Greening thefinancial system

Tilting the playing field
The role of central banks
OCTOBER 2019

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Prepared by the Climate Bonds Initiative
Prashant Vaze, Alan Meng, Diletta Giuliani

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Supported by WWF and
SOAS Centre for Sustainable FinanceSummary
Climate change, through physical damage to assets owned by banks
and insurers and through an abrupt reduction in value of fossil fuelrelated assets, represents a risk to the stability of financial institutions
and the financial system as a whole. Risks of climate change are longterm, rising, poorly understood and hence under-valued by the shortterm metrics used by banks to evaluate financial risk.
Governments have the primary responsibility for developing policy
to reduce climate risks. But Central banks and financial regulators(CBFRs) can and, this paper contends, should play an important role
too. CBFRs have established the Network for Greening the Financial
System. The Network is being used to share research and experienceon how best to manage climate risks.
As regulators, lenders of last resort and monetary policy makers,
CBFRs have a variety of tools to influence the lending and investment
behaviour of banks and insurers.
Individual CBFRs are already undertaking actions to raise theawareness of climate risks in financial institutes and apply theseprinciples in their own operations.
But they could do even more. They could help establish reporting
norms, and then mandate banks and insurers to disclose their climate
risks and perform climate stress tests. They could themselves tilt
their own purchases of financial assets so as to buy less fossilfuel intensive assets and more green assets. They could change
the weightings applied to the regulated financial assets banks andinsurers hold to better reflect long-term climate risks. In several
emerging markets, where central banks play an important role indetermining the allocation of credit in the economy, CBFRs could
develop quotas so that financial institutions switch their lending toand investment in from brown activities to green.

Greening the Financial System Climate Bonds Initiative2

Introduction“4°C warming makes theworld uninsurable”
Thomas Buberl,Axa CEO1This briefing paper looks at the role central
banks and micro-prudential financial
regulators (CBFR) could play in greening
the financial system. Central banks areconcerned with regulating macro-economic
goals like stable inflation and output growth,availability of credit to sectors and theoverall stability of the financial system.
Micro-prudential regulators are moreconcerned with the stability and conduct ofindividual financial institutions. This paper
lumps together central banks and microprudential regulators even though in many
countries responsibilities are spread overmultiple organisations with the precise
demarcation varying between countries.
Section 1 provides a background of how
the CBFR’s have been adopting the climatechange risk agenda. Section 2 of the paper
discusses the current roles played by CBFRs
and reviews the instruments in currentuse (though not necessarily for ‘green’
purposes). Section 3 covers current policies
for reducing climate risk. Section 4 talks
about possible actions they could take toreduce climate risk.

Box 1:
Summary of recommendations from TCFD and NGFS reports
Task Force on Climate-related Financial
Disclosures – June 2017

NGFS – comprehensive report –April 2019

TCFD made recommendations to G20
about the disclosures all organisations
should make to their stakeholders tofacilitate the market’s understanding ofclimate related risks.

Recommendations to CBs:

• Governance: Board and managements rolein assessing and managing climate risks• Strategy: Where material, disclose
short, medium and long-term risks andopportunities including resilience todifferent climate scenarios• Risk management: How organization
will manage climate related risks• Metrics and targets: Disclose theorganisations’ direct and indirectemissions and targets• Integrate climate-risks into monitoringand supervision activities.
• Implement them in portfolio
management.
• Bridge data gaps
• Supply technical assistance and shareknowledge within the central banking
community.
For the policy makers and the private
sector, it calls for:• Robust and consistent disclosure ofenvironmental risks, and;• A taxonomy of green and brown assets.

There were supplemental recommendations
to the finance sector (lender, underwriter,investor and asset manager) of the role itplays in capital allocation and the leverage
this provides to lead best practice.

have committed to support the TCFD
recommendations;4 though investors say
disclosure is still insufficient with only 25%
of companies reporting on five or more of
the 11 recommended disclosures.

The discourse around central bank action
has advanced markedly over the past few
years. Mark Carney’s Tragedy of Horizons
speech,2 given to an audience of insurers
at Lloyds, marked an important point: asenior central banker, the then chair of the
Financial Stability Board, articulated therisks and opportunities stemming fromclimate change. He spoke about the “current
and prospective financial stability risks
from climate change” and the role financial
policy-makers need to play “in ensuring thefinancial system is made resilient to anytransition hastened by those decisions, andthat it can finance the transition efficiently.”
His message was clear: climate change wasa risk to the financial system and financial
policy makers needed to act.

Fast forward two more years, to April 2019,
central banks assembled into a coalitionof-the-willing, the Network for Greening
the Financial System (NGFS), published its
first “comprehensive report”. It outlined six
actions that should to be taken by central
banks, governments and industry (see Box1).5 In essence, the report suggests that
CBFRs implement climate-risk thinking
in their own actions, provide technicalassistance to financial institutions (FIs) andrecommend that FIs collect and disclose
more data to the market. Box 1 summarises
the main recommendations by the NGFS
and the TCFD.

In 2016, the influential Taskforce on Climate
Related Financial Disclosures (TCFD)3 wasestablished by the Financial Stability Board(FSB) and chaired by Michael Bloomberg.
Its 2017 report has played a significant
role in steering the direction of the current
debate on transparency. The most recent
status report says that 785 organisations,of which 374 are in the financial sector,

The securities and exchanges
regulators (IOSCO) have also establisheda sustainable finance network. This
has already published a short explanatory
paper.6 The network is kicking off workby undertaking a stock take on current
actions by members especiallyon standards for ESG disclosures
recommended by regulators.

Greening the Financial System Climate Bonds Initiative

This paper frequently refers to the bondmarket and speaks to the use of green bonds.
CBFR’s remit covers the entire financial
system and many of the points being madeapply equally to other financial instruments,
especially loans. That said, the bond market
is critically important: around half of all
financial assets, roughly USD 100 trillion,7
are held as bonds, especially by long-term
investors like pension funds.8 Bonds issued
by developed market sovereigns andhigh-quality corporates, because of their
low risk of default and liquidity, play animportant role in financial regulation. They
are used by banks and insurers to comply
with supervisors’ requirements to holdHigh-Quality Liquid Assets to fulfil BaselIII’s pillar 1 requirements. This has created asituation where there is a ready market for
highly rated sovereign bonds even if they pay
negative interest rates.9
As prudential supervisors and monetary
authorities, CBFRs have a huge impact on
the bond market, including by (a) deciding
whether or not particular bonds may serveas collateral, (b) determining and validating
any adjustments made to allow for theirriskiness, and (c) proscribing which sorts ofbonds to purchase for own-account reasons.

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What do CBFRs do and what should they do?
“With great power comes
great responsibility.”
Uncle Ben
(Spiderman’s uncle)
CBFRs roles include the following:
1. limiting inflation through settinginterest rates and reserve requirements,
influencing the supply of money andthe allocation of credit in the economy(monetary policy)
2. promoting financial system stability(macro-prudential regulation)
3. supervising banks and other financial
institutions (micro-prudential regulation)
4. fostering payment safety and consumer
protection.
These duties are often split between thecentral bank and specialist sector regulators for
insurance companies, pension companies, etc.
In addition to these primary roles, CBFRs
may also have responsibilities for wider
government priorities like employment,
economic growth or economic sustainability.
In a review of the mandates of 133 central
bank mandates, Dikau and Volz find that
12% have specific sustainability mandates,
generally coached in terms of sustainablegrowth of the economy e.g. Philippines,
Malaysia and Iraq and on occasion forsustainable development: Nepal - “tomaintain the stability of price and balanceof payment for sustainable development of
economy”. Altogether 29% are mandated tosupport government priorities which usually
include sustainability. While the primary
responsibility of central banks includes
creating and maintaining price stability,
some mandates also give equal weightto other economic objectives, including
sustainable growth, full employment andin the case of several emerging markets
anchoring the exchange rate. 10
A hierarchy of goals is seen in the Europe
System of Central Banks (ESCB): “without
prejudice to the objective of price stability,
the ESCB shall support the general
economic policies in the Union with a viewto contributing to the achievement of theobjectives of the Union as laid down in Article 3of the Treaty on European Union.”11
It is important to understand the range of
duties that are already given to central banks
and financial regulators since these will set
the boundaries for the sorts of measuresthey can use and will effect the range ofexisting skills and competencies. Theirroles in overseeing conduct, supervising,investigating and remedying infractions andcomplaints will occupy much of staff time,and determine the skill sets of the staff.
Box 2 gives a summary of CBFR’s roles
and instruments. The underlined items are
discussed further as possible instruments togreen financial systems.
This means that within their current legal
frameworks central banks’ focus is on
economic goals such as price stability,
economic growth and safe-guarding thestability of the financial system. That said
central banks have considerable latitude to
be inventive in the actions taken to support
financial stability – witness the development

