A Transition in Thinking and Action
Remarks given by
Mark Carney, Governor of the Bank of England
International Climate Risk Conference for Supervisors, De Nederlandsche Bank,
Amsterdam
6 April 2018
I am grateful to Alice Carr, Edd Denbee, Tanveer Hussain, Carsten Jung, Krish Kistnassamy, Alex
Michie, Alex Ntelekos, Dimitris Papachristou and Matt Scott for their assistance in preparing these
remarks.
It is a great pleasure to be here in Amsterdam, at the International Climate Risk Conference for Supervisors,
jointly organised by the De Nederlandsche Bank, the Banque de France and the Bank of England.
In my remarks, I will take stock of the progress made in addressing climate-related financial risks since the
Paris Agreement of late 2015. In particular, I will consider how far there has been a transition in thinking and
action.
As we've heard today, the thinking has coalesced around three channels through which climate risk affects
financial stability:
-
the physical risks that arise from the increased frequency and severity of climate- and weather-
related events that damage property and disrupt trade;
-
the liability risks stemming from parties who have suffered loss from the effects of climate change
seeking compensation from those they hold responsible; and
- the transition risks that can arise through a sudden and disorderly adjustment to a low carbon
economy.
The last risk is the most challenging. When I first spoke about the financial stability risks from climate
change, at Lloyd's of London in 2015, I highlighted two paradoxes relating to transition risk in particular.1
First, the future will be past. That is, climate change is a tragedy of the horizon which imposes a cost on
future generations that the current one has no direct incentive to fix. The catastrophic impacts of climate
change will be felt beyond the traditional horizons of most actors. Once climate change becomes a clear and
present danger to financial stability it may already be too late to stabilise the atmosphere at two degrees.
The second paradox is that success is failure. That is, too rapid a movement towards a low-carbon economy
could materially damage financial stability. A wholesale reassessment of prospects, as climate-related risks
are re-evaluated, could destabilise markets, spark a pro-cyclical crystallisation of losses and lead to a
persistent tightening of financial conditions: a climate Minsky moment.
The tragedy of the horizon can be resolved in an orderly, effective and productive manner, however, with
early transitions in thinking and action.
1
See Carney (2015), "Breaking the Tragedy of the Horizon - climate change and financial stability", speech given at Lloyd's of London,
September 2015.
A transition in thinking
Since 2015, a transition in thinking has taken place.
At the One Planet Summit in Paris in 2017, financial institutions responsible for managing US$80 trillion of
- -
assets equivalent to annual global GDP publicly supported the Task Force for Climate-related
Disclosures (TCFD).2
The supporters included 20 globally-systemic banks, 8 of the top 10 global asset managers, the world's
leading pension funds and insurers, the largest sovereign wealth fund and the two dominant shareholder
advisory service companies.
Established by the Financial Stability Board (FSB) in response to a call from G20 Leaders, the TCFD
delivered recommendations for voluntary disclosures of material, decision-useful climate-related financial
risks for the G20 Summit in Hamburg. Suitable for use by all companies that raise capital, the
recommendations:
- include disclosure of governance and risk management arrangements;
-
establish consistent and comparable metrics applicable across all sectors, as well as specific metrics
for the most carbon-intense sectors; and
- encourage use of scenario analysis so as to consider dynamically the potential impact of the risks
and opportunities of the transition to a low carbon economy on strategy and financial planning.
That financial institutions have come out so strongly in support of enhanced disclosure reflects their
recognition that there is a correlation between managing climate risk and long-term value creation as well as
their belief in the power of markets. They know that for markets to do what they do best - allocate capital
-
effectively and dynamically they need the right information. When risks are unknown or ill-defined, the
market cannot allocate resources in an efficient and profitable manner.
Until recently, reliable information on how companies were anticipating, responding or failing to respond to
climate-related risks and opportunities has been hard to find, inconsistent and fragmented.
