Weekly round-up: October 25-29

The top five climate risk stories this week

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1) Bank of England edges towards climate capital charges

The Bank of England (BoE) has said it is open to using capital rules to deal with the “financial consequences” of climate change on the banking system.

A report published Thursday by the Prudential Regulation Authority (PRA) — the BoE unit responsible for the oversight of financial institutions — also said that it would be prepared to impose “an additional capital charge or scalar where appropriate” on firms that have “significant climate-related financial risk management and governance weaknesses”.

However, the PRA added that capital rules are “not the right tool” for tackling greenhouse gas emissions, since their ability to alter investment and lending decisions “is not likely effective unless calibrated at very high level”, which in turn could warp the distribution of financial risks within the banking system.

The report, the second on climate change adaptation published by the PRA following a 2015 document focused on the insurance sector, describes the role of capital requirements in climate-related financial risk management. A PRA statement accompanying its publication said that the regulator will be undertaking work to check whether “changes to the design, use or calibration of the regulatory capital framework” may be needed to guard banks from climate risks.

The nonprofit Positive Money welcomed the BoE’s new stance. “After months of pushing back on the idea of ensuring capital rules reflect climate risk, believing that banks can be left to themselves to address this systemic issue, it is positive that the Bank of England appears to be recognising the need for stronger regulation,” Positive Money senior economist David Barmes said.

BoE officials have previously said they do not see capital rules playing a useful role in the fight against climate change. In June, BoE Governor Andrew Bailey said the case for climate to be incorporated in the capital framework “has yet to be clearly established and possibly may never be”.

2) European Commission backs ‘green’ banking package

Banks in the European Union will be required to “systematically identify, disclose and manage” ESG risks, including climate-related risks, under a bundle of new rules endorsed by the European Commission (EC) on Wednesday.

The review of the EU’s Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD) adopted by the EC — the executive branch of the EU responsible for initiating legislation — would also codify regular climate stress tests by European supervisors and financial institutions.

In addition, the updated CRR would empower the European Banking Authority (EBA) to assess whether “a dedicated prudential treatment” for ESG risks would be justified — meaning potential new capital charges. Article 501c of the revised CRR said such an assessment would include: the measuring of the “effective riskiness” of assets subject to ESG risks; building out a way to categorise physical and transition risks, including regulatory risks; and the possible short, medium and long-term effects of a dedicated prudential treatment on financial stability and bank lending. The EBA would be required to report to the EU’s governing bodies on its findings by June 2023.

The EC’s package will now be discussed by the European Parliament and Council ahead of implementation. 

Finance Watch, a European NGO, said the EC’s proposals are “dangerously weak” in relation to climate-related prudential risks. “By deciding not to tackle climate change-related systemic risks through Pillar 1 capital requirement measures, the Commission is failing on its duty to apply the precautionary principle enshrined in the Treaty on the Functioning of the European Union. Instead it relies on an illusory quantification of risks that will not only take more time than we can afford to spend given the urgency of the climate change situation, but also seems to ignore the conclusions of the recent reports produced by the NGFS [Network for Greening the Financial System] and the ECB,” said Thierry Philipponnat, Finance Watch’s Head of Research and Advocacy.

3) Fed lags other central banks on climate change

The Federal Reserve scored near the bottom of a ranking of G20 central banks on climate and biodiversity policies published just days before the UN Climate Change Conference (COP26) in Glasgow.

The Green Central Banking Scorecard, an in-depth comparison of central banks’ climate research, advocacy, monetary policy, and financial policy, was first published in March and has been endorsed by 24 civil society organisations, including Positive Money Europe, BankTrack, and the Climate Safe Lending Network (CSLN).

The Fed was ranked fifteenth out of 20 in the latest edition of the scorecard, compared with thirteenth place back in March. Its fall was attributed to the lack of any significant policy changes on climate in the intervening months. The central banks of Australia and Canada also dropped down the rankings for similar reasons. 

The Fed has yet to make any policy on incorporating climate change factors into its monetary operations and has issued no guidance or requirements to banks under its supervision on managing their climate-related financial risks. Though Fed Governor Lael Brainard recently said that the central bank would incorporate climate in scenario analysis in the future, a timetable has yet to be published.

