To put it plainly: in order to avoid falling prey to Mark Carney’s tragedy of the horizon, we must acknowledge that the horizon for climate action is now.
The green swan
Today, however, we are not talking about the
Bewick’s swan, but rather the “green swan”, by which we mean potential,
systemic financial crises that stem from climate-related risks. This
concept takes its name from the theory of the black swan. It is a
metaphor for unexpected events that have a wide-ranging impact on
society that can only be explained with hindsight. This phenomenon was
brilliantly described by Nassim Nicholas Taleb
just before the world became engulfed by the global financial crisis in
2008. That crisis was a wake-up call for policymakers across the globe
to take tail events seriously in their analysis and setting of policies.
It is the reason why the sense of urgency about how to deal with
possible green swan events resonates loud and clear in the minds of
central bankers and supervisors.
The green swan book at the heart of today’s conference was released in January 2020
just a few weeks before another major event that has been having such a
tremendous impact on our daily lives for more than a year now: the
coronavirus (COVID-19) pandemic. On top of its wide-ranging human and
economic implications, the pandemic has forewarned us of the scale of
the effort required to prevent green swan events materialising. In 2020
the reduction in greenhouse gas emissions was less than will be required
every year until 2030 and beyond. And this reduction must be achieved
through structural change rather than the human and economic disruption
caused by lockdowns. To put it plainly: in order to avoid falling prey
to Mark Carney’s tragedy of the horizon, we must acknowledge that the horizon for climate action is now.
Turning tide
In
these dire circumstances, and faced with these daunting prospects and
challenges, the call to pursue the required structural changes is
mounting. More and more countries have made a commitment to achieve net
zero emissions by 2050 at the latest. More and more of these countries
are now translating these commitments into legislation and concrete
action plans. And more and more countries are stepping up their earlier
commitments. On 21 May, the G7 made a commitment to keep within reach
the target of limiting the increase in global warming to 1.5 degrees
Celsius. The tide is truly turning towards climate action, and the flow
is gathering force.
This is also reflected in the work programmes
of multiple international organisations. Under the Italian Presidency,
the G20 has made climate action a key priority and an integral part of
the recovery from the pandemic. More specifically, it has re-established
the Sustainable Finance Study Group and upgraded it to a working group
expected to report before the end of the year on any major gaps or
barriers to mobilising sustainable finance. In parallel, the Financial
Stability Board is working on ways to promote consistent, high-quality
climate disclosures in line with the recommendations of the Task Force
on Climate-related Financial Disclosures. It is also continuing to work
on data requirements and gaps that are crucial for assessing the
financial stability risks posed by climate change. The FSB will report
to the G20 on both issues in July. In the meantime, the International
Financial Reporting Standards Foundation is moving ahead with a proposal
to set up an international sustainability standards board to deliver
the first consistent, single set of global norms for climate-related
company disclosures. The Foundation’s proposals have received widespread
support from, among others, the International Organization of
Securities Commissions. At the same time, it is essential that the IFRS
work does not fall short of current investors’ need and international
best practices. In that context, the Foundation’s work can take
inspiration from and should leave sufficient room for the European
Commission’s proposal for a Corporate Sustainability Reporting
Directive. The Commission’s proposal includes transposition of the
Directive into national law by EU Member States by December 2022 to
ensure it is applicable for the fiscal year beginning 1 January 2023.
With all these activities and numerous initiatives from non-governmental organisations,
the green finance landscape is quickly becoming crowded. As everyone
has a vital role to play in addressing the climate crisis, this is
clearly a welcome development. Yet it also requires enhanced
coordination among different stakeholders: first, to ensure that ongoing
work can build on work being carried out elsewhere without anyone
having to reinvent the wheel; second, to ensure that workstreams are
sufficiently complementary; and third, to identify potential
perspectives that are being left unaddressed – blind spots from which a
green swan could emerge.
Following this conference and the G20
meeting in July, the COP26 summit taking place in Glasgow in November
will be a key event for taking stock of the many initiatives currently
under way. It will also be an important milestone for assessing the
progress being made to meet the objectives of the Paris Agreement and a
catalyst for accelerating the actions required to ensure the commitments
made are kept within reach.