of QE first in Japan then US and Europe in
response to deflationary pressures.
Increasingly central banks speak aboutclimate change as a threat to financial
systems, framing their initiatives as a
response to the market’s under-pricing ofclimate risk. In an open letter three central
bankers comment:12 “…We recognise thatthe challenges we face are unprecedented,
urgent and analytically difficult. As long as
temperatures and sea levels continue torise and with them climate-related financial
risks, central banks, supervisors and financial
institutions will continue to raise the bar toaddress these climate-related risks and to“green” the financial system.”
In terms of concrete actions – the response
is still muted. Members of the NGFS are stillBox 2:
Role of the central banks and financial regulators
Monetary policy
Central banks (CB) are required tomaintain inflation within specified levels.
The instruments they use include
1. Open market operations – purchasing/ selling financial assets to stabilise
exchange rate
2. Standing facilities to provide banks withliquidity – using the collateral framework
3. Minimum reserves – regulated banks
must hold a share of net deposits with the
CB (US deposit taking banks must holdat least 10% of deposits with the Fed)

3. Short term liquidity = High Quality
Liquid Assets/ Net Cash Outflows
4. Longer-term liquidity (1 year) =Available stable funding/Required
stable funding
Under Pillar 2 central banks require
supervised banks to stress test theirsolvency and liquidity using a standardised
combination of unfavourable market andclimate assumptions.
Other roles
CBFRs may perform other duties varying
between countries

4. Non-standard monetary policy/QE –purchasing of assets to counter deflation

1. Maintaining currency peg/Managing
foreign reserves

Prudential regulation

2. Investment management – e.g. staff
pension schemes

CBFRs ensure banks, insurance companies
and other FIs are robust against market
risks. These are internationally agreed and(will) follow the Basel III agreement. The
objective of the requirements is to ensure
financial institutions have sufficient capitalreserves to ensure solvency & ready accessto cash if the market conditions change.
1. Eligible capital (mainly from equity andretained earnings)/(credit + market
positions + risk weighted assets)
greater than 7% (in UK)
2. Leverage ratio = Capital measure /Exposure measure. Both numerator anddenominator are based on their non-riskweighted values

Greening the Financial System Climate Bonds Initiative

3. Credit guidance
4. Consumer protection through theregulation of the conduct of banks,
insurers, financial
advisers and other intermediaries
5. Promotion of competition between
financial service providers
6. Regulating exchanges
7. Regulating disclosures of market
sensitive information4

in data collection mode. In the UK, the UK
Prudential Regulation Authority has issued
supervisory notes essentially asking FIs to
implement TCFD’s recommendations on
a voluntary basis. Such actions are useful,requiring forward looking disclosures ofclimate risks by FIs. But their ultimate
success still assumes that self-interested
long-term investors armed with better data
will reassess their investment decisions.
This belief that better information will makemarket participants correctly price climate
risk more efficiently is mishearing Carney’s
more fundamental “tragedy of the horizons”
critique. What if investors prioritise animal
spirits over the greater good?
The UK PRA has gone further than othercentral banks and announced a consultation
on a climate stress test to be undertaken inautumn 2019, followed by introduction of
the stress test itself in 2022. It also issued
climate stress test scenarios for the life
insurance sector, but these leave the key
parameters for the test unspecified and forthe firms to choose for themselves based onrecommended sources.13 The three scenarios
are a down-grading of fossil intense assets
by 2022, an orderly transition broadly inline with the Paris Agreement so to achievecarbon neutrality by 2050, and a physicalrisks scenario of a 4°C temperature rise by
2100.
Despite numerous speeches and reports
about the under-pricing of climate risks
by FIs, CBs have not so far applied theirpowers from prudential regulation ormonetary policy to oblige FIs to reduceclimate risk exposure. FIs remain free tolend to, underwrite, or acquire assets even
if regulators fear they are mispriced. CBFRs
argue democratically elected governments
need to take the lead, using instruments likecarbon pricing to reign in carbon emissions
reductions.
But Governments have so far failed todecisively tackle emissions. Despite 30
years of climate policy, global emissions
are still rising. Government’s difficulty increating and maintaining an effective policy
is evidenced by the EU-Emission Trading
Scheme’s (ETS) major shortcomings. This,
the world’s largest carbon market, has seen
the price of carbon fluctuate from a peak of€30/tCO2 in June 2009, to a nadir of €3/
tCO2 in April 2013, and back to €27/tCO2 in
April 2019, as a result of EU policies aiming
to remove the oversupply of credits from
Phase III of the EU-ETS.
The volatility of carbon price has deterred
the “brown to green” shift in investment
activity. In 2018, the oil and gas majors,
including European companies like BP and

Equinor, collectively spent just 1.3% of
their CAPEX on low carbon investments
such as renewables or CCS.14 Since theParis Agreement was signed in 2015 eight
European banks have provided $16bn of coalfinance chiefly outside Europe.15 Axa, now
divesting from coal, doubled its holdings incoal assets since the Paris Agreement was
signed, and owns around 200 tonnes of coal
per mil USD AUM.16
There are legal and jurisdictional reasons
why central banks, working through capital
markets, might be better placed to mitigate
global carbon emissions than governments.
National climate change policy operates
on territorial emissions as defined by thenation’s geographic boundaries and pays noheed to the fact that managerial control andfinancial benefits might reside elsewhere.
EU governments’ efforts to combat climatechange have not sought to inhibit the
production or financing of fossil assets by
their oil majors or banks and insurers. Indeed,
the global operations of banks and oilcompanies are important sources of national
income. While European governments
have succeeded in reducing their UN-FCCC
defined emissions, European oil companies
continue to undertake worldwide investment
in new fields, and European FIs continue tohold assets in global oil and coal. It is worthemphasising this point. Though many of thericher economies have reduced emissions
within their territories, they continue to reap
the income streams by being the beneficial
owners of assets. Put bluntly they have offshored their carbon emissions to the rest of
the world.
But the OECD economies remain exposed,
via the finance sector, to physical andtransition risks. In theory, CBFRs should
be concerned with the balance sheetsof banks and insurance companies theysupervise no matter where their assets arelocated. This means they are well placed tothink internationally across the world’s capital
markets. In reality central banks will beanswerable to their governors and national
finance ministries. The days of the Governorof the Bank of England intimidating UK bankswith the might of his eyebrow are probably
over, but central banks are more powerfulthan energy and environment ministries, andbetter equipped to undertake the complex
modelling of risks and benefits than otherpublic institutions. Uniquely for publicbodies they are outside the normal politicalprocess and have independent boards thatmake publicly published decisions and are
led by governors whose job tenures extend
much longer than many politicians.

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Using CBFR’s toolkit for reducing climate risk andgreening the financial system
CBFR’s have a wide array of instruments
to change FI behaviour. Figure 1 sets out aselection of instruments that CBFR’s could
repurpose to help the financial system aid
the transition to a climate change friendly
economy. These are discussed further below.

Regulatingtransparency
Green and brown taxonomies
An organisation’s exposure to climate risk
depends on the carbon-dependency, locationand physical resilience of their assets. Since“brown” assets, like oil refineries or coalmines are tied to fossil fuel use, they risk
becoming stranded if global carbon prices
discourage fossil fuel use. Similarly, if assets
are located in areas vulnerable to climatechange then worsening climatic conditions
make the assets less insurable. “Green”
assets like renewable energy facilities orhighly energy efficient buildings mitigate
GHG emissions and are resilient to climatechange. “Brown” assets give rise to GHG
emissions or are vulnerable to worsening
climate conditions. There are many assets,
for instance railways, transmission anddistribution grids that are neither “brown”

Figure 1:Toolkit of policies at central banks disposal
Regulatingtransparency

Green andbrown
taxonomies

Mandatingclimatedisclosures

Standard
climatescenarios

Financial asset
purchase by
central bank

Nonconventionalmonetary pol.

