Policy panel discussion: Sustainable finance

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Policy panel discussion: Sustainable finance
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Third ESRB annual conference - 27/28 September 2018 Policy panel discussion: Sustainable finance Climate change can pose a threat to financial stability due to the adverse impact of climate- and weather related events on the economy and the transition risks associated with reducing carbon emissions. Participants in this policy panel discussed their insights on climate-related financial risks and how they can be addressed by market participants and financial policymakers. Chair: Mark Carney, Governor of Bank of England Panellists: Stefan Ingves, Governor of Sveriges Riksbank Dirk Schoenmaker, Professor, Erasmus University Rotterdam Christian Thimann, CEO, Athora Germany Francois Villeroy de Galhau, Governor of Banque de France
a bad start let me let me start off and thank the ESRB for the invitation Thank You Francesca for organizing this great conference including me in it this is
and for setting up a remarkable panel and I'll get to the introduction straightaway the topic is sustainable finance and there are a number of facets of sustainable finance which my colleagues will will cover they don't need an introduction but let me just hammer home a few points Stephanie miss both his governor the Reichsbank and chair of the Basel Committee and also long service as chair of the SRBs advisory Technical Committee so and in as you'll appreciate in in those various guises bringing forth some of the frontier thinking around these issues presto of Eduardo Gallo governor of the Bank of France and the founder like with every success there are many fathers but the founder of the network for greening the financial system and I hope a trust Francois will expand on that the the work of the central banks and supervisors who've come together under his leadership under the leadership of the Dutch central bank participation of the Bank of England but really bringing together central banks and supervisors which cover over 40% of global output and emissions speak further on that Christian teaming bringing extensive private sector experience experience in the insurance industry currently CEO and chair of a thora Germany participant in leading the --use high-level expert group on sustainable finance I first met Christian though hidden what was the first time but first worked more closely with him when he was vice chair of the private sectors task force for climate financial disclosures I'm going to say a few words on that once I finished introducing the panel but again perspective on how mainstream finance can bring us a sustainable sustainability and professor Dirk shone mocker widely accomplished currently professor of banking and finance at Rotterdam Erasmus I guess the Erasmus University really senior fellow at Bruegel member the Advisory Scientific Committee here at the SRB written extensively on sustainable finance new book out is it out yet in December you might he's very modest men but I'm gonna ask you to speak to what's in the new book I've had a chance to see a sneak preview I I don't want to say too much because we have this panel so I'll just make a couple of quick points one
is that these issues span macro-prudential stability of course the the primary focus of the SRB
micro-prudential issues and in my view mainstream finance and it's on that last point that Ln my introductory comments which is that yesterday I had the honor I was at the one planet summit in New York President Matt Krall secretary-general of the UN as the as the co-chairs of that and what was striking about it was just how quickly over the last several years issues that were on shall we say the periphery of mainstream finance have come into the come into the mainstream that's partly as a consequence of and quite rightly a consequence of the actions that have been taken by governments because after all governments make climate policy certainly central banks and financial regulators don't make climate policy we deal with the consequences of those and we want a system that is resilient to the changes in policy but just to give you a couple of numbers in terms of the change on the disclosure side this task force which Christiaan was vice chair of as of today there are a hundred trillion dollars of assets backing the task force it's 20 it's 3/4 of the world systemic the important banks virtually all the European banks including the UK eight of ten of the largest asset managers including the major passive asset managers who actually use their are now using their votes as passive a fact asset managers in favor of disclosure largest sovereign wealth funds major insurance companies the proxy firms that give recommendations on shareholder votes the ones that control 90% of those proxy recommendations are both supporting supporting this now and the consequence of that demand is we're just starting to see the supply of this disclosure so the leading companies are disclosing against those recommendations and there'll be a big focus in the run-up to the Japanese g20 summit around actually fulfilling the demand for this information providing supply so all of this has implications for for the financial system without further ado I want to turn to the turn to the panel and really ask what I'm going to ask and I'm going to go just for guidance starting with Stefan and work work
across the stage just ask them each outline how they think the financial sector can best adapt and be resilient to climate related risks and relatedly how how it helps mobilize finance to fund the transition to a low-carbon economy will start with Stefan they'll be will have a bit of a discussion here and then in the spirit of this conference open it up for questions from all of you so without further adieu dr. risks and financial sector financial stability generally speaking it struck
me that climate change and financial stability have at least one thing in common and that's something about the timeframe because basically timeframe is somebody is supposed to say no today in order to avoid a lot of problems at a future date and that's what climate change is about when it comes to getting a better handle on on climate change or trying to avoid it and many financial sector stability issues are quite similar in the sense that you say you try to do something today in order to avoid a unknown but with a high likelihood disaster at some time at some point in them in in in in the future and then the time horizon it's something that really really matters and we human beings have a pretty hard time dealing with a long time horizon because it's just hard to engineer those types of decisions so second point is that what we're talking about is is various types of externalities that are not incorporated in decisions by companies and investors either because we don't know about them or they are ill-defined and that needs to change because with better information or with right with the right information then essentially it becomes easier to turn to internalize externalities and then we need various ways and methods to make that make that happen and that's what partly this conversation is is all about 30 issues that which may be obvious that climate change is global and most decision making is local or national and that's a problem in itself when it comes to coming to conclusions on what to do and what what not what not to do and my pollution might affect my neighbor and and that's why it's it's difficult to deal with these issues what are the risks that well this can be defined and talked about in many different ways one is to talk about physical risks we're talking about droughts floods hurricanes heat waves rising sea changing eco systems these are things that at least in the early days affect the insurance sector and either these events have been insured and there is enough money and it sort of works or maybe many times the other way around there is not enough insurance and then the insurance companies end up in trouble and then eventually that could also spread to banks and to others let me let me pick a couple of examples in that have happened in the very very near near term during this summer first example is from July in Sweden were were an insurance company in the southern parts of Sweden started to refrain from insuring housing in Assisi a seaside location in the southern parts of the country because they say that if if the sea level rises this is not going to be sustainable the other example is another insurance company that in the middle of the summer one we had the serious forest fires decided to stop all no all no all new insurance of forests that