Financing the war on climate change

On 12 April 1912 the Titanic set sail. Two days later, while in the Arctic seas Captain Edward Smith received 7 iceberg warnings over the course of the day. But he followed standard procedure which was to proceed at full speed on the basis that the lookout would provide sufficient warning and the ship could steer or smash its way through. Based on backward looking historic data this was smart thinking. He had a schedule to keep, he was expected in New York in three days, and he was after all captain of the largest and newest boat in the world.

At 11.40 pm the lookout spotted an iceberg dead ahead. The engines were stopped and the ship attempted to evade. At 11.50 it struck the iceberg.  At 12.05 the order was given to abandon ship. At 2.05 am the last life boat departed. 700 people were saved 1500 died. There were still plenty of space on the lifeboats but there hadn’t been enough time to get off.

The financial sectors response to climate change is alarmingly similar. Full speed ahead finding and exploiting new fossil fuel assets even though the atmosphere doesn’t have the capacity to safely absorb what we already know about. 30% of bonds and equity is in sectors vulnerable to stranding: natural resources and extraction, power utilities, chemicals, construction and industrial goods.

People in this room all know that these companies are going to have to take massive write-down at some time over the next 15-20 years. They are praying to God they’ll reach the lifeboat before the ship hits the fan. (Forgive my bad taste in jokes)

I am going to talk about the role financial regulators and central government need to play to avert catastrophe to turn the billions into trillions? I make three key points.

Embedding the TCFD’s [Taskforce on Climate-related Financial Disclosures] recommendations is a good foundational step. This report has yielded some important benefits: the financial regulators largely accept systemic risks to the banking and insurance sector and agree something needs to be done. TCFD provides a language for talking and thinking about them: transition risks, climate risks. It asks institutions to establish governance and strategy around climate and undertake scenario analysis which is disclosed to stakeholders.

Central Banks’ Network for Greening Financial Systems is the most important international forum. It shares experiences and best practice. The Network’s three work streams are: sizing the impacts of climate on the economy (including low probability tail risks), mapping how current supervisory practices should be changed, scaling up of green finance.

Finance ministries also have a major role to play, both as direct issuers of green bonds, and also in providing financial incentives for others to issue. The largest sovereign issuer is currently the French OAT with 5 billion Euro new issuance last year some 1% of French Government spending. Singapore and Hong Kong governments provide subsidies to cover some of the costs associated with issuing green bonds.

But that’s not what truly ambitious looks like. We need to look back to the war to see real intervention. Between 1942 and 1945 the US government debt rose from around 50% of GDP to 106% of GDP. Unlike climate change the war was commonly perceived as a clear and present existentialist threat and the country’s financial systems got behind it.

Was debt incurred to fight the war wasted? Of course not. As well as allowing the Allied countries to maintain their freedom this expenditure created a raft of technological benefits that transformed the 20thcentury at least as much as the war itself: the Manhattan Project created fissile materials used in nuclear power and bombs, Bletchley Park produced the first pre-semiconductor computers and cryptographic algorithms. Then there was RADAR, jet engine aircraft.  What marvels will a green New Deal unlock? And without the body bags.

A month ago today a small number of left-leaning Democrat representatives signed a resolution to fund a Green New Deal to transform US energy, transport and buildings stock. In their resolution they say US wildfires would be twice as bad as now by 2050, and by 2100 US climate related losses would be $500 billion/yr ($2000 /person). Its opponents say the cost of implementing the Deal would be $5 to 9 trillion a year.

Turning to the Central banks. What are they doing? The ECB’s and BoE asset purchase programmes, which purchase some green bonds, are nothing to brag about. They are just business as usual. If anything they are biased against green bonds since so many fossil fuel issuers have high credit ratings based on their financial histories. But implementing TCFD is a useful first step.

What does an audacious supervisor look like? In China the central bank PBoC is intervening to allow green bonds to serve as collateral for medium term lending facility; there’s also discussion about using preferential risk weighting for green assets including green bonds and green loans. In India the Priority Sector Lending rules oblige banks to lend minimum volumes of money to agriculture, SMEs and renewable energy. These are out of step with OECD countries light-touch supervision, but are they really less bad than bank capital being poured into another asset bubble.

But supervisors could do even more. During the second world war the Fed was an agent for change, not a supervisor. The second world war was debt financed and the Fed purchased the equivalent to 3.2% of GDP in bonds to keep the yield low. Inflation coupled with high nominal rates of GDP growth in the 1950s allowed the then unprecedented levels of debt to erode away back down to pre-war levels.

But a properly audacious financial regulation would focus on the Tragedy of the horizon – the fact that that finance markets are still myopically rewarding yesterday’s business models. Finance should not be funding new fossil fuel infrastructure because of the halo effect of yesterday’s strong balance sheets. The market’s time myopia means the future stops mattering after 5-7 years once climate-misaligned assets are safely on some-one else’s balance sheet. We need to massively raise the cost of capital for brown assets so they are never built in the first place; and redirect this to green infrastructure. And we need to do this yesterday.

Audacious policy means large Green and brown adjustments to capital weights and bank lending targets set at a level sufficient for an orderly exit out of fossil fuels in the next decade or two. This is what many countries have signed up to, and what we need.

The Titanic had plenty of warning about the hazard it faced, if it’d had slowed down as had other nearby ships that fateful night, the momentum of its terrible coal engines might have been tamed. Spaceship Earth doesn’t have any lifeboats.

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