Climate change and financial stability

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Policy that takes environmental issues fully into account would improve the stability of the global financial system, explains Achim Steiner, Executive Director, United Nations Environment Programme

Inaugurated in 1999, the G20 is a forum through which 19 countries and the European Union – making up 85 per cent of global gross domestic product and two thirds of the world’s population – discuss, build consensus on and decide collectively to address major international challenges.

 

The G20 has, over its short life, embraced many policy issues, while maintaining a clear emphasis on economics. This year’s G20 annual meeting in Brisbane, Australia, will headline the commitment to raise the G20’s economic growth rate by two per cent above its current trajectory over the next five years. It will also touch on other key topics, from energy to anti-corruption and tax, to infrastructure and international development.
However, the G20’s origins, and its focus today, are in finance. The financial crisis of 2008 was the catalyst that took the G20 to centre stage globally. In effectively providing a platform for orchestrating a coordinated short-term response to the crisis, the G20 helped to overcome the dangers of nationally focused policy actions that otherwise could have led to protectionism and, ultimately, the conditions for a damaging fragmentation of the global economy. At the same time, the G20’s creation of the Financial Stability Board (FSB), which provides a mechanism for connecting the world’s leading central banks to the G20 as an international policy process, has provided a longer-term vehicle to strengthen the governance of the international financial system.
Collective environmental security is, in many ways, also a matter of finance. Most obvious is the public finance needed to safeguard the environmental commons – from the water each of us drinks and the air we all breathe to the stewardship of vulnerable biodiversity essential to the world’s circular economy. One such example is the endangered bee population, whose pollinating is vital to food production. Climate is another case in point, with ongoing international negotiations placing considerable emphasis on the question of how much developed countries will finance developing countries’ efforts to reduce carbon emissions, and the costs of communities and economies adapting to climate change.
Yet, public finance is just one part of the nexus between money and the environment. Private finance, and specifically the $273 trillion of private capital worldwide, has considerable implications for the environment. Investment in clean technology, such as renewable energy, makes a difference to environmental outcomes, as does the continued investment in coal-fired energy, which pollutes the atmosphere and water, and is damaging to health. Indeed, the G20’s focus this year on the challenge of financing long-term infrastructure globally, which is estimated to need $5 trillion annually until 2020, has profound environmental dimensions. Building energy-efficient and climate-resilient cities will be a defining feature of their future utility, both to their residents and to the global community. Likewise, investing in agricultural systems that can remain productive in the face of changing and increasingly volatile weather patterns will be the basis for securing adequate, affordable, healthy food for tomorrow’s growing global population.
In the past, the G20 has considered aspects of the environment, including climate. Yet its focus on economic growth has tended to overshadow environmental concerns. Its decision to act collectively in 2009 in response to the global financial crisis, for example, was criticised by environmental groups for failing to ‘green’ the planned $1.1 trillion global stimulus. The launch of the new Global Infrastructure Initiative at the September meeting of the G20 finance ministers and central bank governors in Cairns, Australia, could have been – but was not – an opportunity to ensure that such a bold initiative would minimise pollutants, deliver infrastructure that made best use of limited natural resources and remain effective in the face of a changing climate.

Climate risks and the financial system
The quality of the environment is not just a matter for environmental ministers and policies. A growing number of financial regulators and central bankers are responding to the simple fact that the working of the financial system produces effects on the environment that can impact the health and, ultimately, the stability of the financial system. Brazil’s central bank has a host of environmental regulations, and the China Banking Regulatory Commission’s Green Credit Guidelines provide increasingly stringent directions regarding environmental risk management. While most central banks today remain ambivalent that climate represents a systemic risk to the financial system, the Bank of England has recently commenced a review of the relationship between insurance regulation and climate change. Governor Mark Carney signalled his growing conviction that the future of the financial system and our management of climate were closely interwoven at the recent IMF/World Bank Annual Meeting in Washington DC, declaring that the “vast majority of [fossil fuel] reserves are unburnable”, and by implication of less value than markets currently think, if global temperature increases are to be contained to two degrees as recommended by the world’s leading scientists. The United States Securities and Exchange Commission provides guidance to investors in assessing and reporting on climate risks. Indeed, hosted by the United Nations Conference on Trade and Development, the Sustainable Stock Exchange initiative currently has 16 stock exchange members, including London and New York, all of which are advancing new sustainability-focused disclosure requirements and, in some cases, indexes.

These and many other examples have surfaced during the initial phases of the Inquiry into Design Options for a Sustainable Financial System, established by the United Nations Environment Programme in early 2014. The inquiry, due to be completed in mid 2015, is exploring which rules governing today’s financial system – including financial and monetary policies, financial regulation and private standards such as credit ratings and accounting standards – could be adjusted to ensure that lending and investment decisions take greater account of environmental and also social outcomes. As the examples above illustrate, the inquiry’s approach is to identify and assess the broader potential of existing innovations, of which there are many. Its work is guided by an advisory council made up of financial regulators, central bankers and leaders from key private and international financial institutions.
The G20 is a promising global policy platform for advancing an improved alignment of the financial system with the long-term needs of the real economy, which requires environmental and social issues to be taken more centrally into account. Such a development would take time; it is not simply a matter of highlighting the nexus in the next communiqué.
Three practical steps would help to advance such a development. The first could be to request that the FSB consider the environmental aspects of financial stability for the first time. Given the milestone climate negotiations in Paris in late 2015, a suitable initial focus might be for the FSB to consider the impact of climate change on financial stability. Secondly, to encourage the environmental stress testing of key financial market policies. A starting point here might be to ask the Bank of International Settlements to consider the environmental impacts of the Basel III banking rules, which are thought likely to discourage long-term investing and therefore have an impact on investment in renewables. And finally, to explore the potential for ‘greening’ central banks’ asset-purchasing activities, whether through residual quantitative easing, or, more broadly, because of the growing size and importance of the balance sheets of major central banks.
A healthy financial system is a keystone of an inclusive and sustainable global economy. Such a system must nurture and invest in the key drivers of its economy, which crucially include a supportive natural environment. The G20 is well placed to focus on this nexus, and, in so doing, to further its mandate of securing a sustainable financial system.

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