came back eventually when the fires were put out but that's sort of it's pretty serious in the middle of the summer when everything is when you have some serious forest fires going going on so we have physical risks and then we have transitional risks in terms of this affects the corporate sector and it affects households you are going to have winners and losers in all of this and that means that the distribution of risks will look different in the future compared to compared to in the past let me give you a third example and we can argue to what extent this is about about the climate change or not but I think that most of you in this room have read about the NASDAQ clearing event that took place about two weeks ago and what happened on Monday the 10th of September was that the markets in Nordic and German power went in completely different direction German power prices soared along with with their rally in carbon emission allowances while on the other hand contracts on the Nordic market went the other way because more rain was expected compared to the rain that wasn't there during the during the summer and that meant that all of a sudden out of the blue the spread increased by 17 times compared to normal days change and that of course led to a bankruptcy and all sorts of technical issues within how to deal with that bankruptcy which is a different different topic how to deal with with clearing corporations when things go really really go wrong but it's a remarkable event in the sense that sort of all of a sudden nature changes and things and things happen where am i Basel Committee hat I have sort of sense that from time to time people come and kind of hint that the regulatory regime should be tweaked to incentivize the move to a low-carbon economy that makes me a bit hesitant because to tweak Prudential rules for all sorts of special purposes it's probably not the best way to go go about dealing with this because Prudential rules are there for very special Prudential reasons and that is to deal with the the would risks so I think that with this as a starting point one should make a difference between the e the need to increase resilience due to climate change and that's what Prudential rules are all about and the other one is to argue and discuss how to allocate the flow of capital towards sustained sustainable investments and when it comes to the lateral then it's probably issues on the fiscal side and others other rules not really Prudential rules that are supposed to be a dealt with to be used to deal with deal with that and it's of course hard on the public sector side I think - exactly prescribe what to do and what not to do is some of this will have to be dealt with by by the private sector itself but that is provided that there is good sensible reasonable information out there so that inform decisions can can be made and with that with that way of thinking I think that the International TCF D in issue that mark refer to already is actually quite important because without information clearly it's difficult to fully know what you're doing with information it might be still be hard because it's not absolutely clear at this juncture what that information is supposed to look like but it's not it can't be wrong can't be wrong to have it and it can't be wrong to work work on it over time in order to standardize this type of information in such a way that risks can be identified quantified and taken into account when people make decisions in the financial sector about risks and how to invest in in this and that then being a central banker the other aspect of course is what what should central bank's do and this is where it gets gets a bit difficult because as a central banker it's also up to us to be aware of these these issues but it's not that let's say monetary policy is your first choice when it comes to dealing with environmental issues so it's it's an other set of other set of topics there's topics there and I think that a little bit of the same actually holds when it comes to the management of foreign exchange reserves and maybe it's possible in the future to invest in these types of instruments but as long as they are not all that liquid and as long as the time horizon is very very long it's it's it's debatable what central banks should do when it comes to managing their reserves in this particular field so let me sum up climate-related financial risks are important for financial stability they're likely to be more important in the future because nature will do things to us that we did not expect in the in the past I don't think that rules are designed to deal with these issues except from a risk perspective but not so much from from a credit or capital allocation perspective and finally better access to information and better access or the production of standardized information is going to be a key issue in this field because without standardized information it's very hard to decide what is right what is wrong in this field and there is a need to assess these risks there is a need to price them and there is a need to manage these risks and if that is done properly then the various externalities that we're talking about can be better internalized in various markets and that should also mean that we eventually by internalizing these risks can allocate capital in a better way than in the past excellent you so excellent so just to as
I hand over to Christian to reemphasize a couple points you made which is first
this this element of the horizon and the time horizon and the related to that transition risk and one of the elements of the financial stability risk is is this going to be a smooth transition occasion by far-reaching climate policy and and and timely climate policy or are there going to be jumps in in the level of riskiness and we've seen some of those jumps in policy in the past whether it's been in certain electric utility markets you had an example of a market risk there secondly we emphasize and as I would hope and have expected not to use prudential policy as a substitute for climate climate policy but ensuring that there's resilience kristian you mean you have a unique perspective on this on this panel but i
would say more broadly given your private sector vantage point but participation both around these issues of getting the right information but also in the EU sustainable action plan so I'll give you your five minutes to take it wherever wherever you want thanks very much mark I would say that for me the way to think
about where we stand on sustainable finance the useful framework is to think about two arms of sustainable finance I would say the first arm is about understanding the risks the transition risks analyzing them disclosing them reporting on them taking account of them and governance both in private sector institutions and public institutions and I think there we are a very very good way there's a lot of progress I think the if the FSB star scores will go down in history as a unique experience where the public sector instilled a private sector process that led not a regulation but voluntary measures that equivalent and do the right thing and that's very unique so I see the whole insurance sector mobilized on on the climate risks that's evident we are on the year after the biggest natural catastrophes on record I see the whole banking sector very deeply engaged in in in thinking about the credit process and think about disclosures I see the whole corporate sector utilities energy sector also thinking how are we part of this game the whole discussion about coal about diversification electrification the transport sector so there's enormous corporate engagement and of course now the public sector the ESRB the central banks engaged in this so on this way I would say we are making great progress and I think the TCF D we we are still in touch we have now 500 companies large sector companies we are still talking to them encourage again what we are telling them is their five four questions you have to answer and your report on climate risk what's your governance around risks second holders affect your strategy third what's your risk management of this and fourth what are the metrics you have given yourself and that's a very very simple frameworks and we see many companies taking account of that in the financial reporting there is however the second arm which is the mobilizing are so how do we mobilize the financial sector to invest more how do we how we do get funds into climate mitigation how do you improve the energy system how do we improve the transportation system how do we improve even the food system which is also a huge emitter of co2 and here's I think where the difficulties are we still see that our economy suffers from a