APPG Meeting on Greening Finance: How can we protect the financial system from climate risk?

Greening Finance: How can we protect the financial system from climate risk?

The APPG on Sustainable Finance held a meeting of parliamentarians and key sustainable finance stakeholders on the 27th of October to discuss how we can protect the financial system from climate risk. This was a private meeting and so quotes are not attributed to individuals.

The chair opened the session. She said that green finance is now a mainstream media topic, and that long-term financial investments have the capacity to tackle climate change and she emphasised the need to harness the power of the financial industry. She also said it was important to look at ways of protecting the financial sector against the worst effects of the climate crisis.

One of the vice-chairs of the APPG on Sustainable Finance spoke about his proposed amendment to the Financial Services Bill which would have ensured that prudential regulation takes into account the high risks of investing in fossil fuels. He highlighted the importance of achieving cross-party consensus on climate change. He argued that capital needs to be put into activities that prevent rather than fuelling climate change. He will be putting forward a Private Members’ Bill to propose that financial regulation must account for the high risks of investing in fossil fuels.

The next speaker set the scene on financial regulation, sustainable finance and climate change. He saw finance as the “enabler of climate change” due it enabling fossil fuel industries to operate. Since the Paris Agreement, around £4 trillion of investment has been funnelled into financing fossil fuel industries. Financial regulation doesn’t currently give risk weighting to climate related risks. The climate risks posed by fossil fuels are not accounted for, despite the potential for a carbon bubble to cause the next financial crisis. He argued that the high risks of investing in fossil fuels must be accounted for in financial regulation through introducing climate calibrated capital rules to ensure that the high risks are placed on investors rather than taxpayers. Taxpayers would end up bailing out the banks if there is a carbon bubble induced financial crisis. The speaker highlighted how investors like to be able to quantify risks, but climate risks are fundamentally unquantifiable, due to many forms of uncertain climate tipping points, but legislators need to act now instead of waiting for the “perfect system”.

He referenced the report from the IEA which argued that in order to prevent over 1.5°C of global warming, no new oil and gas fields can be built, which renders projects like Cambo incompatible with our climate targets. He went on to talk about the report from the European Central Bank on the challenge of capturing climate risk in the regulatory banking framework, quoting: “Current capital buffers do not capture climate-related financial risks going to the underlying risk way that do not yet reflect climate-related risk to the full extent”. He also spoke about the NGFS network of central bank’s report on the issues surrounding the methodology of the climate stress test.

The next speaker spoke about Positive Money’s campaigns to reform the banking system for a fair, sustainable and democratic economy. He argued that a “qualitative” approach, rather than quantitative, is best when assessing climate risks, as we cannot wait for the perfect quantification of risks. If greater risk weightings were assigned to fossil fuels, it would help policymakers to move forward with more stringent climate regulation without fear of triggering a financial crash. He added that it was inevitable that climate capital rules will be implemented. Positive Finance previously proposed a green mandate for the Bank of England, and now the BoE has been given a green remit and is announcing its approach to green bond purchases.

Ultimately the key leverage for accelerating progress will be public pressure and political backing. Positive Money is focused on education materials, petitions, consultations, and open letters. Governor of the BoE, on unleashing green investment and introducing climate calibrated capital rules – the letter was signed by 60 MPs and 25 Peers. Positive Money also tries to create a sense of competition across the financial sector by tracking and ranking the green finance policies of financial and monetary organisations across the G20. He added that we’re not just facing a climate crisis, but an ecological crisis too. Nature risks are even more complex than climate risks and this will need to be factored into financial regulation. The European Central Bank has expressed support for capital measures and climate-related restrictions on banks. Finally he said that the institutional arrangements between our macroeconomic authorities needs to be re-evaluated.

The next speaker opened by talking about how the global economic system has been built on fossil fuels over the last 200 years and the challenge will be changing that without huge financial instability. We continue to build fossil fuel infrastructure which ties us into far exceeding our climate targets. To address this we will need a better understanding of risk and financial disclosure. Under the current global Carbon Budget, we have 7 years left at current rates of emissions if we are to achieve a 1.5c warming outcome. The world’s 900 billion tonnes of coal, oil and gas are valued by the World Bank at $39 trillion. There is $10 trillion of energy supply infrastructure and $22 trillion of demand infrastructure. This means that a huge proportion of the economy is dependent on fossil fuels and we need to create regulation that depreciates those assets and looks at unexpected liabilities such as underfunded asset retirement obligations.

Under the IEA 1.5c scenario, we cannot have any new investment in fossil fuels if we are serious about meeting that target. Many of the projections by banks estimate a continued expansion of fossil fuels and this continues to create the capital to fund more fossil fuel extraction. We need an agreement to stop oil and gas production. The UK Government is currently approving the development of new fossil fuel infrastructure, including the Cambo oilfield, whilst the Scottish Government is urging the UK to not approve any more oil and gas fields. Renewables are becoming cheaper than fossil fuels across the world, but investments continue in new fossil fuel infrastructure, which will become stranded assets if we are to meet our climate targets.

The main concerns raised were:

• Do companies consider the effects of material climate-related matters in their finances?
• Do companies disclose quantitative climate-related estimates?
• Do companies ensure that finances are consistent with discussions of climate matters in other reporting?
• Do companies provide Paris-aligned assumptions and estimates?
  In Audit reports:
• Do they consider climate matters in audits? Many don’t at the moment.
• Do they indicate inconsistencies in company reporting related to climate matters?
• Do they respond to specific investor requests to assess Paris-alignment of assumptions and estimates?

One speaker added that the Financial Stability Board has assessed that if the global temperature increases to 4c and much of the planet becomes inhabitable, the loss of damage to the economy will be anywhere between 2 and 9%. Pension Funds have used this to suggest that the loss to pensions will only be between 1 and 9%. He was concerned that these severe underestimates lead to fundamentally bad risk assessments by pension funds.

The chair summarised what had been discussed. Those who can’t find a way to quantify the radical uncertainty caused by the climate crisis are saying not to worry about it, but policymakers need to plan ahead for long-term potential climate shocks. On pension funds, the sector is too dominated by short-term thinking. Policymakers should work out how to put financial incentives in place for the necessary actions to tackle climate change and much greater financial disincentives on activities that deter progress.

One speaker raised the issue that gas is deemed a sustainable activity that isn’t viewed as risky, despite it still being a fossil fuel. He said that this needs to change. He argued that the solution to the current energy crisis is not more domestic gas, but to build more renewables with a long-term, low-price system and multiple suppliers.

One participant asked about how better messages can be used to communicate the complex issues of greening finance and pension funds to the wider public in an accessible way. One speaker said that a simple narrative is needed to explain to people that we need to stop providing finance to stuff we do not need. The alternative is fuelling climate change and another financial crisis caused by reckless risk taking. Another speaker added that where money flows shapes the economy and we need to distinguish between the risk narrative and the impact narrative as the impact narrative of money works better with the public.

The chair closed the event by arguing that “It is possible to invest your money in a Net Zero way.” She added that if you make money in the coming months through investments , it might not provide for your retirement if the climate crisis hits in ways you cannot forecast in advance. Changing regulation to account for the high risks of fossil fuel lending is critical or greening our financial system.