Staff pension
funds

Currency
stabilisation
funds

Financialasset
weightings

Capitaladequacy

Collateralframework

Creditguidance &incentives

Lending
quotasInterest rate
discounts

nor “green” and can be used with sustainable
or non-sustainably sourced energy.
In China the People’s Bank of China (PBOC)
has developed the green catalogue. In
Europe, the European Commission has
tasked the Technical Expert Group on
Sustainable Finance (TEG) to advise it on thedefinition of green assets as recommended

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Climatestress tests

Green bondincentives

by the High-Level Expert Group.17,18 The
TEG published their report on the “green”
taxonomy in June 2019. An agreed definitionof “green” economic activities gives
investors wishing to invest in sustainableeconomic activities protection against false
greenwashing claims. But the European
Parliament shied away from the original
proposals on also defining brown assets.19
Taxonomies could be an importantcomponent in creating a widely acceptedand standardised climate credit risk
assessment. Indeed the NGFS report called
for an understanding of the risk differentials
between green & non-green and brown &non-brown assets.20 These can be used as
the basis for banks to “tag” individual loans
and assets according to whether they aregreen, brown or neutral, in much the same
way that a loan for a mortgage will haveinformation about the loan-to-value ratio.
This data is later used at the portfolio level torisk adjust the overall value of the mortgage
book. Tagged assets can be traced throughthe balance sheets of intermediaries, asset
managers and the end investors.
Why should CBFRs, not governments,
develop brown taxonomies?
CBFRs are tasked with safeguarding financial
stability, in this capacity they are primarily
concerned with brown assets since these
directly embody the aforementioned climate
risks to the financial system. The Governorof the Banque de France has called for brown
penalising factors and noted “13% of Frenchbanks’ total net credit exposure is to sectors
vulnerable to transition risks”.21 Indeed,

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the NGFS’s work stream on supervisionadvocates: “Considering the extent to whicha financial risk differential exists between‘green’ and ‘brown’ assets”.
CRFR’s will be sensitive to the ensure they
have appropriate scientific expertise to
create the classification and ensure that it
evolves keeping abreast of the scientific andtechnical progress in the different sectors.
CBFRs can provide the market with definitions
and eligibility criteria for brown assets to help
identify assets posing systemic risks to FI byextending existing green taxonomies such as
those being developed in Europe and China toinclude brown thresholds or criteria.
Mandatory climate disclosures, scenario
tests and stress tests
The TCFD recommends that FIs likeinvestors, banks and insurers establish
governance, strategic and analytic processes
to provide forward-looking, decisionuseful information for their own boards
and external audiences. Several CBFRs andthe NGFS as a body, have signalled theirintention to initially encourage, and in the
future mandate such disclosures.22 BaselII’s Pillar 2 also asks supervisors to evaluate
whether banks’ capital requirements areadequate for their activities and risk profiles.
Mandatory disclosures by FIs are requiredin Brazil and France. In Brazil, the banking
association, FEBRABAN, adopted voluntary
Green Protocols in 2008. In 2014, theCentral Bank of Brazil (BCB) published amandatory Resolution 4,327 on Social andEnvironmental Responsibility for Financial
Institutions23 as part of their Internal Capital
Adequacy Assessment Program (ICAAP).
It forms part of the Basel III pillar 2 risk
assessment framework and increasing
the capital charge for the bank if it cannot
demonstrate adequate capacity to manage
environmental risks.
In 2015, France adopted the “energy
transition for green growth” law. Article
173 of this text is devoted to improving
transparency on the part of investors,
predating TCFD’s recommendations fordisclosure of decision relevant information
on climate change risks on financial
markets. In the EU, the Capital Requirement
Regulation requires banks to publish their
ESG-related financial risks as from 2022.
Forward looking exercises depend onorganisations making assumptions about
future mitigation policy and climate
impacts. To make these disclosures useful toregulators and stakeholders, scenarios andstress tests need to repeatable, systematic,
and consistent. NGFS’s work-stream 2 isconsidering what role CBFRs should play toassist FIs. The debate is whether rules should
be prescriptive and give precise guidelines
about how forward-looking assessments
be performed, for instance specifying the
trajectories of future carbon prices or theseverity of climate impacts at different
points in the future, or whether FIs develop
their own scenarios. Central banks also needto provide guidance on how to analyse longer
term scenarios (10-15 years into future)
which are inevitably more speculative but
need a set of assumptions on growth and low
discount rates to ensure that the longer-term
interests of society are being considered.
Perhaps a two-tier system be used analysing
the balance sheets on conventional timeframes (3-5 years) and long-term timeframes (10-15 years).
The Dutch Central Bank (DNB) has publisheda paper on the transition risk24 based ona macro-economic modelling of a carbon
price shock. It also undertook a survey25 ofmajor banks, insurers and pension funds
asking about their exposure to fossil fuelproducers. Pension funds had a 5% exposure
to fossil fuel companies mainly in the formof commodities, equities and bonds. Banks’
exposure was 2% almost all in the form ofloans. Banks’ exposure was short term: 68%
less than a year, a further 23% between 1
and 5 years before the loan was refinanced.
The duration of banks’ exposure to risks
through lending to brown projects are far
shorter than the useful life of the underlying
physical assets. This might protect shieldindividual FIs – their own liability to the riskof stranded assets end as soon their financial
position unwinds – but the economic risk ofthe stranding still lies dormant somewhere in
the financial system – either with long term
investors, the oil company (and ultimately its
shareholders), or perhaps with the tax-payer
if the magnitude of disruption requires a
future bail-out. The longer-term analysis ofrisks, perhaps a top-down analysis by central
banks, needs to look at the system widerisks, and not the risks to individual FIs who
might have only short duration exposures.

climate scenarios (a 2˚C and 4˚C world in
2020s and 2040s) and at the impact on FIs’agriculture, energy and real estate sector
portfolios. In May 2019, UNEP-FI and 20
institutional investors published a majorreport with comprehensive investor guidance
to help assess climate risks for investors andalign with the TCFD recommendations. It
finds that investors face as much as 13.16%
of risk from the required transition to a
low-carbon economy (using the IPCC 1.5°C
scenario); the report refers to 18 providers ofphysical and transition risk assessment tools
for investment portfolios.28
The three European Supervisory Authorities,
through the ‘ESAs package’, have beenrequired early 2019 to develop “common
methodologies for assessing the effect ofenvironmental risks on the financial stability of
institutions” and to put in place a monitoring
system to assess material ESG-relatedrisks, taking into account the COP 21 Paris
agreement.
There is no need to wait for these scenarios
to be perfectly aligned to climate science.
Economic stress tests are currently
performed to assess FIs’ vulnerability torepresentative synchronised shocks. The
Bank of England’s stress test of UK’s sevenlargest banks and building societies, forinstance, specifies several parameters
including: “30% depreciation of GBP to
USD”.29 This is in no way a forecast – it is an
assumption used to assess the resilience of
the FI to assure the regulator that the FIs aremaking adequate provision against the risk.
CBFRs are already drawing on IPCC data butthey might consider formally working with
relevant IPCC working groups, in designing thedata collection and scenarios needed for FIs touse and share with their borrowers.