lack of long-term investment in infrastructure but also on sustainability if you think of jobs if you think of Regional Development if you think of education all the long-term issues and the question is what is needed to foster that and regulations the first thing that comes to mind but I would agree that's not the instrument of choice there has been the discussion about the green supporter factor but even the high-level expert group was very cautious on this because the capital frameworks there to cover risks and so it would only be justified to the extent that one could really be sure that the risks of a certain investment allow otherwise it will not be the right instrument the question is what one can do and here in the European high-level group we looked at three areas which we thought were relevant the first there is a total lack of infrastructure investment across Europe and the dramatic development of course the Italian bridge has just been a very powerful reminder of that situation but this is also the whole energy infrastructure transportation infrastructure and this is a paradox because there's not a lack of funds every insurance company would love to invest long in infrastructure so the money is there the need is there but somehow it doesn't happen when we looked at this we thought there's something missing at the European level there's somebody missing who can help develop infrastructure because it's a very difficult technological legally difficult area so this is where we need more development capacity in Europe the second element that discourages investors is not the capital charge this has been lowered by very open and many others so that's that's appropriate what discourages them is that there's no policy stability you don't know what the feed-in tariffs will be over the next 10 or 20 years and you invest in an iliac Walesa and you have policy holders to pay so we have had many many bad experience with government changes and feed-in tariffs that have destroyed cash flow projections of project in the third area that we would say holds back long term investment is still short termism in finance we have and this is Mark I would say your fantastic role of the tragedy of the horizons I would say there's also the tragedy at the short end we do have still a financial sector where large pockets are focusing on short term value attraction using long term instruments let's take equities the stock market equities and instruments which is for the long term if any of you goes to your financial adviser he or she will tell you you have to hold this instrument for a couple of years because this is when the returns will materialize and yet we know that there's a whole pocket of market that uses it for value extraction over days over weeks and so on the average holding of equity in the European Union is eight months portfolio investors turned the entire portfolio in 20 months so we see that something which is a long term instrument is used for short term value extraction and not even speaking about high-frequency trading which is saying provision of liquidity to the market but actually it's a profit-making mechanism on very very very short-term arisings so now you may ask what's the relationship how does that impact long-term investment and I would say it does impact it through some rules in the system and this are the rules that force many players now to move more to market to market so the accounting rules that transpose the volatility we see in the short-term market the short term trading fluctuations on long term balance sheet and an interesting example is if you look at the equity investment of european insurers that has fallen very very consistently is now much lower than the US and if you dig deeper it has to do with the capital framework and it has to do with the accounting framework because these are mark-to-market so you can have a lot of volatility and nobody likes volatility on the balance sheet so I would say today this is a big issue how to see how Queen can insulate and protect people who want to invest
into the long term how we can protect them against and you I would say a new short and volatility in the US for example they have the short swing profit
rules your director you cannot trade the stock of your company on a horizon shorter than six months so there is many times discuss the idea you need to have a longer term dedication for sustainable finance because all the areas that we ask for is illiquid long term investment and I believe we have to make sure this is not disrupted by marking to market practices on the whole balance sheet and so on that puts undue volatility and actually discourages people from going long-term where we need the investment most okay very good we'll come back to
some of those issues that's excellent so there you've thought a lot about these issues about mobilizing finance and a change in perspective yes you did expel thank you Mark and have it's nice to see that the topic is really high on the policy agenda and it has already
been longer high on the agenda of the markets and I was asked to from a book to reflect on markets and products which will become green and writing a book and my academic colleagues know that there's a journey and what I really found out it is not about certain niches and which are cooked as frontrunners like cream bones but is really about mainstream frying finance which gets changed and then that's also a solution to the short-term problem so we should attack the issue as a big issue rather than making a few products and then saying that a silent revolution is already happening because if I would ask you which percentage of assets and the management in Europe is already managed with one form of this called ESG environmental social confidence some kind of ESG factors in mind that's already more than 50 percent so 50 percent of these assets already take into account these issues the same is happening on the banking side they're really major banks if the making credit assessment there is a sustainability section on it on the issues of sustainability but also on its the business model of this company sustainable and so that is happening it is not yet in the models and also if you ask chief risk officers they are a bit the more quantitative you are the more you are away from this issue so these are not all looking at it and but and this is the risk perspective and I think a really like Christians thing of two arms so the risk side and I'm now at the Business School so it got really different perspective so I will call it the opportunity side and what you find academically you have these studies finest people to like this empirical studies so if you run on general is G factors and see whether you outperform the market or not you don't find much evidence not plus not minus but what is really happening is that what matters are material is G issues and that means relevant to the company so for example your work at Central Bank supervises I work at University so first do we have access to intellectual capital young credits that's a material issue if you're a manufacturing company at this health of safety of the workforce in down on the ground so the issues are very different for each industry if you run your empirical studies on this issue so you take for each sector the material issues then the first studies already shown superior financial performance and then I go to my friends at the business school I've been there now for three years I learn a lot they would say yes there's about strategy of the company it's about the business model and then are your future proof so the sustainable development goals I'm happy that Christian also broaden it from climate to raw materials Lent use what to use social calls it is really the big companies not only in utility so the Uni Lefferts and Phillips on health care so it's broadening and basic issue is issue business model the future working on the future there's an opportunity or not so I owe Kodak still making the printed photographs or are you doing the digital photo making so that is at stake so are you moving to this new sustainable economy or are you sticking with your technologies and that's what business is doing not all of them so you have records early runners and then the middle crowds so what's happening in business and exactly the same happens information institutions I talked about this 50% of investors who now look at these issues so is the company I'm investing is see ahead of the game already in a transition or is he using the old technology still it's not only fossil fuel companies if you are car company and you still have to traditional motors and a carbon tax will kick in so you move to electric but you don't have electric motors your