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Quantitative Greening

In the years since the signing of the Paris climate agreement, many of the world's central banks and leading financial regulatory authorities have started to create new tools to assess and manage climate-related financial risks. Behind these efforts is a shared realization: there can be no climate stability without financial stability.

BERKELEY – In 2015, just before the signing of the Paris climate accord, Mark Carney, the governor of the Bank of England (BoE), gave an historic speech warning that climate change poses escalating risks to global financial stability. Now, more than 40 central banks and regulators from countries that account for about 44% of global GDP have come together to address that threat. Through the Network for Greening the Financial System, the Bank of France, the BoE, the European Central Bank, the People’s Bank of China, and other major central banks – with the notable exception of the US Federal Reserve – are developing new regulatory standards and analytical tools for the age of climate change.

As many financial institutions and companies now know, climate risks are no longer simply reputational risks; they are material operational risks that exist in the present, not in some indefinite future, and they are drawing increasing concern from investors. Nearly $1 of every $3 under professional management – around $30.7 trillion in assets – is already invested according to environmental, social, and governance (ESG) criteria. Green bonds have also grown rapidly, with issuance quadrupling from $45 billion in 2015 to $168 billion in 2018 – though the total still represents just 3% of global bond issuance.

According to the UN Intergovernmental Panel on Climate Change, the costs of global warming could reach $54 trillion by 2040 if carbon dioxide emissions continue at current rates. Between the direct costs of environmental changes and severe weather events and the indirect costs of actions to mitigate climate change, there are a variety of risks to financial-market stability, including business disruptions, rising bad-loan portfolios from bankruptcies, losses to insurers from weather-related damage, and declining coastal real-estate values. Moreover, even long-term financial risks can have short-term consequences if fossil-fuel assets are significantly repriced – or even “stranded” – in response to sudden changes in investor preferences or official policies.