Climate change presents a systemic risk to the entire economy and threatens our financial stability, but there has been an underappreciation of this to date. Thankfully, this is starting to change. Asset managers, insurers, banks and pension funds increasingly see environmental factors as material and are incorporating this information into their decision making. But action needs to take place at all levels of the economy and we need a full transformation of the global financial system if we are to have any chance of meeting our urgent environmental goals.
Luckily, there are greenshoots of action starting to appear at this level.
Greening the financial system
Last month, the Network for Greening the Financial System (NGFS), an international group of 36 central banks and financial supervisors, released their first comprehensive report calling for action on climate change, and highlighting the role they see themselves playing in facilitating the low carbon economic transition.
The launch of this report at a conference packed full of financial market participants was historic, marking the first time many from the industry rallied together to discuss their role in solving this global challenge.
Taking stock, the NGFS acknowledged the challenges we face in integrating sustainability in the financial sector. They pointed to a lack of political willingness or leadership to date, a lack of consistent data, issues with capacity and knowledge gaps, and the fact that in any case the level-playing field must be preserved in regulated and supervised institutions.
Hopefully, the ongoing work of the NGFS should address the first of these challenges, given this high-level group are showing clear willingness to lead on this issue.
When it comes to addressing the other challenges, the report sets out six recommendations. These involve central banks and supervisors integrating climate-related risks into financial stability monitoring and micro-supervision; leading by example and integrating sustainability factors into their own-portfolio management; bridging environmental data gaps; as well as building awareness and sharing knowledge through collaboration.
The NGFS made it clear that they cannot accomplish this without the collaboration of policymakers. To that end, they also pointed out the need for robust and internationally consistent environmental disclosures as well as the development of taxonomies of economic activities.
It all starts with disclosure
It is of course hugely encouraging to see this group recognise the need for consistent and comparable environmental disclosures, given this is what we have been pioneering at CDP for the last two decades. While disclosure may not provide the whole solution, it is the bedrock of action and we will not find adequate solutions without this level of transparency.
The good news is that while there is clearly a lot more to be done, we are not starting from scratch and many companies already report environmental data. When CDP sent out its first climate change disclosure request to 500 companies in 2002, 245 of them responded.
Fast forward to last year, and we had 7,000 companies with over half of global market capitalisation providing data to us, not just on climate change, but on the interrelated issues of water security and deforestation too.And in recognition of the role of the Task Force on Climate-related Financial Disclosures (TCFD) in mainstreaming consistent environmental reporting – a framework the NGFS focuses on in its report – we aligned our questionnaires with the TCFD’s recommendations to create an additional lever, and drive more widespread market adoption.
“We must be ambitious and start acting urgently”
To sum it up – disclosure is happening, and it is already happening at scale, but imagine what we could do with the weight of the entire financial system behind it. At CDP, we would relish the opportunity to provide our support and expertise to the NGFS and help make this key recommendation a reality.
Collective action needed now
It is important to remember that while this report shows progress, it is just the starting point on what needs to be a transformational journey. The integration of climate-related factors into prudential supervision is still at a nascent stage, and the tools and methodologies remain in early development.
A more holistic approach is needed to understand the relationship between different levels of risk, resilience and adaptation. This will require cooperation across the market – from NGOs, academia, financial market participants to central banks and supervisors.
Crucially, financial firms should not wait for central banks or supervisors to deliver some sort of universal model. Rather, they should initiate their own work in identifying risks, vulnerabilities and opportunities, and quantify these to make them more sophisticated over time, in tandem with the work of the NGFS.
It is clear that financial policymakers have a clear interest in ensuring the financial system is resilient to any transition, and that delaying it means that sharper and more costly emissions cuts would be required in the future to meet policy targets.
An urgent, but orderly transition
The speed and timing of the transition is crucial. While climate change has the potential to wipe out trillions of dollars’ worth of assets, too rapid a transition could materially damage financial stability, as massive reassessment of assets destabilise markets, spark losses and cause a tightening of financial conditions. On the other hand, an orderly scenario, with clear policy signaling, would allow adequate time for existing financial and non-financial infrastructure to be replaced and for the necessary social, economic and technological progress.
The involvement of central banks and supervisors on this issue at this critical time could not be more welcome, but we must be ambitious and start acting urgently. Environmental factors are not yet sufficiently considered in the financial system, and the transitional and physical risks that once seemed too distant to consider, are now materialising as clear threats to the economy.
In the words of Mr. François Villeroy de Galhau, the Governor of the Banque de France: “it is time to roll up our sleeves”.
Pietro Bertazzi is Global Director, Policy Engagement at CDP and Ludwik Kotecki is Engagement Director, Central Banks and Financial Supervisors at CDP.