company will be worthless stranded assets what is more than only the big oil companies that is really all carbon intensive assets including real estate which has not an efficient energy level so they're really hitting the economy in a big way if carbon taxes are going to come and then the interesting thing is because otherwise you get gloomy that is exciting as Bank or us infested to to invest in this future-proof companies to identify them and what are mechanisms and I think the resurrection census let's not wait for the regulator so things are coming and I think also taxation some countries have it like Sweden having really substantial carbon tax if we get more pictures on the television of permafrost the Canada and Russia the melting IceCaps then politicians will start at some point to convert serious carbon taxes and you are all economists so your doctor let's do it smoothly we announce it and we do it in a five-year frame that's economists I'm also trained as an economist politics is different as soon as the politicians they way to be too long but as soon as they smell they have to do it they do it overnight so it will be not the economy scenario but in political scenario so you get an overnight in high carbon tax and then but I always tell my students is losses will not be compensated because the politicians Oh a promise to the electorate not to business so if the Queen left is introducing a carbon tax it is not going to compensate the losers look at the energy when the here here in Germany eighty percent ninety percent of equity value is lost on the utilities and is borne by the market these losses and and we were almost there in the Netherlands last year when we had the negotiation on the government the first round was the green left in and then we would have had a carbon tax in the end we gotten in coalition without her we left so no carbon tax yet so that's how it can happen and that's what I want to do as a wake up call here politics is brutal and we know which way things are going so early or late we will get these issues on the table finance is about anticipating things happening so it makes a lot of sense to anticipate these things happening so your head of the queue now you can sell your fossil fuel assets when everybody's running for the exit you get 0 for it and then move into supervisors exactly the same if you find a bank or pension fund with a lot of brown assets I would get worried if they have a lot of high carbon assets so I would start to explain large exposure rules to this exposure so supervisors can do the same and then the final thing is the climate stress test that you take a longer horizon than the normal stress test that you look what is in the portfolio's of banks and asset managers really across the financial system because Mario Draghi also said we have to look beyond banking with Metro PD and she really sector-wide and then we couldn't do the climate stress tests on the whole financial system and the Dutch central bank did already last year and survey on all financial institutions on their carbon intensity of all assets including real estate so these things are happening speeding up the progress on this topic and what I like is to look at that as an opportunity to move to the new era rather than only to look from the risk side because otherwise you you become a bit gloomy if you do that too often okay very good
so underscoring strategic resilience of these ideas and I think will try and pull it out a bit in the discussion around scenario analysis climate stress tests and where is that technology and how can it be developed Francois I referenced your your parentage of the
network for greening the financial system which yesterday was described by I try to remember to describe by some head of state described it as the most exciting name in climate finance and there was probably some irani interest
no it was sincere point because it was about great anyways but we are excited about it exactly before saying some words about our network for greening the financial system or we are successful
enough to have an acronym now the common a crime and DFS let me share two preliminary foods first why do we care it's not because we want to be fashionable and there could be a suspicion because we share in this room a conviction that climate stability is in the wrong one of the determinants of financial stability so it's not a sherry on the cake it's the core of our mandate and second trailer meri food we are all familiar with a distinction between physical and transition risks but let me spend one minute on that there could be a tendency or even a temptation to focus on physical risks and to think that they are more or less covered by insurance and that is the business of insurance this would be mistaken first because part of it is not covered by entrance and then clearly it's a risk for banks and the rest of the financial system and second that what might scare people most is not necessary what we should focus on the most transition risk have not yet materialized but they will probably come earlier and we have to deal with them they are of different nature but they affect banks there are business risks there are market risks about the volatility of the prices of brown and green assets so obviously credit risk and there are also legal risk with all the liabilities we at the ACP are so the French supervisor may deferred estimate about the share of the total credit exposure of banks to such transition risk and we had a magnitude of around 13% it's interesting because the DAP supervisor had more or less the same magnitude with the same study so this is what an GFS is about it's our role as supervisors and central banks to deal with these two kinds of risk including transition risk some words about an GFS where we are we created it a bit less than one year ago it was in the first one summit planet in Paris last December and Marc was there Marc is always an attendee of the planet submit because you were yesterday in New York you can tell us we created it as a Coalition of the Willing sand this is extremely interesting so we were eight founding members at the start including the Dutch National Bank who chairs the ng FS at present Frank elder son the Banque de France has a Secretariat and the Bank of England is a very important member we are now 18 this is interesting and we are even 23 if I add five observers including oacd World Bank or B is among the 18 members they come from five different continents and there are some more unexpected members perhaps but very important one like the people Bank of China or the Reserve Bank of Australia and Australia is not famous as the most enthusiast country behind climate mobilization to be fair we don't have yet the US Fed in C and GFS but perhaps they will join the Coalition of the Willing if I can express this they came up with an expression no but it's off the record
note the Central Bank of Canada can join as a first step so but it has been expanding and there is a great mobilization so how do we work and we try to be very operational we have three work streams I don't want to bother you with your practical organization of the
work swing but let me say some words to conclude about the content the first work stream is about sorry I take the exact title supervisory and macro-prudential issues and it's served by the PBOC and here let me make a distinction about the analysis of risk between what I call the snapshot and the video of risk the snapshot is about the disclosure of existing risk by measurement and say disclosure here obviously we have the fantastic help of the TT FD under the sponsorship of the FSB and as we know it's voluntary disclosure it already raises many questions and we try to take stock of the various efforts of various addictions or comparability of data and this is a very technical issue obviously in some countries including mine we have some mandatory disclosure it raises the same technical question but if I can express here a wish that sooner or later we should come collectively from a voluntary to a mandatory disclosure having made progress on a common taxonomy which is obviously a prerequisite this is a snapshot and then we have the video of risk you know forward-looking perspective this is a still more difficult issue and as it is more difficult we have trusted the Bank of England to deal with the issue because this is our work stream number two about macro macro financial questions we are all near the start of this reflection but it's a very important one and to give you two examples if we want to have forward-looking stress test which is probably the most powerful tool we have we have to deal at least with two questions how can we translate climate change scenarios which we know into economic scenarios that can be used in adapted stress testing frameworks and we know how to deal with economic stress test so we need some kind of translation and second is hue how can we assess the impact of shocks on the problem probability of default PD over a much longer horizon than the usual one for PD of one year these are tricky issues but we are taking stock and we are trying to to make to make progress I believe that such tools video forward what I call the video forward-looking stress tests are probably much more powerful than some regulatory tricks if I may use this expression to qualify the Green factor I'm very cautious about the Green factor for the reason already mentioned by it Stephan and Christian just to conclude what are the neck we have third workstream about the role of central banks themselves shared by the Bundesbank what are the next steps we will have an interim report in Bali where we will use this gathering of the international community and we will publish the first full compressed comprehensive report next year in April and having a conference in Paris so again it's a Coalition of the Willing it's a new way of working together we are very enthusiastic but we want to deliver on our personal tools thank you excellent okay fantastic as I expected a