Climate advocates said the rankings showed that Fed Chair Jerome Powell is not up to the task of making the US central bank a climate leader. “We need new leadership to turn this ship around, and we need it now,” Justin Guay, Director of Global Climate Strategy at The Sunrise Project, said on Twitter.

Elsewhere in the rankings, the Bank of England (BoE) slipped from fourth to fifth position as it failed to keep pace with the development of climate-related policy by the European Central Bank (ECB).

The Banque de France claimed the top spot from the People’s Bank of China, which fell down to third in light of its recent credit guidance on supporting the domestic coal industry.

4) UN body sets standard for “credible” net-zero finance pledges

Financial institutions should use a science-based definition of net zero when it comes to aligning their portfolios to the goals of the Paris Agreement, the UN Environment Programme Finance Initiative (UNEP FI) has said.

In an ‘input paper’ drafted for the G20 ahead of its summit in Rome on Saturday, UNEP FI set out 11 recommendations for “credible net-zero commitments for financial institutions which are seeking to employ state-of-the-art practices”. The paper defines a net-zero commitment as one that explicitly follows the 1.5°C carbon budget set out by the Intergovernmental Panel on Climate Change (IPCC). This means that net-zero banks should make sure that all accumulated emissions over the next 30 years track this budget. Under this definition, a bank would not be able to claim net-zero status if it carried on with business-as-usual up until 2049 and then decarbonised its portfolio all at once in 2050.

The paper also states that net-zero banks should ensure their target-setting approaches encourage alignment by their portfolio companies to sector- and region-specific decarbonisation pathways. “Financial institutions … need to understand both individual sector trajectories but also how these trajectories add up to an economy-wide (or portfolio-weighted) trajectory destined towards net zero by 2050,” the report reads.

The framework also calls for financial institutions to set interim decarbonisation targets on a five-year cycle, and publicly report on these on an annual basis.

“It is no longer enough to make new year’s resolutions, but to demonstrate — week in, week out — that we are making progress against them,” said Jakob Thomae, Executive Director of the think tank 2 Degrees Investing Initiative (2DII) and a member of the COP26 Finance Sector Expert Group. “What’s more is that it’s becoming clear that for net zero targets to be meaningful, they have to drive real world emissions outcomes. Moving from portfolio to alignment will be a challenge, but has the potential to transform the way we think about the relationship between finance and society”.

The publication of the UNEP FI framework comes as membership of the UN-convened Net Zero Banking Alliance (NZBA) has surged to 88 banks as of October 29, up from 60 a month ago. Wall Street giant Goldman Sachs joined the Alliance on Monday, meaning all six major US lenders are now members. Signatories to the NZBA commit to transitioning their operational and financed emissions to net zero by 2050 using “the best available scientific knowledge”. However, in recent weeks the alliance has been criticised for allowing members to continue to fund fossil fuel projects while claiming alignment with Paris Agreement goals.

5) Central banks short on resources to tackle climate change

Members of a club of green central banks and supervisors have cited “a lack of internal capacity” as a key obstacle when it comes to integrating climate- and environment-related risks into their oversight and operations.

In a report released by the Network for Greening the Financial System (NGFS) on Tuesday, the group said a dearth of resources, time, funding, and labour were “limiting factors” on its members’ ability to implement the five recommendations outlined in its ‘Guide for Supervisors’, which was published last May.

The findings came out of a survey of 53 NGFS members conducted in the first quarter of 2021. This also revealed that some central banks lack sufficient expertise to operationalise the recommendations, and that the rapidly evolving nature of the climate change field “can lead to challenges in staying abreast of developments”.

Despite these frictions, the vast majority of NGFS members said they had made a start on implementing the recommendations. Ninety-four percent of respondents said they had made substantial or some progress towards developing a clear strategy, establishing an internal organisation, and allocating adequate resources to tackling climate‑related and environmental risks. A majority also said they had made some or a lot of progress pinpointing how climate-related risks could be transmitted through their host economies and financial systems.

However, analysis of how climate-related risks could impact financial assets and institutions is less advanced among NGFS members. Though 60% of respondents said they had identified and assessed these risks in a qualitative manner, just 30% have gathered data or run exposure analysis, and only a few members had conducted forward-looking exercises. Forty percent had analysed transition risks, but only on-quarter physical risks.

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