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Climate change and the financial sector - New trends in the financial sector

The new climate for doing business

By Lake Spencer - Group General Manager and Vice Chairman, Global Banking and Markets, HSBC


The case for taking rapid action to tackle climate change has climbed political and business agendas. The COP21 Agreement creates both the incentive and the imperative to move to a low-carbon economy. Significantly for the financial sector, the role of private finance is widely recognised as key to this transition. Even in China, the private sector is expected to meet the great majority of the costs. The sums involved are huge: IEA estimates $48 trillion in energy investment alone. How to mobilise this and what role for regulation, are central questions to consider.

To answer we need to take account of changes in our own climate for business. First, it is becoming likely that financial institutions will need to “stress test” themselves against climate risks. The ESRB recommended this recently, and the FSB is already looking at the quality of the disclosure of climate risks. FSB Chairman Mark Carney identified three major risks: “physical risk” arising from the immediate effects of climate change such as flooding; “liability risk” as business is landed with responsibility for pollution and other environmental harm and potentially sued by investors; and “transition risk” as assets are in danger of become “stranded” by disruptive innovation or regulation. Enhanced disclosure – the theory goes – will enable the market to begin to price these risks more efficiently, enabling investors to move funds away from certain sectors of the economy and towards those which have a more sustainable future. While this is both necessary and important, there is another risk to be factored in: namely the private sector not grasping the opportunity this shift presents and thereby making the costs of the transition much higher.

To avoid this policymakers, need to take the following steps. First, we expect the FSB Disclosure Taskforce chaired by Michael Bloomberg to deliver clear and effective guidance on what needs to be disclosed to the market and in what form. Unleashing market forces in this way will help enormously.

Second, we need to examine the mix of sanctions and incentives to see if they are fit for purpose. The green bonds market is a case in point. ICMA¹s Green Bond Principles (³GBP²) help issuers and investors coalesce around certain market-led harmonisation – helping the market to grow and building confidence in the asset class. China has set out its own guidelines, based on the GBP, for its market to develop and given its size and importance, has the potential to become the world’s leading green bond market. What we need though is a thorough examination of what incentives may be needed to grow the market further. Green bonds can then truly move from niche to mainstream.

Third, we should continue with efforts by the European Financial Services Roundtable and the B20 to harmonise aspects of the infrastructure market in Europe and internationally. Since most of the investment to tackle climate change will be directed toward new infrastructure creating an observable and investable asset class is key. Commissioner Hill is to be applauded for his efforts under Capital Market Union to push forward with this. Without it, we won’t be able to deliver the Juncker Plan.

Since most of the investment to tackle climate change will be directed toward new infrastructure creating an observable and investable asset class is key.

Lastly we should look for new incentives to encourage the finance to flow towards the new industries and technologies that can help us to tackle climate change. In addition to debt, green equity and lending will be needed from banks – like the UK’s Green Investment Bank – to deliver the transformation. How we risk weight assets should be re-examined in light of the new economic reality. The European Commission recognised the case for lending to SMEs by creating an “SME Supporting Factor” in the CRR to incentivise investment – or perhaps more accurately – to avoid disincentives. We now need a “Sustainability Supporting Factor” or similar to create the right incentives for lending to green business. If we get this policy framework right, the finance will flow. Get it wrong and the consequences could prove disastrous.