very rich set of of comments and I think as you will appreciate if you're if you're new to the topic a lot of substance underneath so it's not this is not an aspirational topic it's not conceptual it's moving into a lot of substance I thought I would if we could I'd ask three or four questions just to
draw a few things out and then open it to the floor and just to sort of nail it down on this question of green supporting factor and both Christian and and Francois commented directly on it I wonder and this is partly influenced by some of the discussions we've had at the ng FS about if not a green supporting factor what about a brown penalizing factor and I'm going to throw it open to anyone who wants to comment in the sense of it satisfies both the Prudential caution and and and some differentiation I welcome any any thoughts from the this
is not now this will not be official Basel Committee tomorrow in a personal capacity yes well I wouldn't surprise me if over time that's the heading that direction we would be heading in because that's basically being aware of future risks yeah and trying to calculate them
in one one way or the other no let me just give you one example which is maybe well-known in this country and I think that rotten farm is kind of a household name in this country basically they as far as I know they had to get rid of eventually got rid of all their brown coal investments and an enormous loss and that's the way these things go hold the section all of a sudden you you sort of bought something yesterday let's look good yesterday but then you realize that this is no good for tomorrow and then you just have to cut your losses and get out now button fund is a government-owned company so in that sense and they had a ton of money so that they could do it but for a privately owned company would be harder to know whether whether actually you could you can sustain that yeah a Christian and then my sense would be I
understand of course it's much easier because it goes in the way of regulatory prudence prudence but on the other end it suffers from the same shortcomings I mean I think it would be only justified if indeed it was riskier sure so and if
that's the case maybe it's just cold I was still at AXA when in 2005 AXA decided disinvest that was without any penalizing factor we just realized this is a risky investment going forward that's you had the horizon in order to do that yes first of all I would say sit
on these questions the jury is still out not very strangely the banking industry tends to favor a green factor diminishing the Prudential requirements and the severity sites tend to favor a
brown factor penalizing so this is not very surprising but we should have one very simple principle it should remain risk based and not intention based and on this field asset the jury's still out but there are probably more reasons for brown penalizing factor which are more risky in the long run that for advantaging green factor excellent turkey and I can keep also an extra
argument for them because I talked about opportunities on the sustainability side but nobody knows whether wind or solar
who will win we don't know there's a business risk so both are renewable energy sources and they will be scaled up but which one will be really profitable and on both sides raise a lot of investment going on so one will relatively came to the other sort of normal business risk is around on the green side like in any business there's no reason to lower and I argued about maybe a large exposure rule for high carbon concentrations in in your asset side the alternative will be a brown capital factor but I think we on the panel are more or less agreed if you have too much high carbon assets in your portfolio then you need to do something about it well it is large exposure and brown capital charts or Auto guidance but the supervisor should then act on it yeah excellent I'll just mention just
because I brought it up the the PRA the Supervisory arm of the Bank of England came out with a report will actually came out with a super supervisory
consultative document yesterday and reference some analysis in it around this issue and I think going in the prior would have been once you control for other factors you wouldn't find out performance on the green on the green side but in the case of UK mortgages they found the controlling for income controlling for location there was actually some of performance which which is interesting and that's well what can one it's it's it's a bigger discussion but it goes to the core point that you've all made in front of all most forcefully then it has to be risk-based and then the question is what's your horizon for the risk and where do you see it and that's to give a sense and that again gives a sense of the analytic basis for all of this and depth to it let me let me shift to if I could to scenario analysis and and stress testing because this has come up and I didn't be helpful would be helpful for me but for others to get a bit of perspective of where are we in how early days are we in scenario analysis and and stress testing and and and where do you see the direction of travel and I'll start with you Dirk if I may given your your perspective as you remind us rightly on both opportunities and risk and yeah and of course strategic resilience goes to very much to the opportunities what I did is I'm now teaching for a third year
sustainable finance and sometimes you do experiments and you don't know what comes out of it and I did a lecture together with somebody who used to work at Shell shelest and more or less the inventor of scenario analysis given the the lower risings of their investments so he I did explain sustainability he explained how scenarios work and all the students were mid-year so they knew how to do a valuation of a company so he gave them cash flow analysis by an analyst oh like ten fifty year outs of JP Morgan of shell of accelerometer and then told them okay you got this you know how the cash flow system work of this company now you search yourself one or two material factors and you make your own scenarios and then we have two teams on each stock and it was really amazing like on steal on accelerometer both teams came to about one third of the stock and they are not only carbon but they had to find us and what to use it so they were really without any guidance from us they were really deep going so my main message is the main thing is they really look properly at this is G so really look very carefully at what you want to talk and come very deep down so if you want to take a climate issue or something else go very deep and then it is less important whether you put a 30 or 25 percent percentage on scenario because there's anyway subjective but go very deep on the on the on the factor itself do it serious and then what all people already set here and coming from you Marcus you need a longer horizon the one year clearly you need a longer horizon so don't mix it up with the standard stresses you're already doing banking
make a separate one across the financial system will be my advice Gerson in the
corporate sector I would say we adhere to so people are experimenting this it's gaining traction the great thing is that it forces forward-thinking by definition is exactly what Francois said it's the film not the picture so
