The systemic failure of US leadership on climate

No, this is not about Donald Trump. He is as much a symptom as a cause. Failure to provide leadership – or even just match benchmark standards – is far more widespread than just the President or even the Republicans.

Take, for example, US central bankers.

Globally there is now growing momentum among financial authorities to address climate risks. The Central Banks and Supervisors Network for Greening the Financial System (NGFS), which was launched at the end of 2017 by eight institutions, now consists of 42 members and 8 observers, including the European Central Bank, the Bank of England, the People’s Bank of China, the Banque de France, the Bundesbank, the Dutch central bank as well as the Swiss National Bank.

Yes, the Federal Reserve is absent.

What could US central bankers be doing? Here are some examples from around the world:

• The Bank of England (BoE) has taken to accelerate the integration of climate risks into the risk management frameworks of banks and insurance companies (see e.g. its supervisory statement here, as well as its inclusion of climate risk scenarios into its insurance stress test here). It has also committed to report on how it accounts for climate risks in its own operations, i.e. including its monetary policy operations (see here, “From next year, the Bank will become the first central bank to adopt the TCFD recommendations across our entire operations.”)
• The Banque de France has adopted a responsible investment policy for its own funds and pension fund portfolios (see here).
• The Dutch central bank, DNB, has started exploring the financial stability impacts of climate-related financial risks (see e.g. here) and has run an energy transition risk stress test for the financial system of the Netherlands (see here). The DNB has also become the first central bank PRI signatory for its own reserves (see here).

Similar steps should obviously also be on the agenda of the Fed. For an interesting exchange on the reflection of climate risks in the Fed’s supervisory role between Senator Brian Schatz and Fed Vice Chair Randal Quarles click here (1:11:10-1:17:28). To quote Senator Schatz: “I am asking you to make sure that to the extent that the whole of the federal government understands, predicts, measures the risks related to climate change, that you make sure you have all of those datasets, you have access to all that expertise and that it informs your process.”

Likewise, climate risk analytics should also be integrated into the Fed’s monetary policy operations. A recent staff paper from the FRBSF argues that this is not relevant for the Fed as it “can only purchase government or government agency debt” (see here). This ignores, however, the fact that the Fed’s collateral framework includes a much broader array of assets than its outright purchases (see here) and applies external ratings (which the NGFS has highlighted as not sufficiently accounting for climate risks) to determine eligibility.

With this in mind, the case for integrating climate risk into credit risk assessments appears to be a much more relevant one for the Fed’s own operations than is usually acknowledged. Looking at the Fed balance sheet collateralized credit currently appears to play only a small role. But looking at the numbers back in 2008/2009, e.g. at the Term Auction Facility as well as Primary Credit, and assuming that we cannot rule out seeing such numbers again, a closer look at climate risk in the Fed’s collateral framework looks like a critical step to take. For additional background on how that can be done, as well as an illustration for the corporate bond portfolio of the ECB, see the paper by the Council on Economic Policies here.

Fundamentally the question comes down to the understanding of systemic risk by the board members and senior executives in the US central banking community.  Can they take action whilst the White House is occupied by a climate denialist President?  Yes, they can – and they must.

It is important climate aware investors lead the call for the USA to catch up with peers.

Author: Raj Thamotheram

In the interests of full disclosure, I am a board member of CEP but the views expressed here are my own.