But what is needed is a more granularanalysis of how individual FIs would be
impacted based on a portfolio level analysisof their assets. Two preliminary analyses
were piloted by 16 European banks with
UNEP-FI on the physical risk26 and transition
risks and opportunities.27 These highlightthe need for a co-ordinated enhancementin the underlying data about the assets
being financed (their location, and otherphysical attributes) held by FIs especiallywith regards to their exposure to climate
risks. The physical risks looked at two

Greening the Financial System Climate Bonds Initiative

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Financial asset
purchases by centralbankCentral banks are major purchasers of bondsand equities. They are acquired for purposes
like non-conventional monetary policy,
reserve management and exchange rate
targeting. The current practice varies between
different uses and CBFRs, but in general
the preference is to use ‘market neutrality’principles to decide what assets to buy.
The EU Technical Expert Group
recommended that CBFRs consider
promoting greening the financial system
by expressing and implementing apreference for EU Green Bonds (i.e. green
bonds consistent with the EU Green Bond
Standard) when purchasing green bonds.
Non-conventional monetary policy
Non-conventional monetary policy (QE)
has resulted in vast purchases of assets bymonetary authorities. The Eurosystem’s (theECB and Eurozone countries’ central banks)
Asset Purchasing Programme (APP) has
bought over €2.6tr of securities.30 This vast
holding represents over 10% of the Eurozone
countries’ combined GDP. Purchases underthe APP include government bonds (around€2.2tr of purchases) and €300bn of highquality corporate bonds, covered bonds andasset backed securities (ABS). Even though
the programme has now stopped acquiring
new net assets it will continue purchasing
assets to replenish redemptions.

fitness for the low carbon economy. QE has
ostensibly sought to make market neutral
purchases gradually acquiring assets
through the secondary market (monetaryfinancing by ESCB institutions is prohibited)to avoid dominating or tilting the market.
But through their steady and persisting
demand they are actually lowering the costof capital for incumbents, in contradiction to
the government’s emissions targets.32 This
discriminates against new business models
and smaller companies that could play animportant part in decarbonising our economy.
Central banks could explore options
like setting aside credit ratings agencies
assessments. These do not yet properly
incorporate long-term climate risk into theirassessments and are focussed just three
years ahead on credit risks of individual
issuers. Allowance if not made of the systemwide risk that fossil fuel issuers would
experience en masse if lack of progress in thebrown to green transition triggers a robust
public policy response against emissions.
The authors of the LSE paper are wary about
central banks increasing their purchases ofgreen bonds because of the still small scaleof the European green bond market. They
argue substantial purchases might cause amispricing in this nascent market. They dohowever see merit in the purchase of bonds
from public development agencies like the EIB
and removing prohibitions from purchasing
off the primary market. Programmes like
KfW’s funding for green building renovation
projects, or EIB’s green financing and lending

The APP has purchased €18bn green bonds(€6bn corporate and €12bn public sector31)
which accounts for less than 1% of APP
purchases. The tight eligibility criteria set
by ECB restrict asset selection to secondary
market purchases of highly rated, and highly
liquid bonds. With the rise of sovereign green
bonds starting in late 2016 the proportionof green bonds purchased is likely to rise.
The EUR4.5bn sovereign issuance from
Belgium, saw a high share of central banks
in the deal: 26%, compared to only 20%
for a comparable deal in January. By 2016,
the Bank of England, which is outside theEurozone, purchased £435 billion of assets
through its QE programme. However, it does
not publish data showing the magnitude ofgreen bond purchases.

programmes are directly creating new green
assets and policies by CBs that reduce thecost of finance could increase the size of the
programmes.
The recent speech from Lagarde, the newhead of the ECB, stating that the ECB should‘gradually eliminate’ carbon assets and prefergreen bonds, will accelerate the discussion.33
Central banks could reconsider their asset
purchasing from FIs that lend to green
projects and should reconsider rules thatprohibit purchases from the primary markets.
Concepts like market neutrality should not
automatically trump policy considerations
like reducing the cost of the green transition.
Currency reserve management
Central banks hold foreign currency
assets for short term management oftrade imbalances, or to fund currency
management mandates. For instance, theHong Kong Monetary Authority (HKMA) is
responsible for pegging the HKD exchange
rate to USD. It maintains a foreign currency
reserve fund of liquid assets (the ExchangeFund). These are currently valued at USD
440bn34 some 125% of Hong Kong’s GDP.
As the manager of the Exchange Fund, theHKMA has recently announced a set ofmeasures to support and promote Hong
Kong’s green finance development: aprinciple that priority can be given to Greenand ESG investments if the long term returnis comparable to other investments on a riskadjusted basis ; an increase of the Exchange
Fund’s green bond portfolio; participation in

GR E E N B O N Do2

QE by the Bank of England and ECB targets
high quality, liquid assets. The universeof assets allowed by their criteria favour
incumbent fossil fuel business issuances whichhave many decades of history in issuance indebt capital markets. Their strong balance
sheets are based on their historic performance
which may not be a good indicator of their

Greening the Financial System Climate Bonds Initiative

8

ESG-themed public equities investments.35
However, the HKMA could make even more
ambitious use of its vast reserves. Looking at
Norway’s Sovereign Wealth Fund (SWF),36
the HKMA could for instance establish an
exclusion list with environmental criteria.37
HKMA itself could inspire China, which –with the world’s largest foreign exchange
reserves – holds USD 3tr of assets.
Central banks could explore including
green hard currency assets in their reserve
management policy.

PO L LU T ER

CO2

Perhaps only a proportion of the reserves
need to be highly liquid to defend thecurrency. Bangladesh Bank became thefirst central bank to announce they would
target some of their reserves for green bondinvestment in October 2015.
Pension schemes managed by Central Banks
Central banks may manage their staff
pension schemes, and sometimes thepensions funds of a wider population (thenational civil service). These are often
managed conservatively focussing on
government bonds.
Central banks could make long-term purchasesof assets that will contribute to reducing
carbon emissions and be better adapted tophysical risks.
There are examples of central banks
assigning their staff pension schemes withethical mandates. The Banque de France’s
pension fund has €20bn of assets and its
responsible investment charter excludes
coal.38 ECB has delegated proxy voting
for equity investments to asset managers
that have signed up to the Principles for
Responsible Investment (PRI), requiringthem to incorporate ESG factors in theirvoting policies.39 The Bank of Italy recently
announced its intention to purchase €8bn
of green assets of which around €1bn will begreen bonds. This is motivated by the desire
for banks to reward companies taking action
on climate change.
The Norges Bank Investment Management –technically a unit of the Norges Bank - but inreality, a sovereign wealth fund, goes muchfurther. It manages the Government Pension
Fund Global investing government earnings
from exploiting the country’s oil reserve.
The fund is currently valued at NOK9tr(USD 1.1tr) making it one of the world’s
biggest asset managers. The management
mandate is set by the Ministry of Financeand incorporates ESG principles. This
includes a list of companies excluded orunder observation for ethical reasons. This
list includes firms producing coal, causing
severe environmental damage, human rights
violations, tobacco, nuclear weapons.40

Financial assets
weightings
Central banks require banks and insurancecompanies to hold reserves (capital
adequacy and liquidity tests) to ensure FIs
can sustain losses triggered by financial
shocks and ensure the stability of system
as a whole. CBFRs set weights / haircuts
for the different classes of assets to reflect
the probability that the realised value, in theevent of a forced sale, will be lower than theirface value. The requirements are describedbriefly in Box 2 (page 4).
CBs provide large banks liquidity against
collateral, and act as lender of last resort aspart of their monetary policy operations to
set risk-free interest rates. The time frame
over which the liquidity is provided ranges
from within the day to three months.
Capital adequacy and liquidity
Capital adequacy rules ensure FIs holdsufficient loss-absorbing capital (shareholder
equity and retained earnings) to finance any
losses arising from adverse adjustments to FIs’assets (e.g. loans, mortgages, bonds and otherasset classes e.g. property). Under Basel III loss
absorbing capital rules are being made more
stringent, the risk weights for different assets
were made more granular and the accord
standardises the approach to a greater degreewith tables detailing weighting factors.41

Greening the Financial System Climate Bonds Initiative

Overall FIs are incentivised to hold assets
like residential property loans with low
loan-to-value (LTV) ratios and sovereign andcorporate bonds with good credit ratings.
These assets use up far less ‘regulatory
capital’.42 For instance, debt issued by a“AAA” rated corporation has a risk weightingof 10%, a below “BB” rated company has arisk weight of 150% discouraging FIs fromholding such bonds. Mortgage weights havebeen made more granular: residential lending
with an LTV ratio of less than 50% (i.e. thehome-owner has a 50% equity stake) has aweighting of 20%, but a 100% mortgage hasa risk weight of 50%.43
These risk weights are calculated using
backward looking assessments of default riskthat take no account of long-term climate
risks. The chances of widespread mortgage
default following a major climatic event
rendering an area temporarily uninhabitable
would be materially increased despite theimpeccable credit history no matter that thehomes have a low loan to value ratios.
Basel III also sets one-month liquidity rules
to ensure FIs have sufficient High-Quality
Liquid Assets (like cash and highly liquidbonds). The purpose of this provision in the
Basel III accord is to identify easily realised
sources of cash.
For both the capital adequacy and theliquidity assessment, labelled green assets
9