obliges you to think forward corporations are interested in that the two hesitations they have is one which scenario to take that's always very difficult there are several scenarios out there technically and then is that my country scenario is that the European scenario the global scenario so that's one of the difficulties and the other difficulty is that they say how much time do I have to experiment on this because this is new and how quickly am obliged to disclose it publicly how quickly will the supervisors come how quickly will the investors come so that's a bit they would love to have a phase of experimentation before this gets real because as much as it's useful it is very very strong because if you extrapolate trends going forward you see the Delta is really growing so you really really really see valuation so that's a bit the tension where they are and then of course for them all of us is
the question will the investors share the long term perspective because we have many investors in the stock of a company that are looking at the next year returns still and there to say you know we discount really very much what
happens in five or ten years down the road so I would say that's where that's where we currently are can I if other
colleagues have comments on that I'll give you the four in a second but I want to come back on this issue of long-term perspective and again investor perspective and I think one of you
mentioned that one I think was you actually when that there wasn't necessarily once you control for climate there's not necessarily outperformance and because there is a school of thought on ESG ESG related issues that people are willing depends of course to pay for ESG SDG performance a sustainable development goal performance so how much alpha am I giving up but what some are finding then I'm you can tell I'm very tentative about it because I don't think it's conclusive certainly not in front of this audience some are finding that it's at least consistent with the market in some cases performance because there is certainly a correlation between companies that are looking at these types of risks climate related risk SDG risk and who think about other long-term structural challenges opportunities to business they tend to be more long long-term thinking is that I just yes yes that that's absolutely I think what you described is sort of consensus the the the aspect the conflict however it was
different and let me tell you a story because I talked to many CEOs obviously on this and I thought one CEO described the paradox most visually and he said the problem is when I think about long-term investment utilities come free you know new technologies new energy is that I always have to have two speeches in my suit here on the left hand side I have a speech for the analysts the speech for the analysts that come and if you ever run the company you you get frequent visits from the analysts that that that come that year there's professional investors and they want to know how is the current year going and next year that's the horizon and they ask you all technical questions about the return on equity the dividend payout ratio that you have leverage and so on it's it's this year and the next and if
you tell them all we have a longer model the seven that we discount too much we really want to know this year and the next he says then in my right hand pocket of my suit I have a speech about my economic role my role in society my role for the planet for the youth and
the climate and that's the speech I use when I speak in front of employees politicians or when I go to Davos and he says what drives me crazy is that these two speeches are not connected and I think it's a very powerful algorithm the moment I deviate from the short-term results you know short term optimization and say I switch technology I go more to more renewables and energy provision I invest in electric cars and whatever the moment I leave this path of short-term optimization I get punished by the first group so maybe I will be a hero in a few years down the road but I will go through hell in the mean time so this is a bit the tension that they feel between
the long and the short term because and that many investors are the same and I think it really will paradox because when you talk to the asset managers they tell you the same story they tell you I'd love to be stickier long-term but I'm always measured against competitors by you know they indicators tracking and so on if I deviate from the benchmark for one quarter my boss calls it a tracking error and I have to justify so that's what you often hear the story that we are very much focusing still on short-term tracking uniformity meeting the benchmark and so on and that that environment to go out and do the big technological changes that's the challenge I would say yeah you and then first of all and then I'll come to the there's an empirical evidence what we
read it one of the u.s. stories and they were very strong on our performance and then we found that quality was really
important as factor the quality cents mainly for quality of management I think it is in the end to see all who there's only to use his right hand side speech it stops with the left hand speech I think management quality because it is about the future and do you have your future of your company on your on your eyes do you have a good strategy and that I think that's the key issue do you dare to be long-term ignoring the short-term which is difficult and the question can you afford it yeah
sometimes you can't really fold it and that's where you have to trouble interesting first one and Stefan two quick remarks so first one about the schizophrenia you just described Christian and this is a key issue there is a paradox here I don't know if the paradox is a solution but investors are
often rather short term as you said but savers and investors manage savers money are individual citizens and this individual citizens are more and more sensitive to sustainable development and it's it's a great movement in our society so will we see some translation of this savers expectation to the investors expectation it's an open question my second remark is about forward-looking stress test and mark you raised the issue one technical word about that we are convinced in the ng FS this is probably one of the most powerful tools but let us be honest none of us has a technical solution at present it's why our work stream is really started taking exercise and we try to elaborate on apophysis if I could put it in a nutshell I would say that we have two solid foundations for our reflections we have the climate scenarios and more or less we all agree about them and we have
the stress test financial stress that methodology and we learnt much about it in the last ten years how can we converge the two we have to bring the climate scenarios to economic scenarios as I said none of us thinks now that we can apply directly climate scenarios to stress this so to translate them into economic scenarios and if I look at the
other end of the spectrum about the financial stress test we have also to take them in a longer-term perspective it's not only a challenge for investors let us be honest even for us regulators which are always longer-term it's not obvious to have the horizon of the present stress test I mentioned the example of the one year for the PD in the much longer term perspective we need for climate change but this is a work we are trying to deliver in the coming year excellent it's definitely for the past
30 years when I've been in this business so I've always listened to people who complain about marking to market and same thing today so in that sense it is not new and there are many contradictions and difficulties in all
of this because essentially stress testing is marking to market when it comes to looking at what happens in the future and that's why it's not so easy to find the right balance in in in all all of this because stress testing essentially is about telling stories about the future actually being honest about what stuff is worth in the future and that's that's that that's what it is and and at the same time people seem to hate more to market and that's that's not so easy then to to deal with if I just made a notion of granularity in this debate I
think it's not for or against marking to market so the question is should it be applied to each and every instrument of each and every investor type so I think for the banking sector for example you
have the banking book and the trading book for the insurance sector paradoxically which is a longer term second you don't have that so in theory you mark to market everything except real estate so this calls us then a lot of short on volatility and fluctuations and that for assets of which you know that we'll all likelihood you're not selling them the next eight years because that's the average maturity and you have other assets to sell in case of Liguria stress the question is are we not shooting ourselves in the foot to apply market to market to these various at go yeah okay excellent so I wanted to open promised