2
For a full list of current supporters see: https://www.fsb-tcfd.org/tcfd-supporters-march-2018/ and supporters at the Paris Summit see:
https://www.fsb-tcfd.org/wp-content/uploads/2017/12/TCFD-Press-Release-One-Planet-Summit-12-Dec-2017 FINAL.pdf
The information needed goes beyond the static to the strategic. Markets need information to assess which
companies are well positioned to seize the opportunities the transition to a low carbon economy brings.
Which car manufacturers are leading the way on fuel efficiency and electrification? How are energy
companies adapting their mix of energy sources? This needs to be considered against investors' views of
- International Energy Agency's
possible transition paths the Sustainable Development Scenario, for
example, sees the consumption of natural gas rise by nearly 20% by 2030 to become the largest single fuel
in the global mix.3
Given the uncertainties around climate, not everyone will agree on the timing or scale of the adjustments
required. And different people will have different views about the effectiveness of timelines of government
climate policies. The right information allows sceptics and evangelists alike to back their convictions with
their capital.
At the same time as this increased investor focus, there have been signs that global companies are
becoming increasingly aware of the risks climate change can pose. Whereas in previous years it barely
registered as a risk, now close to a third of global CEOs are 'extremely concerned' about the threat climate
change poses to their organisation's growth prospects.4
A transition in action
So how far is this transition in thinking translating into action?
First, governments. In reaching agreement in Paris, global leaders took political action to mitigate the
catastrophic impact of climate change.
They committed to curbing carbon emissions to limit the rise in global average temperatures relative to those
in the pre-industrial world to 2°C, and to pursue additional efforts to limit the temperature increase to 1.5°C.
Governments are taking some of the necessary policy actions. For example, in the UK, the Government
published its Clean Growth Strategy last year, including policies to make homes, businesses and transport
lower the carbon intensity of the UK's energy supply. EU Emissions Trading
more energy efficient, and to
Scheme (ETS) reforms agreed last year, and due to come into effect from 2021, have driven carbon prices
above €10 per tonne for the first time in six years.
Even so, the national determined contributions towards meeting the Paris goals, summed to no more than
2.7°C, making it clear climate policy will need to tighten further if the Paris commitments are to be achieved.
3
-
It also sees US$69 trillion of investment in clean energy technologies and energy efficiency and the share of oil and coal in power
generation falls to 6%, which is burned with accompanying carbon capture and storage technology.
4
See PWC (2018), 21st CEO Survey, The Anxious Optimist in the Corner Office,
https://www.pwc.com/gx/en/ceo-survey/2018/pwc-ceosurvey-report-2018.pdf
Second, climate disclosures. There has been a series of actions to transform climate disclosures. 2017 was
a record year for climate-related shareholder resolutions, with a threefold increase in motions (184 vs 63)
and with investment managers controlling over 45% of global assets under management backing
shareholder actions on carbon disclosure.
Several of the world's largest asset managers - -
including the two largest, Blackrock and Vanguard have
written to a number of public companies calling for such disclosures. Other long-term investors have joined
forces to press for disclosure through groups such as Climate Action 100+ and the International Investors
Group for Climate Change (IIGCC). Meanwhile ISS and Glass Lewis, who account for over 90% of the
shareholder advisory services market, have updated their 2018 proxy voting policies to make clear that they
will assess the adequacy of climate disclosure.5
With the providers of capital demanding enhanced disclosure, and the TCFD recommendations providing a
framework for doing so, a number of public companies have begun disclosing their climate-related financial
risks for the 2017/18 year end. Reporters drawing on the TCFD include energy giants and extractors
through to financials and consumer goods companies.
The Task Force is delivering two initiatives to support this process. First, in time for the Argentine G20
Summit, drawing on the work of the Big Four accounting firms, the Task Force will report on implementation
experience, focusing on examples of good practice to foster wider adoption. Second, the Task Force is
launching a Resource Hub to provide technical support, data, and collaborative partnerships - all aimed at
helping companies implement the recommendations in as effective and efficient a manner as possible.
