The writer is Managing Director of Fidelity International
“There have been three great inventions since the dawn of time”, the American humorist Will Rogers would have said: “The fire, the wheel and the central bank”.
Rogers made his comment about a century ago, and central banks are now more influential than ever. They have evolved, like all good inventions, to remain relevant to the world in which they operate.
We face a climate emergency that demands collective action and central banks must undergo another, perhaps uncomfortable, transformation to play their part in addressing it. By reshaping their interventions in asset markets, they can accelerate carbon emissions reductions and shift the cost of capital to address climate risks hidden in the financial system.
So far, central banks have worked to ensure that the transition to a more sustainable economic system is orderly and financially stable, using tools such as banking system stress tests to detect vulnerabilities in the event of failure. sudden overhaul of fossil fuel assets.
These are useful exercises but can only be considered as the foundations of a more active position. The scale of the physical risks associated with climate change means that central banks must use their full range of powers to help the transition to a low-carbon world. And one of their tools is speed.
Rather than wait for governments to agree on legislation, investment programs or carbon taxes, central banks can act now to better reflect the cost of climate change in the cost of capital and to change business behavior, increasing it for emitters and reducing investment in carbon reduction.
In terms of financial impact, issues are always risk-free and cost-free to the producer or investor – yet they significantly damage our environment and their financial cost is borne elsewhere.
This leads to worrying arbitrage. State-owned enterprises are encouraged by investors and public opinion to get rid of their dirty assets. However, some of these assets risk being taken over by private equity buyers with access to cheap finance, not leaving the company better off and global emissions targets are no closer to being. achieved.
Past upheavals, such as the 2008 global financial crisis and the eurozone crisis, have forced central banks to expand their toolkits, which can be used to accelerate our society’s transition to net zero carbon emissions. . To this end, there are powerful political levers that they can and should pull.
Direct monetary action, in the form of targeted asset purchases, quantitative easing programs, will lower the cost of capital for green businesses and innovation.
Take the case of the European Central Bank’s current QE program, which can easily be extended to include increased green sovereign issuance as part of program purchases.
And it could also be tilted to increase the allocation of green business bonds, forming an effective tool to subsidize the cost of capital for environmentally conscious businesses. A selective stand-alone program of corporate bond purchases, perhaps linked to corporate issues, would change the behavior of issuers and investors.
The mere signal of a policy change would have a profound effect on the market. Investors will change their behavior long before any real QE purchase.
And separately, central banks could attack the macroprudential toolbox to impose additional capital requirements on activities contributing to emissions. Central banks could consider accelerating work on a Basel ‘green’ framework of bank capital measures as a logical next step, once they have completed the basic work of stress testing and developing a bank. Globally consistent taxonomy of green investments.
Basel IV, scheduled for 2023, includes a detailed system of rules to mitigate the risk of a banking crisis, thereby reducing the possibilities for international regulatory arbitrage. This powerful global tool is immediately available and can be adapted to take into account the ecological risks of business activities.
In approaching this carbon trade-off, central banks will undoubtedly be faced with difficult questions regarding their mandate, market neutrality and lack of democratic control. But time is running out and the gravity of the climate threat favors aggressive action rather than a wait and see attitude.
Central banks cannot solve this problem on their own. But as Mark Carney said almost six years ago, then governor of the Bank of England: “Once climate change becomes a critical issue for financial stability, it may already be too late. “