(covered bonds, sovereign bonds) can be
included within the asset being assessed but
at present they are not separately identified.
Different asset classes could be segmented
to identify green and brown loans and bonds
allowing these to be separately monitored.
The People’s Bank of China (PBoC) has
included consideration of green credit in
its Macro Prudential Assessment (MPA), a
scoring system that assesses banks’ capitallevels and monitors risks. The greater theamount of green assets a bank holds, thehigher the score it receives in the MPA.
Green credit accounts for around 9% of total
outstanding loans. According to a survey
conducted by China Banking Regulatory
Commission, the green loans outstanding
from 21 major domestic banks reached CNY
8.22 trillion (USD 1.2 trillion) by 2018.44
Even within Europe, there is a precedent
for support factors to be used to remedysocially undesirable outcomes in the way FIs
allocate capital. In 2003 the EU Commission
introduced a SME support factor for loans ofless than €1.5mil made to SMEs to counterthe tendency of banks to underserve SMEs.
A ‘green supporting factor’, modelled on
the European SME supporting factor, tolower capital risk requirements for green
assets and ‘brown penalising factors’ wasin the EU Commission’s action plan ofsustainable finance issued in March 201845
and supported by the French Banking
Association. But this proposal has been
criticised by many central bankers forundermining the risk-assessed basis ofcapital requirement regimes, since evidence
does not support green assets as having alower level of default.
In the review of the EU Capital Requirement
Regulation, the European Banking Authority
has been tasked to publish in two years a
study on “whether a dedicated prudential
treatment of assets exposed to activities
associated substantially with environmental and/ or social objectives, in the form of different
capital charges, would be justified from a
prudential perspective”.
Collateral framework
Central banks lend money to banks but
require collateral of marketable financial
securities like bonds and non-tradable
assets. These are termed ‘eligible assets’.46
This creation of credit allows the central
bank to expand or contract the supplyof money in the economy and set thebank rate of interest, so is a vital part ofmonetary policy. Central banks assign andadjust haircuts to selectively downgrade thevalue of some assets accepted as collateral
to reflect their perceived view of riskiness.
The haircuts to collateral reflect the credit

risk models being used. CBs make useof ratings agency scores where they areavailable.
At its peak in 2012 around €1.2tr of assets
were pledged as collateral to the ESCBs47
which represents around 10% of banks’eligible collateral. The most important
assets included covered bank bonds, asset
backed securities and credit claims each
representing a quarter of pledged assets.
The preponderance of mortgage and loan
products used as collateral reflects thebalance sheets of banks i.e. the sorts ofassets they hold.
In its first progress report, the NGFS
highlighted that “climate- or environmentalrelated criteria are not yet sufficiently
accounted for in internal credit assessments
or in…credit agencies’ models which many
Central Banks rely on for their operations”.
Collateral policy may have an impact on
the asset portfolios held by commercial
banks (and other central bankcounterparties), as banks may prefer
to hold more assets that are favourably
treated as collateral. Therefore, it canencourage more bank financing throughgreen bonds lending to priority sectors in
the economy. The PBoC already includes
green bonds in their collateral frameworks
and give lending priority to banks holding
green bonds. If other central banks
followed suit this could incentivise banks
to hold more green bonds on their balance
sheets, encouraging more bank financing
for low carbon sectors.
PBoC accepts lower rated (AA, AA+) green
bonds and green loans as collateral for its
Medium-Term Lending Facility (MLF). The
MLF offers three, six and 12-month loans
to commercial lenders with the aim of also
guiding credit to underserved sectors. This ispart of a broader strategy aiming to increase
support for smaller firms, agriculture, andthe green economy and to help “alleviate theshortage of highly-rated corporate bonds insome financial institutions”.48
Green bond subsidies
To stimulate green bond issuances andencourage good practices such as external
reviews of the bond’s environmental credentials,
central banks could provide financial support tofirst time issuers and cover the associated extra
costs of labelling the bond as green.
For example, the Monetary Authority ofSingapore49 has announced a Green Bond
Grant Scheme to cover the additional costsof going green for issuers. The HKMA has
a similar programme for compensating
issuers the incremental costs of green bondissuance, like the verifier costs.

Greening the Financial System Climate Bonds Initiative

Credit guidance
Though no longer fashionable in developed
economies, several developing economies stilluse credit guidance policies to direct privatebanks to fund specific sectors of the economy.
The Reserve Bank of India (RBI) makes use ofpriority sector lending (PSL) quotas to direct
40% of bank lending to target sectors of theeconomy.50 At present these priority sectors
include agriculture (18%), micro-enterprises(8%), weaker sections of the community(10%). The 4% balance of the PSL quota
must be spent on a group of different uses
which include renewable energy and several
other uses, like housing, social infrastructureand exports. This stipulation applies to all
domestic banks, and also foreign banks withmore than 20 branches. A criticism by banks isthat it increases the general cost of finance inIndia, forcing commercially viable customers
to cross-subsidise priority lending customers
and increasing the overall operational costs
since they either must open branches in rural
areas or purchase PSL obligation certificatesoriginated by other institutions with larger
footprints in the rural community.
With a targeted refinancing line, Bangladesh
Bank51 (BB) allows commercial banks torefund themselves at reduced interest rates
for loans given to priority segments of theeconomy. In contrast to outright subsidies,
they rely on the private sector as a gatekeeper
in the allocation of capital. The default risk
remains with the banking sector. BB recently
announced a Green Transformation Fund of
USD200mil for the export-oriented textile
and leather sectors to set up environment
friendly infrastructures.52 Banks can borrowfrom BB at LIBOR+2.5% and are expected tore-lend with a margin of between 1.00 and
2.5% of the cost of borrowing. The tenor of
the loans would 5 to 10 years.
In addition, in 2016 BB announced that every
financial institution was obliged to allocate atleast 5% of their loan portfolio to green finance.

Monetary Authority ofSingapore’s Green Bond
Grant Scheme
Qualifying issuances will be able
to offset 100% of the expenses for
obtaining an external review for green
bonds, up to a cap of SGD 100,000(USD 71,450) per issuance.
Qualifying bonds can be denominated inany currency but must:• be issued and listed in Singapore• have a minimum size of S$200 million• have a tenure of at least three years.

10What should central banks and financial regulators do?
“It is also part of ourmandate for monetary policy
because climate change
affects price evolutions,affects the economic
outlook…This is one of themost difficult shocks wecentral bankers have to deal
with.”
Francois Villeroy de Galhau,
ECB Board member, speech
to Amundi annual conference,
June 2019In a survey of central banks, 64% of
respondents said that climate change isbeing handled as “a concern we are closely
monitoring”, but 27% of respondents also
considered it an issue “that other institutions
should be concerned about”.53 Questions
were asked about the reserve purchasesby the central banks: 69% said “there weresocietal benefits from reserve managers
taking green credentials into accountwhen deciding asset allocation”. However
just 26% of central banks use ESG factors
when managing their reserves themselves,a mere 6% asked “commercial banks todisclose their climate related risks”. Only
one respondent currently includes climaterelated risks in their stress tests. On a more
promising note: 59% of the respondents said
they are considering or already looking at
including climate-related scenarios in stresstesting.