As preparers, financials and investors 'learn by doing', a virtuous cycle will be created where more and better
information creates the imperatives for others to adopt the TCFD and for everyone to up their game on the
quality of information they provide.
This iterative process is a reason why there is likely cause for the Task Force to continue beyond the
Argentine Summit in late 2018 and into the Japanese presidency. In particular, it will be important to get
feedback from investors on which disclosures are truly decision useful so that this process is as efficient and
effective as possible.
Third, insurers and banks.
Insurers have long been on the front line of the physical risks posed by climate change such as extreme
weather events.
Since the 1980s, the number of registered weather-related loss events has tripled. Inflation-
adjusted insurance losses have increased from an annual average of around US$10bn in the
5
See ISS, (2018), United States Proxy Voting Guidelines, Benchmark Policy Recommendations, and Glass Lewis, (2018), Guidelines:
An Overview of the Glass Lewis Approach to Proxy Advice.
1980s, to around US$55bn over the past decade (Chart 1).
Chart 1: Weather-related losses worldwide (1980-2017)
US$ billions (2015 values) 350
Uninsured losses
300
Insured losses
Moving average total economic losses (a)
250
Moving average insured losses (b)
200
150
100
50
0
1980 82 84 86 88 90 92 94 96 98 2000 02 04 06 08 10 12 14 16
(a) Total Economic Losses = Insured + Uninsured losses. (b) 10-year moving average
Source: Munich Reinsurance Company, Geo Risks Research, NatCatSERVICE
General and reinsurers insurers have long deployed sophisticated modelling of climate and
weather-related physical risks, and have adjusted their cover and business models accordingly.
Lloyd's of London underwriters, for example, are required to consider climate change explicitly in
their business plans and underwriting models. Their genius has been to recognise that the past is
not prologue and that the catastrophic norms of the future are in the tail risks of today.
For example, by holding capital at a one-in-200 year risk appetite, under a forward-looking capital
regime, UK insurers were able to withstand the events of 2017, the worst year on record for
weather-related insurance losses at around US$130bn.
Given evidence that suggests increasing levels of physical risk, insurers will need to consider the
potential impact of more intense and clustered weather-related events. Work by Bank colleagues
finds that intense hurricanes, of the type most likely to cause large insurance losses, seem to be
getting more frequent and the chance of two or more intense hurricanes occurring close together
insurers'
may be higher than previously thought.6 So improvements in risk modelling must be
unrelenting.
While the ability to re-price annually or to withdraw cover can mitigate risks to general insurers in
the short-term, as climate change progresses, they will need to consider the longer-term impacts
on their business models.
And as the PRA found a few years ago in its review of the sector, insurers need to be wary of
cognitive dissonance within their organisations whereby risks that are managed prudently by their
by the firm's asset managers, such as in their real estate exposures.7
underwriters are ignored
Consistent with the tragedy of the horizon, the risks posed to banks from climate change have
tended to be beyond their planning horizons. A recent survey by the PRA of banks accounting for
-
around 90% of the UK banking system, found that these horizons averaged four years before
physical and litigation risks would be expected to manifest, and prior to stringent climate policies
likely taking effect.
There are signs, however, that banks are beginning to treat climate-related risks like other financial
-
risks. The PRA survey finds that a majority of banks now see them as financial risks rather than
just a reputational or corporate social responsibility issues. As such, oversight of climate-related
risks and overall responsibility for setting the climate risk strategy, targets and risk appetite has
been elevated to Board level.
Banks have begun considering the most immediate physical risks relevant to their business models
-
from the exposure of mortgage books to flood risk or, for globally active banks, the impact of
extreme weather events on country risk. And they have begun to assess exposures to transition
risks where government policy is already pulling forward the adjustment. This includes exposures
to carbon-intensive sectors, consumer loans secured on diesel vehicles and buy-to-let lending
given new efficiency requirements.