Role of central banks and supervisors
In
this crowded field, central banks and supervisors are also increasingly
showing their resolve and dedication to contribute within their mandate
to integrating the effects of the climate crisis in the exercise of
their tasks. They have done so individually, but also collectively as
part of the Network for Greening the Financial System (NGFS) which I
have been proudly chairing since its inception in December 2017. Back
then, the eight founding members represented 30% of global economic
activity. Now, the NGFS has evolved into a network of 91 members and 14
observers covering five continents, around 85% of global emissions, 88%
of the global economy and all global systemically important banks. And
it continues to expand its coverage, reach and range of activities.
Activities which know no taboos and cover all the core missions of
central banks and supervisors: microprudential, macroprudential and
monetary policy.
NGFS activities
Let me outline some of
the ongoing activities of the NGFS that contribute towards taking
immediate action to deal with climate-related risks. I will base this
discussion on what the green swan book refers to as two “epistemological
breaks” that central banks and supervisors need to consider. Two ways
to radically revisit conventional thinking and attitudes towards policy
action. Two paths to do justice to the exceptional nature of the climate
crisis. Two avenues for immediate action.
The first proposed
break refers to the importance of taking a forward-looking approach in
the analysis and management of climate-related risks. This differs from
traditional approaches to risk which typically use historical
regularities to project possible future outcomes and are ill-suited for
identifying the possible emergence of black or green swans.
To
close this gap, the NGFS has published macrofinancial scenarios on the
potential long-term consequences of the climate crisis and climate
policies. Under the leadership of the Bank of England’s Sarah Breeden,
the NGFS will next week publish new vintages of the scenarios that were
first released in June 2020. These scenarios provide a framework for
analysing the impact of physical and transition risks under different
climate policy assumptions. While they have been developed for use by
central banks and supervisors, they may also be useful for governments,
academia and private sector entities. With these scenarios, the NGFS
provides – and intends to regularly update – an important public good
for all stakeholders, public and private, to help them engage in
forward-looking climate-risk analysis under a common and consistent
global reference framework.
While they are an important piece of
the puzzle, scenarios alone cannot mitigate climate-related risks.
Scenarios need to be developed into stress testing methodologies for
assessing risks and vulnerabilities on an ongoing basis. This is the
type of analysis and policy assessment that is the bread and butter for
central banks and supervisors for so many other sources of risks.
Thanks to the shared experiences of its wide-ranging membership and its
collaboration with academia, the NGFS is uniquely placed for its work
on climate scenarios and stress testing to feed into and inform the
broader international policy agenda.
Given the deep uncertainty
with respect to climate change and climate policies, we need to
continuously evaluate the impact of physical and transition risks.
Collecting consistent and comparable climate data linked to economic
activities is vital. In March 2020 the NGFS established a workstream
dedicated to mapping data gaps more systemically and proposing ways to
bridge them. An interim report published last week lays the groundwork
for a comprehensive stocktake of the data needs of various stakeholders,
their objectives, and their activities across the financial sector.
In a nutshell, the report concludes that better data does not simply
mean more data. Both the public and the private sector need
high-quality, granular, reliable and comparable data. At the same time,
we cannot afford to wait. And the report indeed concludes that we don’t
need to wait. We already have significant scope for drawing on available
data and building on existing approaches to improve our awareness,
analysis and assessment of climate-relate financial risks. The NGFS
interim report provides important input for the Financial Stability
Board’s report on data gaps to the G20. A final NGFS report, focusing on
how to effectively bridge remaining data gaps, taking on board the
Financial Stability Board’s report to the G20, is expected by the end of
the year. We will use the knowledge and expertise gathered from
bridging data gaps to evaluate and update the forward-looking scenarios
under consideration.
The green swan book advocated a second
paradigm shift. Central banks and supervisors must be more proactive to
enable them to fulfil their mandate while avoiding the tragedy of the
horizon. Here the NGFS has clearly taken the lead. Since its inception,
the NGFS has acknowledged that the climate crisis is a driver of
financial risks, putting it squarely within the mandates of central
banks and supervisors. And along with research partner INSPIRE, the NGFS
will soon publish an outline of a research proposal on the financial
stability risks of biodiversity loss.
To avoid overlooking green swans, we urgently need to move beyond
climate-related risks and better understand the materiality of the risks
of environmental degradation for the financial sector.
