## A New, Sustainable Financial System to Climate Change (Mark Carney)

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### Overview
- Urgent need for a new sustainable financial system to avert runaway climate change.
- Key constraints: record temperatures, wildfires, severe storms, and sea levels rising faster than previously thought.
- Timeframe warning: "we have only 12 years left to stop runaway climate change" per a 2018 Intergovernmental Panel on Climate Change report.
- Current trajectory: global energy emissions increased 1.7 percent last year.
- Target to limit warming to 1.5̊C: "a 45 percent decrease by 2030 and net-zero emissions by 2050."

### Climate losses, insurance gap, and macroeconomic benefits
- Insured losses in 2018: $80 billion.
- 2017 losses: insured $140 billion plus uninsured $200 billion.
- Insurance penetration under 1 percent in Bangladesh, Egypt, India, Indonesia, Nigeria, the Philippines, and Vietnam.
- Lloyd’s of London estimate: a 1 percent rise in insurance penetration can translate into a 13 percent reduction in uninsured losses and a 20 percent lower disaster recovery burden on taxpayers.
- Macroeconomic benefits from closing insurance gaps include increased investment and higher output (potentially up to 2 percent of GDP).

### Scale of investment needed for low-carbon transition
- International Energy Agency estimate: a low-carbon transition could require $3.5 trillion in energy sector investment every year for decades—twice the current rate.
- Under that scenario requirements by 2050:
  - nearly 95 percent of the electricity supply must be low carbon;
  - 70 percent of new cars electric;
  - the carbon dioxide intensity of the building sector must fall 80 percent.

### Reporting and disclosure
- Task Force on Climate-related Financial Disclosures (TCFD) provides a comprehensive framework for corporate disclosure of climate-related risks and opportunities.
- Current supporters control balance sheets totaling $120 trillion and include major banks, asset managers, pension funds, insurers, credit-rating agencies, accounting firms, and shareholder advisory services.
- Climate-related shareholder resolutions spiked to 90.
- Investment managers controlling more than 45 percent of global assets under management now back shareholder actions on carbon disclosure.
- Companies representing over 90 percent of all shareholder advisory services now support the TCFD.
- Disclosure uptake: four-fifths of the top 1,100 G20 companies now disclose climate-related financial risks as some TCFD recommendations advise.
- Three-quarters of those who use this information have seen an improvement in the quality of climate disclosure.
- Next step recommended: make disclosure mandatory; the United Kingdom and European Union have signaled this direction.
- Implementation timeline emphasis: "Over the next two years, the current process of disclosure... will be critical" to ensure TCFD standards are comparable, efficient, and decision-relevant.

### Risk management and supervisory reforms
- Climate-related financial risks require improved understanding and management by banks, insurers, asset managers, and supervisors.
- Anticipated reassessment of virtually every financial asset due to changes in climate policies, technologies, and physical risks.
- Bank of England observations:
  - almost three-quarters of banks are starting to treat the risks from climate change like other financial risks.
  - Banks are assessing exposures including: mortgage books to flood risk; extreme weather impact on sovereign risk; exposure to carbon-intensive sectors; consumer loans for diesel vehicles; mortgages for rental properties given energy efficiency requirements.
- Bank of England supervisory expectations to be embedded:
  - Governance: embed climate risk consideration into governance frameworks, including at the board level, and assign oversight responsibility to specific senior managers.
  - Risk management: consider climate change in accordance with board-approved risk appetite.
  - Regular use of scenario analysis: necessary to test strategic resilience.
  - Appropriate disclosure of climate risks: develop and maintain methods to evaluate and disclose these risks.
- The Bank of England will stress-test its financial system under various climate pathways, including a business-as-usual catastrophic scenario and a transition to net zero by 2050 consistent with the UK-legislated objective.
- Stress test will integrate climate scenarios with macroeconomic and financial models, developed in consultation with industry and experts from the Network of Central Banks and Supervisors for Greening the Financial System (a 48-member group representing jurisdictions that account for half of global emissions).

### Sustainable investment, markets, and taxonomy
- Sustainable investment seen as a new horizon with opportunities (e.g., transforming energy, reinventing protein).
- Estimated infrastructure investment between 2015 and 2030: $90 trillion.
- Green bond market:
  - offers rated, liquid, long-duration investments for investors;
  - taps the $100 trillion pool of long-term private capital managed by global institutional fixed-income investors.
  - green bonds accounted for only 3 percent of global bond issuance in 2018.
- Need to mainstream sustainable investing beyond excluding brown industries and financing deep-green technologies; must catalyze companies shifting from brown to green.
- "Tilt" strategies (overweighting high ESG stocks) and "momentum" strategies (focusing on companies improving ESG ratings) have outperformed global benchmarks for close to a decade.
- Biggest hurdle: inconsistent measurement of ESG.
- Need for a common taxonomy to identify environmental outperformance and direct investment; the EU green taxonomy and green bond standard are a start but are binary (dark green or brown only).
- Goal: a richer taxonomy—"50 shades of green"—and ability for asset owners to report the climate pathway of their portfolios.

### Policy implications and recommendations
- Financial markets will amplify but not substitute for coherent, credible climate policy action.
- Policy frameworks with greatest impact will be:
  - time-consistent (not arbitrarily changed);
  - transparent (clear targets, pricing, and costing);
  - committed (through treaties, nationally determined contributions, domestic legislation, and consensus).
- Faster issuance of legislated objectives and concrete climate actions will accelerate sustainable finance and the shift of capital toward low-carbon activities.
- Financial policymakers’ role: develop frameworks for markets to adjust efficiently and avoid a climate "Minsky moment."
- The more prolific the reporting, more robust the risk assessment, and more widespread the return optimization, the quicker the transition and the better the prospects for breaking the Tragedy of the Horizon.

*Mark Carney, Finance & Development, December 2019.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2019/december/a-new-sustainable-financial-system-to-climate-change-carney.pdf_