Weekly round-up: May 17-21

The top five climate risk stories this week

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1) Biden tells US agencies to tackle climate risks

President Biden has ordered US federal regulators to draft plans to integrate climate-related risks in their policing of the financial system.

In an executive order signed Thursday, Biden directed Treasury Secretary Janet Yellen, as Chair of the Financial Stability Oversight Council (FSOC), to issue a report within six months “on any efforts by FSOC member agencies to integrate consideration of climate-related financial risk in their policies and programs”. The document should also include a discussion of actions to improve climate-related disclosures.

FSOC is made up of the heads of all the major US financial watchdogs — including the Federal Reserve, Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission (CFTC).

Biden said in the order that it is his administration’s policy to promote “consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk” and to “act to mitigate that risk and its drivers”.

Climate advocates celebrated the order. Jamal Raad, executive director of lobby group Evergreen Action, called it “groundbreaking”:

“Today’s order begins the work of building a better financial system. It is a starting gun from the White House to Treasury, the SEC, and others to get moving on America’s work to not just monitor and disclose the risks that climate change poses to our financial well-being, but actually mitigate those risks.”

The order also directed the Labor Secretary to identify any actions that could be taken under current law to “protect the life savings and pensions of United States workers and families from the threats of climate-related financial risk” and prepare a report on the topic within 180 days.

A strategy to address climate-related financial risks to federal government programs, assets and liabilities will be developed within 120 days under another section of the order. Brian Deese, Director of the National Economic Council, and Gina McCarthy, the National Climate Advisor, will draft this plan with the input of the Treasury and Office of Management and Budget. This will also cover financing needs for transitioning the US economy to net-zero emissions by 2050. 

“This order sends an important message that the Biden Administration understands the urgent need to address climate-related financial risks,” said David Arkush, managing director of the Climate Program at Public Citizen, a nonprofit consumer advocacy organisation.

2) New IEA roadmap calls for immediate halt to new fossil fuel spending

No new investments in coal, oil and gas projects should be made if the world is to achieve net-zero emissions by 2050, a new report by the International Energy Agency (IEA) says.

‘Net-zero by 2050: A roadmap for the global energy sector’ details a “narrow, but still achievable” opportunity to limit global warming to 1.5°C that is “the most technically feasible, cost‐effective and socially acceptable” to date.

The pathway laid out projects no new oil and gas fields beyond projects already committed for 2021 and no new coal mines or coal mine extensions: “The unwavering policy focus on climate change in the net zero pathway results in a sharp decline in  fossil fuel demand, meaning that the focus for oil and gas producers switches entirely  to output — and emissions reductions — from the operation of existing assets,” the report reads.

“Unabated coal demand declines by 90% to just 1% of total energy use in 2050. Gas demand declines by 55% to 1,750 billion cubic metres and oil declines by 75% to 24 million barrels per day (mb/d), from around 90 mb/d in 2020,” it adds.

In order for the world’s energy needs to be met without new fossil fuels, the pathway require “huge leaps in clean energy innovation”, including “widespread use of technologies that are not on the market yet”. By 2050, about half of the emissions reductions projected come from currently untested technologies at the demonstration or prototype stage today: including advanced battery storage, hydrogen electrolysers and direct air capture and storage.

Existing renewable energy production also has to scale up dramatically under the roadmap to achieve the net-zero goal. By 2050, two-thirds of total energy supply has to be produced by wind, solar, bioenergy, geothermal and hydro energy. Solar is the biggest source of energy, accounting for one-fifth of total supply.

Overall, the IEA roadmap is more aggressive than similar pathways laid out by the Intergovernmental Panel on Climate Change (IPCC). It projects just 65% of the fossil fuel use of the median IPCC 1.5°C pathway, a seventeen-percentage-point larger increase in wind and solar use and less reliance on negative emissions technologies.

Source: IEA

IEA pathways and scenarios are widely used by businesses and financial institutions to guide their own decarbonisation strategies. For example, UK bank Barclays uses the 2018 IEA Sustainable Development Scenario to set Paris-aligned benchmarks for its energy and power portfolios.

3) Firms are underestimating “green swan” impacts, says BoE’s Breeden

The challenges involved in running climate scenario analysis mean financial and non-financial companies alike are probably lowballing the losses posed by cascading climate shocks, a top official at the Bank of England (BoE) has said.

Sarah Breeden, who oversees the BoE’s efforts to prepare the financial system for the effects of climate change, said on a Tuesday webinar that the use of new models, data and analytical frameworks by firms — together with a tendency to focus on a small number of climate risks and risk transmission channels — means they are only getting a partial view of their real exposures. Reliance on past data and historical correlations, which may be upended by climate change, may also be skewing their findings, she added.

“All of these factors lead me to believe that financial firms and businesses are significantly underestimating the potential impacts, and ‘green swan’ events are not just possible but likely until capabilities, understanding and management of these risks are greatly improved,” she said.