throughout the economy, they are different
to other sector-level threats. We do not havea historical data to guide us, left unattended
the costs of inaction will rise, and there is ahigh chance of contagion between regions asa sudden fall in fossil fuel price will quickly
be transmitted through energy markets, andcannot be reduced by diversification.
Using their regulatory toolkits to require
the finance sector to adjust could be a
powerful agent for change55 alongside
efforts by government. The finance sector
in more advanced countries is facilitating
the continued investment in brown assets(e.g. organising large syndicated loans tofund continued oil exploration) in developing
countries thereby circumventing Paris
Agreement targets in investors’ home
economies. Conventional credit risk models
used by banks exacerbate the issue raising
the cost of finance for fledgling, capitalintensive low-carbon businesses impeding
the roll-out of green technologies. A morefinancial crisis has been more successful
than governments faltering efforts to createa unified carbon market.
CBFRs could consider acting alongside
governments, analysing and then acting on
the continued under-pricing of carbon risks
through the world economy.
Existing prudential regulation tools
were strengthened by Basel III, allowing
supervisors to better identify risky
behaviours (lending to mortgages withhigh LTVs, varying assumptions in risk
assessment models and increasing theholding of inadequate loss-taking capital).
The tightening of the rule book now
emphasises the holding of liquid and highquality capital and increasing the amountof loss-taking capital. These were tailoredto solve the causes of the global financial
crisis. But liquidity and capital buffers are
no defence against system-wide risks likea sudden change in sentiment causing arepricing (“Minsky moment“) of carbon
assets which will impact on large swathes ofthe economy
A second problem is that current
interventions that maintain ‘market neutral’asset purchasing either for QE or reserve
management are themselves distorting,propping up older well-established fossil fuelintensive companies and current maturity
distributions locking in old business models
and impatient investment. It is importantthat any package of recommendations bringforward a perspective cognisant of future
generations interests to overcome thetragedy of the horizon.

More generally, CBFRs recognise thepotential impact of climate risks on thefinancial sector. But they believe “the prime
responsibility for climate policy will continue
to sit with governments”.54 Within the
NGFS, what CBFRs’ precise role should be
is still being debated. The NGFS agrees that
CBFRs should ask FIs to better disclose theirclimate risks and present them in a format
that stakeholders can readily digest andstrategic decision-makers within the FIs canact upon. But this is simply asking banks to
act at their own behest. CBs do not yet agree
they should help resolve these issues using
their regulatory toolkits.

far-sighted risk assessment would view
low carbon solutions more favourably.
Also, because of the international natureof capital flows, it is difficult at a global
level, for governments to restrict the flowof investment into new brown assets
even though governments have signed
international agreements like the Paris
Agreement that imply such investments areunnecessary and dangerous. The absence ofeffective and credible carbon markets after
so many decades of discussion illustrates
the limits to what politics and treaties canachieve.

We would contend that they should. The
risks posed by climate change are different
to other ESG matters in two important ways.
First is the issue of the tragedy of the horizon.
Short-term benefits accruing to financial
players are creating long-term threats which
are transferred to society. Because they
are non-cyclical, increasing and pervasive

In this note we have suggested the sortsof actions already being used by CBFRs
which could be applied to reducing potential
climate risk exposures. The roll-out of QE
across USA, Eurozone and UK has shownthat central banks are able to develop, coordinate and implement powerful new policy
tools. Arguably the reaction to the global

Greening the Financial System Climate Bonds Initiative

A number of commentators have proposed
policy changes to affect the way central
banks manage the risks from climatechange.56, 57, 58 & 59 Below we add our own
suggestions to emphasise the most urgent
changes that we believe should be made.
These are drawn from the case studies
describing tools already used by CBFRs.

11

Recommendations
Market infrastructure
1. Define a brown taxonomy: EU’s andChinese governments are taking action
to create a green taxonomy to support
increased green lending and reduce thescope for green-washing. CBFRs are arguably
more interested than governments in an
accurate understanding of climate risk.
Unlike the green taxonomy the browntaxonomy will not be ‘voluntary’ assignment
in which an issuer selects to apply for agreen certification, but an involuntary one
in which a FI has to assign a loan as brown,
possibly despite the issuer’s protestations.
As the prudential regulator they are themain customers of a brown taxonomy so as
to properly identify climate risks on banks’and insurers’ balance sheets. Defining astandard for brown assets (fossil fuel assets,
equipment using and inputs into fossil fuels,
assets highly vulnerable to physical risks
from climate) would provide the building
blocks for better climate risk disclosures.
They should provide guidance on how
the taxonomy is used by FIs to adjust thereported value of their assets.
The definition of a brown taxonomy has
proved to be highly political. Businesses
in the ‘brown’ economy have successfully,
through the European Parliament, stopped
the EU Commission developing such ataxonomy. Governments depending on
their endowments of fossil fuels deposits
may take different views of whether say
gas infrastructure is brown or a transition
solution. Mark Carney has argued “aricher taxonomy that does not take abinary approach is needed” and is callingfor different shades of green. We believe
such a brown taxonomy is necessary, andinternational working groups of regulators
like NGFS better able to weigh up theevidence of what sectors to include andexclude. Potentially this could be led by a‘coalition of the willing’ grouping of CBs likethe European System of Central Banks could
seek to understand the brown taxonomies.

Decision useful transparency
2. Mandate FIs to disclose climate risks:
Requiring banks to disclose their exposures
to climate risk as recommended by the
TCFD. Ideally this understanding of risk
should be built bottom-up, from assets in thereal economy, to the balance sheets of theorganisations that borrow and issue, throughto FIs’ balance sheets. Use would be made of
the above taxonomy to undertake a portfolio
analysis using individual loan/bond level
data for each asset on FIs’ books.

Policy measures to stimulate green investment

When?

Market Infrastructure

short-term

1. Define a brown taxonomy and guide on its usage
Decision useful transparency
2. Mandate FIs to disclose climate risks

immediately

3. Climate scenarios and stress tests

short and medium-term

Prudential
4. Adjust risk weightings for capital adequacy

medium-term

5. Adjust High Quality Liquid Assets haircuts

medium-term

Monetary
6. Brown penalties and offsetting green support factors forcollateral framework

medium-term

7. Align APP with ESG objectives

medium-term

Other functions
8. Green reserve management & pension funds

short-term

9. Central banks that already use credit guidance tools
should extend them to include green lending

short-term

3. Climate scenarios and stress tests: The
TCFD suggests the disclosure of climate-riskdata should inform organisations’ boards andtheir strategies. CBFDs can help stimulate
the process by developing a set of test
scenarios consistent with advice provided bybodies like IPCC or national environmental
protection agencies on future mitigation
pathways and climate impacts to stresstest capital adequacy under Pillar two of
the Basel III. While a small set of reference
scenarios (including a 1.5°C scenario) should
be defined to ensure comparability, FIsshould be free to add their own scenariosand explain the rationale for their inclusion.

Greening prudential regulation
4. Adjust risk-weightings for capital
adequacy tests: Basel III’s Pillar 1 capital
adequacy rules cannot be changed without
extensive international consultation, andthe need for substantial financial evidence.
However, under Pillar 2 stress tests thecapital adequacy rules could be subjected toclimate stress tests where holdings of green
and brown assets would perform differently.
Our proposal is that CBFRs use brown andgreen taxonomies and the results from stresstests to set differential weights used for riskweighted asset assessments. This is a majorchange requiring the risk weights to use
forward looking scenario models to augment
the existing methodology to assess historicalGreening the Financial System Climate Bonds Initiative

risks. Similar adjustments could be madeunder Solvency II for insurance companies
that operate in the EU.
5. Adjust high-quality liquidity assets
haircuts: Adjustments valuing high-quality
liquid assets perhaps increasing the quality
requirement for brown assets 1-2 notches
but loosening the liquidity or credit quality
requirement for green assets to allow theminto the eligible universe. Central banks
are understandably reluctant to reduce theoverall stringency of the capital adequacy
and liquidity tests, and the reweighting
should be undertaken to ensure there is no
overall, deterioration in the bank balance
sheet quality when the brown and green
adjustments are jointly applied.

