"Let's dance"
Keynote speech Frank Elderson
At the Global Capital Sustainable & Responsible Markets Forum
4 September 2018
At his keynote speech at the Global Capital Sustainable & Responsible Markets
Forum, Frank Elderson shed his light on the ways central banks are contributing
to the greening of the financial system.
I understand you have already had a very interesting morning. You have
discussed a broad spectrum of climate-related topics. From the plastic polluting
our oceans, to the nitty-gritty of the EU's sustainable finance taxonomy.
It is a great pleasure to join today's forum, which brings together market
participants seeking solutions for greening their portfolios. But we are also here
in a wider context, to support the Sustainable Development goals.
It is a pleasure to be here in my capacity as chair of the NGFS. I noticed in the
program a very small mistake. I don't mean to be a nitpicker, but the acronym
NGFS is explained there as 'The Network ON Greening the Financial system'. I
would like to be very precise here and highlight that we do not just aspire to be a
network that merely speaks about a green economy... Or shares opinions on this.
We aim to provide added value, and to actively support the creation of green
markets. More so, it is our ambition to facilitate that the entire financial system
can become green. Therefore, a Network FOR greening the financial system.
Today you will get an insight into our work and progress. And I will describe
how our activities fit within the broader context of international developments
in this area. This should also give you, the private sector, a preview of what to
expect in terms of regulation and supervision. I believe a stable and predictable
regulator benefits everyone. But before I describe what we do and how we do it,
let me first take you back to the WHY.
Role central banks
I don't need to tell you that we face a climate problem. You all know that at the
end of 2015 the international community came together to sign the Paris climate
deal. It is clear we have to be greener. Clearer still is that this must be a joint
effort. Globally. Across all sectors and segments of society.
It's not just up to the end consumer to pick green energy over brown, or the
utility company to provide green energy. Or the bank to finance the green utility
company. It needs a concerted effort from all parties. But bringing about a green
transformation requires enormous investment. And that means the financial
sector - which is you, my friends! - has a crucial role in channeling its resources
towards a green and sustainable economy.
And that is why there is an overwhelming case for supervisors and central banks
to respond to environmental challenges. From the perspective of both risk and
opportunity.
Let me address the risk side first. Because as a supervisory authority, we tend to
focus on risks. We are very sensitive to all types of risks to the stability of
financial institutions, or to the system as a whole. So we also need to look at
climate-related risks: we must assess how the physical effects of changing
climate, like extreme weather events, can translate into financial risks for the
institutions we supervise.
The same goes for risks that can arise from the transition to a low carbon
economy. This transition may lead to stranded assets and policy risks, which in
turn can mean financial risks for the institutions we supervise. We aim to
identify these risks. And where possible to manage, resolve or even mitigate
them.
And then there is the opportunity side. We supervisors do see sunny sides too,
you know. Or at least we try to. I believe we must fulfill our responsibilities. As a
supervisor, together with the financial sector, we must align our financial system
with the sustainability goals. And we must support opportunities for green and
sustainable finance.
Of course, as a central bank and supervisor, we must not overstretch our
mandate. But safeguarding sustainable prosperity falls well within our mission.
This not only means financial institutions should have sufficient buffers to
absorb unexpected losses. We also have to reexamine our current methods for
creating prosperity. If these cause significant ecological damage, preventing
future generations from obtaining similar or higher levels of prosperity, then
how we create prosperity today is not sustainable either. This runs counter to
our mission.
There are ways we can impact investment decisions and credit allocation. Our
supervisory policies could, for instance, take into account the transition to a low
carbon economy. That's why we as a central bank can help transform the
financial infrastructure, so it facilitates the necessary flow of capital to where it is
needed most. To help transform our economy into a low carbon one.
We should remove all unnecessary obstacles to this transition. And assist the
sector in creating common definitions and standards. As well as provide the
necessary guidance. The development of a sustainable taxonomy is a good
example of this.
I know, this is not a conventional area of focus for a central bank. So, like the
private sector, we are developing new tools and methodologies to support us in
this goal. And guess what! We are not the only central bank or supervisor
exploring this new type of risk. Central banks and supervisors worldwide are
studying these issues. Of course, there are trailblazers: You're probably all aware
of the Bank of England's pioneering work in this area.
And this morning you discussed the EU taxonomy, which would take probably
some time to enter into force. This is completely understandable for such a
complex task. In this regard it is worthwhile to look at the Chinese approach for
laying the foundation for green finance. They managed to develop a green
taxonomy in just over two months! A remarkably short period of time.
These are a couple of examples of countries that are ahead of the curve. At the
other end of the spectrum are central banks, for which these issues are
completely new to the agenda.
Background and membership of NGFS
These developments laid the foundation for setting up the network of central
bank and supervisors at the end of last year, the NGFS. (You remember, the
network for greening the financial system...). It brings together institutions that
are determined to move forward on green finance and climate-related risks.
Within the network we share experiences and best practices. This means we
don't all have to reinvent the wheel and are able to join forces.