to open it up if you just raise your hand I'm sure microphone will mysteriously appear or you can shout loudly and I'll repeat your question Mary professor Pagano and if just for the benefit I think many are known to each other but even if you're world-famous you can tell us right there yes I was it's Francois Valera I was talking about this Malaysia this translation of the climate scenarios into stress test requires very complex the type of operation I imagine because different scenarios climate scenarios will be presumably associated with all kinds of
socio economic phenomena such as a mass migration deriving from climate change or very complicated general equilibrium effects including also political reactions to climate change so
essentially the mapping may be extremely complex because it's not like you know something that we have two models actually the whole social social and
economic system how it would react to the climate change to translate it into economic consequences that then we can map in terms of stress for the companies or the banks so so I was wondering she was talking about you know what we really need in terms of analytics very complex general equilibrium and not just economic equally but also social economic equilibrium models to do that should we take money why don't we take a
few so Governor behind you like to go along the same line I'm the remaini central bank Daniel Durant [Music] like what strikes me here is that
finance is willing to be more for looking to be strategizing when we acknowledge that markets or myopic I mean more or less we have economics of insanity if we think about climate change and what can happen with our planet instead of having my economics of sanity so how can we internalize in economics I mean it's the externalities and and the self-destruction we have embarked on this is one one thing so we have a combination of new technologies which are displacing labor we have climate change which is splitting up and we are not responsive enough and we have a cluster of financiers I mean if people who are trying to look to strategize and to think look it's it's dramatic but then what are the underlying alyttle underpinnings which should help us when it comes to economics I think economics is a huge problem our models and then how can finance how can we have finance in the driving seat how can we have the sort of due diligence which should convince economies politicians to look we have a huge problem and we have to change the way we behave the way we calculate so that we should not not sustainable finance not sustain not finance should be sustainable our economy should be sustainable so that's okay two excellent
questions I'm going to turn in I'm gonna supplement the last bit if I may Daniel which is to just make the point that some of the more simple stress tests and this is all complex is to say assume a two-degree scenario take an IAEA scenario 2?? scenario and what is the
implicit price of carbon and other policies that are consistent with that and then one Maps - what does that mean for my asset portfolio in my business yeah now that's already starts to get pretty complicated but it-it-it steps out from whether or not whether or not that will happen it just assumes that action is taken so that it does happen and what would that mean and maybe some of the market cynicism cynicism isn't a right word myopia in this sense is that it just doesn't think that will happen the first stages of that the two-degree but these are these are complex mapping questions from Professor Pagano and and from from the governor so francois can I start you please I will try to be short on these
two question only your third question so fair answer it's a journey but we are making progress on this journey if you start with physical
scenario it's exactly what Mark just said there is now an agreement unfortunately about the physical scenario it was not the case 10 or 20 years ago and probably there is only one important American citizens who is not convinced about the GTR then we have to
translate it in economic consequences and all your questions are perfectly accurate but it's not completely blank sheet if you look at IMF or oacd studies we have already economic simulations we have probably less consensus on sale and it still macro but we could elaborate
and then we have to translate these macro consequences in micro for each company or each financial institution but we are on the journey so I cannot say when we will be the end but I'm confident we will come to a credible economic scenario and stress this about markets Danielle only slide those of optimism a slight one if you look at the development of green finance it's an impressive market phenomenon we have already one trillion outstanding we know we have huge needs ahead of us up to 100 trillion dollar probability 2030 but here we have market developments which are completely spontaneous and driven by supply and demand and you mentioned the opportunities green
finance is probably not at the core of our panel but it's a financial opportunity and we need to develop it quantitatively with perhaps and this is one of our challenge some qualitative
improvement because to be fair at present green finance is a very diversified content and here again it's a question of LaBelle charters taxonomy but we can make progress on that but we have one field where markets developed in the right direction excellent because I also would say we
should rather be encouraged because we are quite fast on this journey if you think the Paris agreement was 2015-2016
was ratification 2017 was T CFD and high-level expert group 2018 we have the movement ation so I mean that's a very very fast I think there are few cases where the implementation will be as fast I think if we fail to take these two arms we will not fail because of a lack of awareness I think we will fail because of underinvestment I think today the problem the financial sector has it cannot invest in assets that don't exist we still have a shortage of green infrastructure energy transition project transport transition and I think that's also role for economic policy it's easy and China they say we do you know a gigantic battery a plant and they do that very simply in a market economy this is very difficult in the questions for economic policymakers I think they also should start to invest big times and redirect financial flows I think that's the message to them to tell them the financial sector is ready to go long term please do create these assets do create these technologies that give us the opportunity to finance them okay all
these scenarios exactly I should set mark what what is a sensible price and
we have this data out we have to stick let's turn that I think that's the latest report which says forty to fifty dollar midterm but in in in the lower term 100 carbon price we did that with the Dutch data so this these are initial results so we have this data of the financial system and then we apply this 100 carbon tax overnight and then 50% about 50% of the equity capital of the financial system will be wiped out and it's our first round losses so no second round and first result so don't quote me on that we will work further on it but it shows that is massive it's a bit late the labels SCH o en yeah
and finally ought to pick on the safe francois you set I think that starts now our pension funds they're doing surface
among the beneficiaries and they say of course we care about our pension in a livable environments and that's what we see so the push behind is G is also financially driven but also is G driven because and even us academics although they are European born all of her heart and the witches in Calais they have this paper okay they say if if we don't want that Walmart is selling machine guns we can wait for regulation but we know what happens to Washington nothing here but there are shareholders if you are a shareholder of Walmart you can go to the annual meeting and felt against it so this idea of pro-social shareholders and so in that sense things can move and I think that's why but they like most of Christians reporters this strengthening of the fiduciary duty I think that's so important that we write down and that is happening now in the legislation that investors have an asset manager have a duty to check on sustainability when they make an investment they are not allowed to ignore it anymore and that can be quite helpful great
