Introductory remarks by Isabel Schnabel, Member of the Government Board of the ECB, on the Authorized Convention organised by the European Central Financial institution on “The incorporation of environmental issues within the supervision of prudential dangers”
Frankfurt am Predominant, 5 September 2023
This yr has been a document yr in lots of respects. July was the world’s hottest ever month, seeing the most popular day ever recorded, whereas ocean temperatures hit all-time highs. We’ve skilled heatwaves, droughts, floods, gigantic hail and document low ranges of sea ice formation in Antarctica. Local weather scientists attribute these information to human-made local weather change, exacerbated by the arrival of El Niño.
Not solely do these occasions trigger intensive injury to the setting and lead to monumental human struggling, however additionally they adversely impression the macroeconomy, giving rise to vital monetary dangers.
Coping with monetary dangers is the core activity of prudential supervision.
Local weather-related and environmental dangers (C&E dangers) at the moment are an essential focus for supervisors. The subject of right this moment’s panel dialogue – the authorized features of the incorporation of environmental dangers in prudential supervision – might subsequently not be extra apt or well timed.
I’m thrilled to be chairing an all-female panel on this essential subject with three distinguished audio system, every of whom I’ll introduce earlier than they converse.
In my brief introductory remarks, I want to clarify why C&E dangers benefit particular supervisory consideration from an financial perspective.
There are three fundamental causes. First, their dimension, international dimension and non-linearity, which indicate massive draw back tail dangers. Second, the irreversible nature of local weather change and environmental degradation, and the corresponding time criticality for taking motion. And third, the lack of understanding and information on these dangers.
Dimension, international dimension and non-linearity
The sheer dimension of C&E dangers justifies giving them particular consideration. Local weather change constitutes an existential risk, implying massive draw back tail dangers.
In keeping with the Community of Central Banks and Supervisors for Greening the Monetary System (NGFS), as much as 13% of world GDP can be in danger by the tip of the century, even earlier than accounting for the potential penalties of extreme climate occasions, sea-level rise and wider societal impacts from migration or battle.
Bodily local weather dangers are usually correlated globally, as evidenced by right this moment’s simultaneous prevalence of utmost climate occasions, limiting the scope for diversification and creating systemic dangers for the monetary sector. The financial penalties of bodily local weather dangers may very well be mitigated by closing the massive local weather insurance coverage safety hole. Within the EU, solely 1 / 4 of losses attributable to climate-related catastrophes are insured, giving rise to extra dangers to the macroeconomy, monetary stability and public funds. On the identical time, monetary sector dangers usually are not confined to bodily local weather dangers; the sector can also be uncovered to transition dangers emanating from adjustments in insurance policies across the globe in response to local weather change.
Lastly, the existence of tipping factors might give rise to robust non-linearities. Small adjustments can have a lot bigger results than noticed traditionally, making predictions extremely unsure.
Irreversibility and time criticality
A second distinct characteristic of C&E dangers is that in the event that they materialise, the consequences are sometimes irreversible. Subsequently, taking motion is time essential to decelerate international warming and the degradation of the setting.
An orderly local weather transition is extra possible if decisive motion is taken at an early stage. In an orderly transition, a sudden repricing of property could be prevented and monetary intermediaries are in a position to regularly rebalance their funding portfolios and construct up buffers that may take up potential future losses.
Furthermore, in distinction to different dangers, C&E dangers have an essential suggestions mechanism, which accentuates time criticality. Not solely does local weather change have an effect on the dangers on monetary intermediaries’ steadiness sheets, however the financing of local weather or environmentally unfriendly actions additionally amplifies C&E dangers, creating externalities.
Lack of information and information
A 3rd essential characteristic of C&E dangers is that the info obtainable and the data now we have about them stay restricted. We all know that local weather change and biodiversity loss are already unfolding quickly however we nonetheless lack data about their exact timing and potential tipping factors. Which means we should work with eventualities with an unknown chance of prevalence.
Financial fashions of local weather change are usually calibrated on historic information, which suggests they’ve difficulties in accounting for non-linear dynamics which have by no means been noticed. They could subsequently underestimate the financial fallout. Using eventualities, as executed in macroeconomic local weather stress exams, offers a helpful method ahead. However such eventualities might should be enriched by socioeconomic components, reminiscent of the chance of violent battle or mass migration.
Even for identified dangers, the info are restricted. Personal and official information suppliers are working intensively to shut the info gaps. To make progress on this entrance, there may be an pressing want for additional disclosure initiatives based mostly on the double materiality precept.
In view of the present information and data gaps, it is rather possible that climate-related and environmental dangers are at present underpriced. Some dangers will not be priced in any respect, as confirmed by latest analysis. Ranking businesses have solely simply began to include local weather threat into their fashions.
In keeping with our bottom-up local weather stress take a look at, most banks underneath European banking supervision insufficiently take into account climate-related dangers of their credit score assessments. On the identical time, varied initiatives on the supervisory entrance present that banks are making progress of their administration of C&E dangers, though the pattern isn’t uniform and laggards stay in all areas.
Market mispricing of C&E dangers can solely be mitigated if extra data on these dangers turns into obtainable, particularly through complete disclosures. On this respect, we nonetheless have a protracted option to go.
To conclude, climate-related and environmental dangers benefit particular consideration owing to their dimension, international dimension and non-linearity, the irreversible nature of the injury they’ll trigger, the ensuing time criticality of motion, in addition to data and information gaps.
I’m now curious to listen to how the incorporation of environmental issues within the supervision of prudential dangers is seen from a authorized perspective.
So let me flip to our first speaker, Suzanne Kingston.
Since January 2022, Suzanne has been a Choose on the Basic Courtroom. Earlier than that she was a Senior Counsel practising on the Irish bar. Furthermore, she appears to be like again on a distinguished educational profession, instructing regulation at prestigious universities such because the College Faculty Dublin, Columbia College and Cambridge College, amongst others, and acquired a prestigious ERC grant on the right way to make nature legal guidelines simpler.
So, we’re very a lot trying ahead to listening to your insights.
Our second speaker is Juliana Bolzani.
Juliana is senior counsel on the Worldwide Financial Fund, working on the Fiscal and Monetary Unit of the Authorized Division, which offers authorized recommendation to member nations on the design and implementation of authorized reforms. Earlier than becoming a member of the IMF, she labored as a lawyer on the Central Financial institution of Brazil. She is a specialist on central financial institution independence and the evolution of central banks’ authorized mandates, and he or she has additionally written about greening central banks’ steadiness sheets.
We’re very curious to listen to your views.
Our ultimate speaker is Veerle Colaert.
Veerle holds the chair for monetary regulation at KU Leuven College and is co-director of the Jan Ronse Institute for Firm and Monetary Legislation. Moreover, she is the chair of the Securities and Markets Stakeholders Group advising the European Securities and Markets Authority, and he or she is a member of the Belgian Decision Authority. One among her many analysis pursuits is sustainable finance.
Nice to have you ever right here – the ground is yours.