Greening monetary policy
6. Applying a brown penalising factor in
the collateral framework: Central banks
could review the haircut applied to brown
assets used in forward looking stress tests.
This would mean larger haircuts for brown
assets (loans and debt instruments) offered
as collateral. This means that banks thatuse loans (or bonds) with underlying assets
which are vulnerable to physical climate andtransition risks, would have a higher haircut.
7. Offsetting green supporting factors
FIs would be allowed to offset, but notexceed, the aggregate value of the increased
haircut from their brown assets by using
12

green assets (green loans and green debt
instruments) which have a lower haircut.
Our proposed change would ensure thatthe overall collateral framework was noless stringent than now, but banks wereincentivised to lend to more climate resilientand high energy efficiency properties.
8. Green QE: Quantitative easing (QE)
could contribute to the structuraltransition to a low carbon economy byinjecting money into targeted sectors
such as renewable energy and low carbon
transport and shunning brown assets, while
simultaneously fulfilling its primary aim ofstimulating the economy.12 At the moment
there are often insufficient issuances ofqualifying green bonds, but pre-announcing
the intention to include these additional
criteria would incentivise issuers to
identify suitable assets, and to originate
new green loans that could be refinanced
through green bonds. To achieve this,central banks would purchase green assets,like green asset-backed securities fromcommercial banks. These would specify
climate resilience and energy efficiency inthe underlying loan pool perhaps startingwith the housing markets in countries withhigh quality data on climate physical risks.
Conversely properties that are vulnerable toclimate risks and bonds from firms exposedto transition risks would be negatively
screened. Such criteria enhanced quality
criteria in a targeted manner for qualifying
green assets. This would redress thissystematic bias and help expand credit tothese sectors.

Other central bank functions
9. Greening reserve management and CB
pension schemes: CBs preference for assets
purchased for reserve management is forhigh quality assets that are highly liquid.
This is true even for authorities like HKMA
or ECB that hold vast pools of assets forvery long periods of time where liquidity,and “quality” should be assessed on forward
looking scenario assessment. The same logic
discussed for QE could be applied for reserve
management and CB pension schemes too.
10. Credit guidance: CBFR setting explicit
targets or discounts to interest rates to guidebank lending to preferred sectors has fallenout of favour in most OECD countries. Suchmechanisms could be used to guide green
investment, where central banks still perform
such a role, for instance in India (Priority
Sector Lending targets) or Bangladesh.

The idea here would be to relax the credit
requirements for green assets perhaps by
one or two notches and increase thosefor brown assets. This would broaden theuniverse of assets being purchased for
QE replenishment, and also stimulate theissuance of more green debt instruments(and indirectly of green loans), and witha greater variety of tenors. This could beviewed as a move away from the market
neutrality principle towards a market-making
role and needs to be considered carefully
with government. It needs to be recognisedthat QE - through its scale and duration has likely distorted the economy already,and question is one of what sort ofdistortion best serves society’s needs.
The proposal provides a forward signalthat the monetary authority is keen topurchase green assets to stimulate thedevelopment of the market especially of longdated green bonds and loans. There mightalso be a tightening of requirements forbrown assets, or indeed screening criteria toremove some brown assets altogether fromthe eligible universe.

Greening the Financial System Climate Bonds Initiative13

Endnotes
1. Buberl, Thomas, CEO of Axa, “Unsustainable business is uninvestable and uninsurable business” One Planet Summit – Axa
CEO Speech, 12 December 2017, Boulogne-Billancourt, France,
available at : https://www-axa-com.cdn.axa-contento-118412.eu/
www-axa-com%2Ff5520897-b5a6-40f3-90bd-d5b1bf7f271b_
climatesummit_ceospeech_va.pdf
2. Carney, Mark, Governor of the bank of England, “Breaking thetragedy of the horizon – Climate change and financial stability”,
Lloyd’s City Dinner, 29 September 2015, London, United Kingdom,
available at : https://www.bis.org/review/r151009a.pdf
3. TCFD, Final Report: Recommendations of the Task Force on
Climate-related Financial Disclosures, June 2017 available at:https://www.fsb-tcfd.org/publications/final-recommendationsreport/
4. TCFD Status Report, June 2019, available at https://www.
fsb-tcfd.org/wp-content/uploads/2019/06/2019-TCFD-StatusReport-FINAL-053119.pdf
5. NGFS, First comprehensive report “A call for action”, April 2019,available at : https://www.banque-france.fr/en/financial-stability/international-role/network-greening-financial-system/press-events
6. IOSCO, Final report, Sustainable finance in emerging markets andthe role of securities regulators, June 2019, available at : https://www.iosco.org/news/pdf/IOSCONEWS534.pdf
7. BIS data on debt securities outstanding see https://www.bis.org/
statistics/c1.pdf
8. Silver, N (2017) “Finance, Society and Sustainability: How to
Make the Financial System Work for the Economy, People andPlanet” Palgrave Macmillan
9. https://www.ft.com/content/312f0a8c-0094-11e6-ac983c15a1aa2e62
10. Dikau, Volz, Central Bank Mandates, sustainability objectives andthe promotion of Green finance, Working Paper No 222, SOAS, March
2019, available at: https://www.soas.ac.uk/economics/research/workingpapers/file139494.pdf
11. https://eur-lex.europa.eu/LexUriServ/LexUriServ.
do?uri=CELEX:12008M/PRO/04:EN:HTML12. Carney, Mark, Francois Gilleroy de Galhau and Frank Elderson
https://www.theguardian.com/commentisfree/2019/apr/17/thefinancial-sector-must-be-at-the-heart-of-tackling-climate-change
13. Bank of England, Prudential Regulation Authority, Life
Insurance Stress Test 2019, Scenario Specification, Guidelines andInstructions, June 2019, available at https://www.bankofengland.
co.uk/-/media/boe/files/prudential-regulation/letter/2019/
life-insurance-stress-test-2019-scenario-specification-guidelinesand-instructions.pdf
14. Barraclough, Kiadeh, Harris, CDP, “European oil majors spending
up to 7% on low carbon but wider industry needs to step up”, 12
November 2018, available at https://www.cdp.net/en/articles/
investor/european-oil-majors-spending-up-to-7-on-low-carbonbut-wider-industry-needs-to-step-up
15. Europe Beyond Coal, Fool’s Gold, the financial institutions
bankrolling Europe’s most coal-dependent utilities, 21 May
2019, available at: https://beyond-coal.eu/wp-content/
uploads/2019/05/foolsgold_final.pdf
16. Influence Map “Who Owns the World’s Fossil Fuels”, 2018,
Accessed 27/08/2019, available at : https://influencemap.org/
finance-map
17. Technical expert group on sustainable finance, available athttps://ec.europa.eu/info/publications/sustainable-financetechnical-expert-group_en
18. High-Level Expert Group on Sustainable Finance, Final Report,
available at: https://ec.europa.eu/info/publications/180131sustainable-finance-report_en
19. European Parliament, Amendment 80, Proposal for a regulation
Recital 6, Establishment of a framework to facilitate sustainable
investment, 28 March 2019, available at: http://www.europarl.
europa.eu/doceo/document/TA-8-2019-0325_EN.html?redirect
20. page 25 NGFS Call for Action report https://www.banquefrance.fr/sites/default/files/media/2019/04/17/ngfs_first_
comprehensive_report_-_17042019_0.pdf
21. Villeroy de Galhau, Governor of the Banque de France, “Greenfinance – A new Frontier for the 21st Century”, Opening keynoteof the international climate risk conference for supervisors,
Amsterdam, 6 April 2018, available at : https://www.banque-france.
fr/en/intervention/green-finance-new-frontier-21st-century

