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Raise capital charges for ‘climate risky’ assets, experts tell UK ahead of COP26

Report calls for assets with high environmental risk to be subject to higher capital charges

Ben Caldecott, Director, Oxford Sustainable Finance Programme
Ben Caldecott, Director, Oxford Sustainable Finance Programme

Influential policy experts have urged UK rulemakers to update banks’ capital charges to incorporate environmental risk. 

The recommendation comes as part of a wider report co-authored by Oxford University’s well-known professor of green finance, Ben Caldecott, and Benedict McAleenan, a Senior Adviser at think tank Policy Exchange. The pair explore how the UK should promote the ‘greening’ of the financial system as part of its current Presidency of both COP26 and the G7. 

Capital charges - the money that banks must hold on their balance sheets to offset any risks tied to their lending - should be increased for transactions that carry climate or nature-related risks, says the report. It adds that the changes should be phased in from 2022, but calls for charges to be “immediately” lowered for green infrastructure.

It is not the first time solvency ratios and capital requirements have been suggested as a tool for steering finance away from polluting assets and into green ones, but it remains a controversial one. The EU has been considering the idea for a number of years, but has pushed it down the agenda in response to widespread backlash - in part because there is not strong enough evidence that ‘green’ assets are less financially risky than fossil-based ones.

The report says changes to capital charges should be “a priority” for the G7 presidency, which will culminate in the UK hosting a meeting this summer with Canada, France, Germany, Italy, Japan, and the US. 

A few months later, in November, the UK will host a broader range of governments as part of crucial climate negotiations for COP26. Caldecott is a Strategic Advisor for Finance to the UK Government ahead of the summit.

The report also recommends that the Government should mandate nature-related financial disclosure, mirroring its recent efforts to strengthen reporting on climate risks via its three financial regulators. 

It suggests that the fastest way to do this would be to speed up the development of a Taskforce on Nature-related Financial Disclosures (TNFD), an initiative that was kicked off by the UK last year. Under current plans, the TNFD will be fully established by the end of 2021, and plans to enter its ‘uptake’ phase in Q1 2023.

Developments on biodiversity and nature-related risks are moving fast, with the University of Cambridge’s Institute for Sustainability Leadership today publishing a framework to help identify such risks. The framework, developed in partnership with a number of financial institutions including Robeco, Deutsche Bank and BNP Paribas, identifies the causes and sources of nature-related risks, their impact on companies, and how this translates to financial risk.

The Policy Exchange report further recommends that all supervised financial firms and premium listed companies should be required to develop Net Zero transition plans. Public finance for firms, including bailouts and export finance, could be made conditional on them having a transition plan in place, it suggested. 

The full list of 12 recommendations is:

  1. Mandate nature-related financial disclosure
  2. Advocate for other countries to mandate TCFD and TNFD-aligned disclosure
  3. Introduce higher capital charges for assets at risk from climate change. 
  4. Promote principles-based instead of rules-based financial regulation
  5. Promote the Bank of England’s Supervisory Statement
  6. Design asset purchase schemes to account for environment-related risks 
  7. Lead global cooperation to map physical assets using satellite data
  8. Require supervised financial firms to implement targets and transition plans and promote this approach internationally
  9. Require premium listed firms on UK stock exchanges to implement transition plans which should be subject to shareholder approval
  10. Base public finance on sustainability performance
  11. Create a voluntary ‘gold standard’ on corporate governance
  12. Base the UK green taxonomy on scientific evidence alone, instead of a mix of scientific evidence and industry input. The UK should also develop a taxonomy for environmentally harmful activities.
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