‘Green swan’ events, a term coined by economists at the Bank for International Settlements (BIS), are those climate-related shocks that are deeply uncertain but likely to inflict outsized financial losses on governments, business and financial institutions.

Breeden said existing risk models need to be re-examined and historical correlations re-assessed to account for the step-change in causal relationships that could occur because of climate change. “There are perhaps parallels to the financial crisis where models provided false comfort. The most obvious case for this is in physical risk where we know there are non-linearities that are not well captured,” she said.

Breeden offered advice to financial institutions conducting climate scenario analysis, too. She said attempting to produce precise quantitative outputs “can be unhelpful and unnecessary for decision-making”, and that firms instead should aim for “sound qualitative assessments supported by some quantitative analysis”.

She also pressed firms to look at their physical and transition risks “coherently”:

“Some combination of these risks will materialise. If you are assuming there is no price on carbon in your risk models, you’re implicitly assuming a high degree of warming. If you do believe some policy action is inevitable but don’t know what the shadow price of carbon is, don’t assume it is zero. That is equivalent to not knowing for sure how [the] Bank rate will evolve but assuming it away when discounting over 30 years,” she said.

The BoE is scheduled to begin its own inaugural climate scenario analysis of the portfolios of major UK banks next month.

4) Too-big-to-fail banks most exposed to physical climate risks  — ECB

Twenty-five top lenders hold more than 70% of loans and debt in the European Union banking system vulnerable to physical climate shocks, new analysis in the European Central Bank’s (ECB) latest Financial Stability Review suggests.

The potential concentration of these risks among a handful of banks “could have implications for financial stability”, the agency said.

“While physical risks are not new for the assessment of credit and market risks, more frequent, more severe and more strongly correlated physical hazards may place additional strains on the banking system, especially for banks with lending in limited geographical areas,” it added.

Source: ECB

However, of the 25 lenders identified as the most exposed, the majority are large and have well-diversified loan books, plus thick capital buffers because of their status as systemically important financial institutions. This should allow them to absorb losses from physical shocks without slipping into insolvency.

The ECB used data from 357 firms to run its analysis. The grading of credit exposures by their vulnerability to physical risks was provided by FourTwentySeven, a climate risk business owned by Moody’s. The physical risk ratings were set using the location of each corporate’s head office, and therefore may not reflect the full exposure of multinational companies with operations around the world.

The ECB review also featured a breakdown of EU banks’ exposures to transition risks. It found that the amount of loans and debt outstanding to the manufacturing sector, which has some of the highest emissions, was “significant”, making up around 20% of banks’ total credit portfolios.

“The manufacturing sector’s emissions are mostly defined as scope 3 [indirect emissions], giving grounds to assume that changes in consumer preferences would entail significant transition risks. Our analysis therefore suggests that exposures to manufacturing firms represent a major source of climate-related credit risk in banks’ corporate loan portfolios,” the ECB wrote.

5) Bank of England launches plan to green its bond portfolio

The UK’s central bank intends to shrink the climate impact of its corporate bond holdings as part of its efforts to support the country’s transition to net zero emissions by 2050.

The Bank of England (BoE) plans to set climate targets for its £20 billion Corporate Bond Purchase Scheme (CBPS) and tilt future bond-buying towards issuers which are making big strides towards net zero and away from those that are not.

Speaking at Bloomberg in London on Friday, Andrew Hauser, the BoE’s Executive Director for Markets, said greening the bank’s bond portfolio does not conflict with its monetary policy objectives.

“Doing so lies clearly within the MPC’s [Monetary Policy Committee’s] revised remit, and can be justified by noting that current market prices do not yet fully reflect the inevitable increase in the shadow carbon price,” said Hauser.

In March, the UK finance minister amended the BoE’s mandate to factor in a commitment to net zero.

Hauser laid out a few options for setting portfolio climate targets. One would use the weighted carbon intensity of the portfolio, aligning the bond book’s emissions footprint over time with the overarching net-zero target. Another would use an ‘implied temperature rise’ metric, which transforms data and projections of the current and future emissions of companies into estimated future temperature levels.

In order to tilt the portfolio towards high climate performers, Hauser said the BoE could use a ‘scorecard’ approach, which would rank issuers using a series of metrics, such as the level and speed of change of their carbon footprints, the existence of regular climate reporting, their commitment to specific reduction targets, and credible third-party validation of those targets.

The BoE will gather comments from the financial industry and other stakeholders on its plans until July 2. The bank said earlier this year it intended to adopt a new approach for bond-buying ahead of the next round of CBPS purchases, planned for Q4 2021.

Please send questions, feedback and more to louie.woodall@climateriskreview.com

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First image: lev radin / Shutterstock.com, Second image: QiuJu Song / Shutterstock.com All other images under free media license through Canva.