22. UK’s Prudential Regulatory Authority issued a supervisory note
to banks and insurers in April 2019 - https://www.bankofengland.
co.uk/prudential-regulation/publication/2019/enhancing-banksand-insurers-approaches-to-managing-the-financial-risks-fromclimate-change-ss
23. https://www.ifc.org/wps/wcm/connect/5962a2da-1f594140-a091-12bb7acef40f/SBN_PAPER_G20_02102017.
pdf?MOD=AJPERES&CVID=lHehxyG
24. DNB, An energy transition risk stress test for the financial
system of the Netherlands, 2018, available at : https://www.
dnb.nl/binaries/OS_Transition%20risk%20stress%20test%20
versie_web_tcm46-379397.pdf
25. DNB, Tine for transition, An exploratory study of the transition
to a carbon-neutral economy, 2016, available at : https://www.dnb.
nl/en/binaries/tt_tcm47-338545.pdf
26. UNEP Finance Initiative, Navigating a new climate: assessing
credit risk and opportunity in a changing climate, Part2: Physicalrelated risks and opportunities, July 2018, available at: https://www.unepfi.org/publications/banking-publications/navigating-anew-climate-assessing-credit-risk-and-opportunity-in-a-changingclimate/
27. UNEP Finance Initiative, Navigating a new climate: assessing
credit risk and opportunity in a changing climate, Part1 : Transitionrelated risks and opportunities, April 2018, available at: https://www.unepfi.org/publications/banking-publications/extendingour-horizons/
28. https://www.unepfi.org/news/industries/investment/changing-course-unep-fi-and-twenty-institutional-investorslaunch-new-guidance-for-implementing-tcfd/
29. Bank of England, Stress testing the UK banking system: key
elements of the 2019 annual cyclical scenario, March 2019,available at : https://www.bankofengland.co.uk/-/media/boe/files/
stress-testing/2019/stress-testing-the-uk-banking-system-keyelements-of-the-2019-stress-test.pdf?la=en&hash=9F5CF1B969F5987CE2DBE1F1EA50D7ED5786AB4F
30. https://www.ecb.europa.eu/mopo/implement/omt/html/
index.en.html#cspp
31. author’s calculations – based on ECB data https://www.
ecb.europa.eu/pub/economic-bulletin/focus/2018/html/ecb.
ebbox201807_01.en.html
32. Matikainen, Campiglio, Zenghelis, The climate impact ofquantitative easing, Grantham Research Institute on Climate
Change and the Environment, LSE, May 2017, available at: http://
www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2017/05/
ClimateImpactQuantEasing_Matikainen-et-al-1.pdf
33. https://www.euractiv.com/section/energy-environment/news/
european-central-bank-should-gradually-eliminate-carbon-assetslagarde-says/
34. HKMA, Hong Kong’s Latest Foreign Currency Reserve Assets
Figures Released, 6 June 2019, https://www.hkma.gov.hk/eng/keyinformation/press-releases/2019/20190606-3.shtml
35. HKMA, 7 May 2019, HKMA introduces key measures onsustainable banking and green finance, https://www.hkma.gov.hk/
eng/key-information/press-releases/2019/20190507-4.shtml
36. Although HK’s Exchange Fund primarily aims at currency
stability while Norwegian SWF mainly deals with the long-term
management of oil revenues, both funds share common features.
Both are managed by their respective central banks. Like theNorwegian SWF, HK’s Exchange fund also deals with country-wide
long term objectives, as it aims at ‘...maintaining Hong Kong as aninternational financial centre...’. Like HK’s Exchange fund, Norway’s
SWF has a currency reserve function for Norway’s Central Bank.
Sources: Hong Kong, Exchange Fund Ordinance (Cap. 66), 1992
; Norway, Government Petroleum Fund Act (June 22, 1990, No.
36). Douglas Arner and al.,Financial Markets in Hong Kong (2nd
Edition), March 2016 ; Backer et al., Sovereign Wealth Fund
as Regulatory Chameleons: The Norwegian Sovereign WealthFunds and Public Global Governance Through Private Global
Investment (May 4, 2009). Georgetown Journal of InternationalLaw, Vol. 41, No. 2, 2009. Available at SSRN: https://ssrn.com/
abstract=1398835
37. Example of environmental criteria used by the Norwegian SWF:“(2) Observation or exclusion may be decided for mining
companies and power producers which themselves or throughentities they control derive 30 per cent or more of their income

from thermal coal or base 30 per cent or more of their operations
on thermal coal. (4) Recommendations and decisions on exclusionof companies based on subsections (2) and (3) above shall notinclude green bonds issued by the company in question wheresuch bonds are recognised through inclusion in specific indices forgreen bonds or are verified by a recognised third party.” Guidelines
for observation and exclusion from the Government Pension Fund
Global, 17 February 2017https://www.regjeringen.no/globalassets/
upload/fin/statens-pensjonsfond/formelt-grunnlag/guidelines-forobservation-and-exclusion-from-the-gpfg---17.2.2017.pdf
38. Rust, IPE, French central bank formalizes responsible investment
stance, 4 April 2018, https://www.ipe.com/countries/france/
french-central-bank-formalises-responsible-investment-stance/
www.ipe.com/countries/france/french-central-bank-formalisesresponsible-investment-stance/10023976.fullarticle
39. Letter from Mario Draghi to Paul Tang MEP, 19 Feb 2019
40. Norges Bank Investment Management, Observation andexclusion of companies, assessed on 27/08/2019, https://www.
nbim.no/en/the-fund/responsible-investment/exclusion-ofcompanies/
41. Summary document of Basel III from BIS https://www.bis.org/
bcbs/publ/d424_hlsummary.pdf
42. Regulatory capital includes shareholder equity and retained
earnings, and reserves such as debt instruments
43. Table 1 BIS (2017) “High Level summary of the Basel III reforms”
https://www.bis.org/bcbs/publ/d424_hlsummary.pdf
44. http://www.xinhuanet.com/money/2018-02/14/c_1122416988.
htm
45. European Commission, Commission action plan on financing
sustainable growth, 8 March 2018, available at : https://ec.europa.
eu/info/publications/180308-action-plan-sustainable-growth_en
46. Bindseil, Corsi, Sahel, Visser, Occasional Paper Series, The
Eurosystem collateral framework explained, May 2017, available at:https://www.ecb.europa.eu/pub/pdf/scpops/ecb.op189.en.pdf
47. Corsi, European Central Bank, The Eurosystem collateralframework and the functioning of collateral markets, 13 July 2018,available at: https://www.ecb.europa.eu/pub/conferences/shared/
pdf/20180709_ecb_central_banking_seminar/2018-07-13_The_
Eurosystem_collateral_framework_and_the_functioning_of_collateral_markets_-_Corsi.pdf
48. Central Banking (12 June 2018) “PBoC accepts lower-grade
and green bonds as collateral” https://www.centralbanking.com/
central-banks/monetary-policy/operating-framework/3569726/
pboc-accepts-lower-grade-and-green-bonds-as-collateral
49. Hogan Lovells, MAS Green Bond Grant Scheme, https://www.
hoganlovells.com/~/media/hogan-lovells/pdf/new-mas-greenbond-grant-scheme.pdf?la=en
50. Reserve Bank of India, Frequently asked question, Assessed on
27/08/2019, available at : https://m.rbi.org.in/Scripts/FAQView.
aspx?Id=87
51. UNEP Inquiry, “Monetary Policy and Sustainability - The Case of
Bangladesh”, 2015
52. LFMEAB, “Bangladesh Bank to set up $200M Greentransformation fund”, available at : https://lfmeab.org/bangladeshbank-to-set-up-200-m-green-transformation-fund/
53. Victor Mendez-Barreira and Karolina Šilytė “The calm before
the storm – the climate change 2019 survey” Central Banking &Amundi. 34 our 100 central banks responded.
54. Open letter from Central Bank governors 19 April 2019: https://www.bankofengland.co.uk/news/2019/april/open-letter-onclimate-related-financial-risks
55. We note that the finance sector plays a major role in addressing
money laundering.
56. Volz (2017) “On the role of central banks in enhancing Greenfinance” UN Environmental Inquiry
57. Monnin, Pierre (2018) “Integrating Climate Risks into Credit
Risk Assessment” Council on Economic Policies
58. Dikau, Volz, “Central banking, climate change and green
finance”, Asian Development Bank Institute, September
2018, available at: https://www.adb.org/sites/default/files/
publication/452676/adbi-wp867.pdf
59. Campiglio Emanuele et al, “Climate change challenges forcentral banks and financial regulators”
Nature Climate Change, 8 (6). pp. 462-468. ISSN 1758-678X

Prashant Vaze, Alan Meng and Diletta Giuliani, Climate Bonds Initiative
Climate Bonds Initiative © October 2019www.climatebonds.net

Supported by WWF and SOAS Centre for Sustainable Finance
The authors are grateful for comments and drafting suggestions by Alexander Barkawi, Bob Buhr, Emanuele Campiglio, Sebastien Godinot,
Alison Harwood, Kate Levick, Sean Kidney, Lionel Mok, Mathilde Bossut, Gregoire Lunven, Frank Van Gansbeke and Ulrich Volz.
The views expressed in this paper are the authors alone and do not necessarily reflect those of the commentators.
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