Governments
clearly bear primary responsibility for addressing the climate and
environmental crises we are facing. While central banks and supervisors
should of course not overstep their mandate, there is also a legal risk
of being sued for failing to act and comply with legal obligations. In
recent years, we have observed a steep increase in climate-related and
environmental litigation, which has more often than before been
successful. Most examples have so far involved litigation against non-financial corporates and governments.
However, also central banks and supervisors can become exposed to this
kind of litigation risk just like the financial institutions that they
supervise.
The implications of these legal risks for the conduct of policy and for
the stability of the financial system also need to be considered by
central banks and supervisors.
With
the strong conviction that central banks and supervisors not only can,
but must, take into account climate-related and environmental risks and
act urgently to fulfil their mandate, the NGFS seeks out ways to inspire
its membership, to push the frontier and act as a trailblazer.
Specifically,
the network is now thoroughly analysing progress in supervisory
practices in the field of climate-related and environmental risks. A
progress report detailing the results of the analysis is expected to be
published ahead of COP26. Preliminary results show that more supervisors
clarified how existing legal requirements will be applied in the
context of climate-related and environmental risks.
These will guide the supervisory dialogue on these matters in the
future. It should be recognised that both supervisors and financial
institutions are in the early stages of the journey towards sound
management of climate-related and environmental risks. Therefore, it is
to be expected that guidance will be refined and the bar will be set
higher over time as expertise and regulations develop and capabilities
improve.
However, setting expectations is an important step, given the need to
urgently start integrating climate-related and environmental risks in
financial institutions’ decision-making and risk management processes.
On
the monetary policy side, the NGFS has explored ways in which central
banks can incorporate climate-related risks in their monetary policy
implementation frameworks. A report published in March identified nine
high-level options covering credit policies, collateral frameworks and
asset purchases.
It is up to individual central banks to explore what combination of
actions to take under their mandate and in their specific legal context.
Yet, the full membership of the NGFS sent a clear message by
collectively rallying behind the insight that climate change has
implications for the conduct of monetary policy.
The
NGFS has focused extensively on providing practical guides for central
banks and supervisors on building their capacity to act. As our
collective knowledge is evolving apace, this guidance will need to be
continuously updated. That is why I am very pleased to inform you that
the NGFS is currently exploring how it can help build capacity within
the central banking and supervisory communities and is considering
developing training initiatives in cooperation with some other key
stakeholders. We will announce progress on this soon.
Moving with the tide
Let
me conclude. There are different ways to approach a swan. In the
context of traditional financial crises, there has been a lively
academic debate about whether central banks should “lean against the
wind” to mitigate the risks of a crisis or focus instead on cleaning up
afterwards. In my view, a similar discussion is obsolete in the context
of green swans for at least three reasons. First, the cataclysmic and
irreversible nature of green swan events imply that cleaning up
afterwards is simply not an option. Once certain thresholds have been
passed, the current, delicate status quo of our ecosphere can no longer
be restored. Second, as the NGFS has demonstrated beyond doubt, climate
action is fully consistent with the mandates of central banks and
supervisors. From where we currently stand, the risk of doing too little
too late is significantly larger than the risk of central banks and
supervisors overstepping their mandate. Third, and maybe most
importantly, when it comes to climate policy, headwinds are turning into
tailwinds. In other words, central banks and supervisors can benefit
from the changing tide that is turning strongly in favour of climate
action as underlined by the increasing commitments made by governments.
However,
commitment alone is not enough to address the climate and environmental
emergency that we face. We must show resolve. The NGFS was established
as a coalition of the willing. The NGFS has become a coalition of the
committed. The NGFS will set out to be a coalition of the ones that
deliver. To quote Nassim Nicholas Taleb in his black swan masterpiece:
“History and societies do not crawl. They make jumps.” Let’s act on that
lesson in addressing green swans. Let’s jump. And let’s move forcefully
with the tide towards climate and environmental action. Let’s move by
urgently and fully addressing the profound consequences of the advent of
the green swans, thereby stopping the eastward shift of the Bewick’s
swans’ hibernation grounds. The horizon to act is now. Let the word
horizon henceforward no longer be associated with the word tragedy. Let
us embrace the horizon.
SSM
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