should think about the issue. Firms’ boards must have a position on it, and a governance structure, with at least one senior official responsible.

Firms that discover risks should manage them as carefully as they would any other risk, using their risk management systems, including producing reports explicitly characterising and, to the extent possible, measuring climate risks.

Assessments of climate risks should henceforward be included in the main Icaap and Orsa documents banks and insurers prepare, evaluating the risks they face, which are submitted to the regulator.

Work of the imagination

And they should use scenario analysis — as recommended by the TCFD. This is a different kind of risk management discipline many financial firms are not used to. It means imagining a future scenario, perhaps 10 or 20 years hence, in which climate change has progressed to a certain degree. The modeller has to estimate what kinds of effects on the climate and economy will have occurred, and then work out how this would affect the business.

An advance guard of global banks is trying to figure out how to do this — Barclays has made one of the fullest efforts, with a pilot study of its exposure to 250 power companies in the US and Europe.

Velvet glove

None of this will be compulsory. But the way financial supervision works in the UK is more subtle than that. The Bank of England is guiding firms to do it. It says it “expects” them to do many of the things it suggests — and if they do not, it will want to know why. If it thinks they are being cavalier about risks, it can impose higher capital charges for certain assets.

Many green finance proponents will be delighted with the Bank’s announcement. A public, but non-political institution is stepping into the breach where elected governments are afraid to tread — just as, with governments paralysed, central banks had to be the most dynamic actors in reflating Europe’s economy after the financial crisis.

Outsourcing chunks of policy to independent organs of the state is a long habit in British politics. The Bank of England itself is one example; another is the Climate Change Committee, an entity set up under the Climate Change Act 2008 to advise the government on how to meet its legally enshrined emissions targets, and monitor compliance.

Direction clear, distance not

Political scientists can argue over whether this tendency illustrates the strength of UK institutions, or a weakness of political will, determination and governance.

Financial players are more interested in the effects. The Bank of England is the one pointing the way, for the moment gently. In a few years, it is likely to upgrade what it currently “expects” to a mandatory requirement — once techniques have been established and there is more consensus in the market on how to engage with this new issue.

To those concerned about the climate, that polite, gradual, consensual approach is worrying. It is quite clear that radical cuts in greenhouse gas emissions, globally, are needed right now if we are to have any chance of avoiding catastrophic climate change.

But the degree of coercion is not the real issue. It’s a reasonable bet that banks will go where the Bank of England wants, without it having to even show them a stick.

What becomes crucial if policy is to be guided in this courteous way is the intentions of the guide. How far does the Bank want to push banks and insurers? Will it be content to just get them thinking about this issue seriously, and producing worthy reports about it?

Or is it expecting to see repricing of mortgages on flood plains, estimates of hurricane risk across the UK — even a pathway towards disinvestment from fossil fuels?

We can only guess. There are encouraging signs in the draft Supervisory Statement — the language used about how seriously and meticulously and formally climate change risks should be assessed.

The Bank has also got the intellectual grounding sorted out. Financial firms are responsible for protecting themselves from risk — but if there is a disorderly transition due to climate change, the risks they face will be higher. It therefore behoves firms to try and ward off those risks (one might add, at a global level).

Getting real

There are also worrying signs. The consultation paper talks about risks of flood damage to property and new regulations that will prevent homes with the worst energy performance ratings from being rented out.

This is kids’ stuff. There is nothing of the kind of urgency that seems called for, after a summer with blazing temperatures across much of the world. Sooner or later, this worsening weather is bound to cause much more serious disruption to agriculture.

Shouldn’t the Bank of England be telling banks to stress test a 50% failure in the European wheat crop within 10 years? Or the Indian rice crop? Or the Pacific fish catch?

Perhaps the Bank is afraid to sound the alarm, for fear of being seen to invade politicans’ territory. But its duty to safeguard financial stability requires that it not shirk its responsibilities.

Central banks have joined the fight against climate change. That is welcome. They deserve no medals — they took an awful long time to get here. (Did the young Mark Carney read Margaret Thatcher’s speech on global warming at the United Nations in 1989?)

Now, if political leaders are hobbled by short-sighted quarrels between nations and communities, and non-political state bodies have to take the lead in protecting humanity, they must shoulder that leadership responsibility in the fullest sense.

The Bank of England “expects” — and we expect much of the Bank.

  • By Jon Hay
  • 16 Oct 2018

Global Green Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Bank of America Merrill Lynch 7,730.22 32 6.66%
2 BNP Paribas 7,328.41 37 6.32%
3 Credit Agricole CIB 7,005.73 43 6.04%
4 Citi 6,125.14 30 5.28%
5 HSBC 6,015.28 43 5.18%