I might just see if we have a couple more questions and then we'll we'll close for governor lane yes at the back please yeah dripping Socko yes or me I couldn't help noticing that your angle is very much Metro Prudential so I'll give you an example of what I mean I was
sitting at dinner once with a chief compliance officer of an airline and she was laughing her head off because she was saying my job is to prevent planes from crashing your job seemed to be to calculate exactly how much insurance we have to put aside to pay for the cost of the passengers dying so I heard a lot about capital a lot a lot about valuation but isn't the whole thing about trying to avoid the externalities there are implicit in the mechanism and try to avoid the plane crashing rather than putting aside capital so when it crashes we have enough to to cover for the pensions or to cover for the cash flows question goes to the heart and
then last question Costas Carlos here just up her dr??bak yeah thank you I want to go back to the question that was raised by Christian ten years ago he was
a TLV we launched the first green bond it was a new and one problem that we had at that time was to be sure that we were able to show to the investors that we are using the money for green projects and this means that one of the points that we had care about is about certification of the projects why because there is a reputation risk that is we take the funds from the market the investors are very very keen to to Rend to projects but after we need to show that we were able to deliver what we were promising and then it's linked with the Christian point we need to be sure that we are able at the end of the year to show at the end of that every euro have been used for that and on that point I want to say on point is that Europe was the first mover on the green bond side before even before all the bank but certification is a critical point because reputation after will be at stake if we are not able to show that you use magic in the right way okay excellent so I'm gonna go to Christian
for observations on on if I make green ball and the green bond market is now over three hundred billion euros I believe outstanding but that and then obviously you can come in on the other but I I would phrase the the question from our colleague about are we trying to stop the plane from crashing are we
putting foam on the runway or are we helping a broader process of smooth a smooth landing but Christian first on the green Carlos indeed it's a very very
important segment I think we can be proud the a/b tool to have championed that the challenge will be to develop new projects so not just to identify
existing ones that are green but really to renew the European Commission believes that we are lacking a hundred eighty billion investment every year investment in energy efficiency in renewable energy and so on and if you dig deep and talk to people on the ground to mayor's to poor local politicians you always come back to the issue it's the development capacity that they are lacking to do offshore wind is a very complex issue technologically legally financially to leave this to to low positions they need capacitors our plea was whether the air be or somebody could go out and help and draw experience off from Denmark to Portugal let's say to say what has worked what hasn't worked because we have now lots of examples where renewable energies for example have worked and other seven worked so one agency that can transplant experience then really develops new projects I think that's what what's missing most excellent francois on the on the plane
you're flying the plane on the plane there's a plane is for me or for now obviously we all agree with your question our aim is to avoid the plane
crushing two or three thoughts about that finance is important but finance cannot solve the old issue it's obvious but it's very important if you take the Paris agreement the EU has committed to reduce its carbon emissions by 40 percent at least till 2030 and we will not sell that mainly for finance it's a political will with many of the instruments which and which you mentioned but finance can help and we focused more on risks today but we touched upon the issue of green finance and how can finance support the huge investment needs we have and here I want to support what Carlos said the question of certification is very important if we want to develop it on a sustainable basis in significant quantities in the years to come we have to improve the certification if not sooner or later we could have a qualitative doubt I don't elaborate more last remark I see no contradiction between everything what we said about risks how to measure them how to disclosure them how to look to them in a forward-looking spective and avoiding czar playing to crush on the contrary I think what we are doing through finance is an alignment of interests and if through the rest side and through the opportunity side finance is really incentive to take into account the climate transition we will help avoiding the plain question excellent it's
definitely the one issues to deal with let me call them present risks and if presently risks are higher today than there were yesterday that should matter in terms of how we think about them and
what capital you need and how much equity you need in order to to carry those risks the different thing is to think about investments and risks in the future and how to price those risks so that when you look into the funding mechanisms that you use if you want to invest in let's say something Brown for the future you probably would end up with a problem compared to wind power and then you need to have the proper map and the proper the proper information that you would need when you think about which investments to make and then given the information available provided that it's sort of reason accurate information then one needs to have mechanisms such that the price mechanism is such that some pretty bad investments can't get funding and some pretty good investments should more easily get funding the
plane-crash basically what we're talking about here is the transition or of today to a new type of economy which is low-carbon occlusive and a lot of other things so in a transition journey so that is your
safe space of not too many planes coming down and forward-looking business leaders and then I'm tapping a bit also on what Stephen saying forward-looking business leaders are exactly looking that so they aim for the aim is avoiding reducing this externality rather than only that kind of thing and and if you look at the World Business Council for sustainable development and let me give one clear example outside climate but just for example health care Philips has is doing integrated reporting and one issue they put out as a coal is health care for three billion people so not only earning in the West a lot on the medical equipment but also helping out in Africa and other areas and at the same time they are reducing carbon efficiency they're doing that more efficient the rest they compensate so they're really committed on this future and I think that's a challenge and then finance comes in later steering companies to love journey and trying to support these forward-looking companies avoiding the short-term mission but that's the big challenge no that's exactly was excellent excellent way to
bring it together I think one thing that this this trajectory for the financial sector makes possible is that the more credibility there is around climate policy so the more Paris is translated into climate action the more financial
markets allocators of capital can do what they do best which is to pull forward action to anticipate and to make those investments possible and cost-effective and and everyone in this room can think of the analogues to you know monetary policy credibility and and macro-prudential policy credibility in that once you've established it it works there and and what these individuals and the ESRB and many of you can do is is to help build the tools so that the financial system is resilient and responds to a political will that comes from society's underlying demand and that and and that is the virtuous circle that is made possible so thank you all
now just I want you to note the the difference I show up 10 minutes late Oh I mean admittedly I was told I was supposed to start at 4:00 but I showed up 10 minutes late governor Lane has been patiently sitting here for 45 minutes right nothing to chance left nothing to chance and I don't know
if you do you get a formal introduction or am i introducing you this is the formal introduction the formal introduction well we're in for a treat Philip Lane is going to give us a talk let me please join me in thanking this
excellent panel for everything they do and for this