Since its launch in December 2017, the NGFS has experienced a rapid growth in
terms of new members and observers. There were eight founding countries to
begin with. But as chair I am proud to say we now have seventeen members and
five observers. Hopefully, there are many more to come. And our members come
from across the globe. It is not just a European party. No. All continents are
represented. China, Singapore and Mexico were three of the founding members,
as well as for example France and the UK.
This summer, the ECB, including the SSM, the Single Supervisory Mechanism,
came on board. I expect this to have a major effect within Europe. The SSM
directly supervises all one hundred and nineteen significant banks in the euro
area and also indirectly supervises the less significant banks in this area. That
means all countries in the banking union are indirectly linked to the NGFS.
Members demonstrate a strong collective commitment to the greening of the
financial system. They are taking up their responsibility to contribute to the
implementation of the Paris Agreement. Now you might be thinking, what do we
actually do? What impact are we trying to achieve?
Activities
NGFS members voluntarily exchange valuable experiences and best practices on
climate risk analysis and mitigation tools. These activities are structured around
three workflows: microprudential supervision; macrofinancial issues; and
scaling up green finance.
In terms of microprudential supervision, we study and identify best practices
of central banks and supervisors in analyzing climate-related risks affecting
individual institutions. We map current supervisory practices for integrating
environmental risks into micro-prudential supervision. This forces individual
institutions to consider the impacts on their balance sheet. We also review
current practices on environmental and climate information disclosure by
financial institutions so we can identify best practices.
Secondly, we attempt to quantify the physical and transition risk at a
macroeconomic level. Here, we will identify examples of good practices by
NGFS members. These include for example macro stress tests or scenario
analyses.
Our last area of focus is the role of central banks in scaling up green finance. We
discuss current practices for incorporating ESG criteria in all areas of central
bank operational activities. Against this backdrop, the NGFS will organize the
seminar 'Sustainable & Responsible Investment for central banks'. The event will
be hosted here at DNB, on the 21st of September. Then, we will discuss best
practices and principles for integrating sustainability considerations into
management of official reserves.
Concrete examples
This might still sound a bit abstract in terms of what it could mean for you, for
the financial sector. So let me return to the first area of activity: how can
supervisors integrate climate risk into supervision? Last year, DNB examined the
exposures of financial institutions to carbon intensive sectors. We published our
findings in a report titled 'Waterproof'. This gave us a good indication of the
vulnerabilities in a hard transition scenario. We also looked at how new types of
national policy could cause financial risks to materialize already in the shorter
term.
A good example of this is in the Dutch commercial real estate sector. In the
Netherlands, as of 2023, all office buildings will have to meet minimum energy
efficiency requirements, or face closure. In 2017, it was estimated that half the
offices in the Netherlands did not meet this requirement. This raises the
prospect of write-offs for lenders. As I said, I strongly believe in predictable,
transparent public institutions. This example shows how new policies to achieve
our Dutch carbon emission goals require transparent implementation, to avoid
sudden shocks.
Annual data requests, as part of our supervision, could give greater insight into
the size and nature of the risk. This can form the basis for supervisors to engage
in dialogue with institutions. We may then expect them to prepare a strategy
for integrating ESG risks in their short and longer term risk analyses. To explain
how they can adapt their investment strategy to align with the Paris ambition.
And to demonstrate they have a clear view on the viability of their business
model in a two degree scenario.
In contrast to a supervisory dialogues, the one thing I believe we must not do, is
to create wrong incentives. There are also advocates for changing capital
requirements. To discourage brown exposures, or encourage green investments.
However, we at DNB believe that capital requirements must essentially
safeguard financial solidity and stability. Hence, without conclusive evidence
that green exposures are less risky than other exposures, lowering capital
requirements by introducing a green supporting factor will only increase the
risks to financial stability. With evidence, the situation would change
dramatically...
We are not there yet. We need to work harder to determine the risk in "green",
but also in "brown" exposures. And to identify whether there exists any risk
exposure differential between green and brown assets. This also is one of our
focal areas in the NGFS. We can draw on the experience of all our members. And
arrive at a common view. Also to safeguard a level playing field across prudential
jurisdictions.
Timelines NGFS
Standing here now, I must say I'm very proud of the network's progress. Ten
months ago, the acronym NGFS still sounded odd. But today, we are right back on
track and more and more countries are queuing up to board the train. It may run
on only partly renewable sources at the moment, but hopefully in the near future
it will be fully powered by certified green energy! And you will be able to assess
the extent to which we succeed. The analysis conducted in the work streams will
feed into a NGFS report to be issued in the first half of 2019. The final purpose is
to define and develop best practices and promote these such so they will be
implemented within and outside of the membership of the NGFS.
Conclusion
NGFS and DNB need to demonstrate they can support, underpin and promote the
transition to a green financial system, as part of their regular mandate. And
while our research on a possible future supervisory framework will continue,
we're excited by the initiatives that you, the private sector, have taken to model
the risks and transform the financial markets. I believe you can drive innovation
and might even be able to provide a more significant lever to advance global
change. However, at a time of rapid change it is also important to analyse
innovation within the public sector so as not to create new risks. So therefore,
we hope to continue our dialogue and work on this challenge together.
Or, in other words, as we are now in the 'Grand Ballroom' of the Okura hotel:
Together, let us face the music and dance. Let's dance together!
Thank you.