But many banks have indicated that there is some way to go to identify and measure climate-
related risks more comprehensively, including given the need to improve data and expertise. This
includes developing their approaches to stress testing for climate-risks as well as, over longer
horizons, more dynamic scenario analysis. It is clear, however, that the TCFD framework is
helping, including to identify metrics and promote use of climate-related scenario analysis.
6
Bank Underground post, forthcoming,
7
See PRA (2015), The Impact of Climate Change on the UK Insurance Sector,
https://www.bankofengland.co.uk/prudentialregulation/publication/2015/the-impact-of-climate-change-on-the-uk-insurance-sector
Fourth, financial policymakers.
At the Bank of England, the risks posed by climate change are currently most directly relevant to
our micro prudential responsibilities for the safety and soundness of the banking and insurance
sectors.
Assessing how well general insurers and reinsurers are identifying, measuring and mitigating
weather-related risks, has long been part of supervising insurers. We published a stocktake of
insurers' progress in adapting to climate change in late 2015, and are working to update and
deepen our assessment with a second stocktake in 2018. More recently, we have extended our
focus to the financial risks faced by the UK banking system, and will publish the full results of the
survey I referred to a moment ago in coming months.
The aim for both pieces of work is to consider whether insurers and banks have adequate
governance arrangements to develop strategies for identifying and mitigating climate risk across
their entire businesses, both their liabilities and assets, and over sufficiently long time horizons.
We aim to highlight examples of good practice and to articulate our supervisory expectations later
this year.
We are also considering our approach to assessing risks across the system as a whole.
The Bank has routinely included weather-related shocks in the scenarios for its biennial general
insurance stress test, including three North American hurricanes in 2017. This meant we had a
good sense of the likely resilience of the market and individual firms when Harvey, Irma and Maria
-
hit both in terms of exposures and mitigating actions.8 On climate, remember, past is not
prologue. In the depressing spirit of Bayesian updating that the current climate change trajectory
demands, when considering scenarios for 2019, that we include weather-related events that are
more severe and clustered.
To help firms improve their own testing, the Bank has been encouraging knowledge sharing on the
types of scenario analysis envisaged under the TCFD.9 This will allow firms to explore how 2°C
and other transition scenarios might impact their strategy and financials.
More broadly, and like the other financial authorities represented here today, we recognise the
value in sharing expertise and best practice to increase the rate at which firms, and indeed
ourselves as regulators, move to embed more thoroughly climate-related financial risks into our risk
assessment and mitigation.
8
https://www.bankofengland.co.uk/prudential-regulation/letter/2017/general-insurance-stress-test-2017-feedback
9
This included co-hosting a conference with TCFD in late 2017. For further details see:
https://www.fsb-tcfd.org/event/tcfd-boeconference-climate-scenarios-financial-risk-strategic-planning/
Conclusion
Given this heavy agenda, it is encouraging that central banks and supervisors - from eight
countries that together account for over a third of both global financial assets and carbon emissions
-
have come together to found the Network for Greening the Financial System (NGFS) to take
forward coordination.
There are, however, limits to our roles. Financial policymakers will not drive the transition to a low-
carbon economy. Our efforts cannot substitute for those of governments who have direct
responsibilities to deliver the policies to achieve their Paris commitments.
The good news is that governments are now establishing the policy frameworks, and the private
sector is beginning to allocate capital accordingly.
Our efforts will help smooth the transition prompted by these actions. With better information and
risk management as the foundations, a virtuous circle is being built with better understanding of
tomorrow's risks, better pricing for investors, better decisions by policymakers and a smooth
transition to a low carbon economy.
Financing the transition to a low carbon economy is a major opportunity for investors and creditors.
It implies a sweeping technological revolution, including investments in long-term infrastructure at
roughly quadruple the current rate.
As this event testifies, climate finance and risk management is moving into the mainstream.
There has been a transition in thinking. And this is now beginning to be translated into action, and
the NGFS will play an important role in this.