Financiers want climate risk integrated into EU’s Capital Markets Union

An Oxfam activist at the UN climate summit 2011 in Durban, South Africa. [Oxfam International/Flickr]

Investors managing over €13 trillion in assets have called on EU regulators to foster a financial system that better takes climate risk into account when the European Commission reviews its Capital Markets Union next year.

The Institutional Investors Group on Climate Change (IIGCC), a powerful coalition of green investors and pension funds, has called on EU regulators to accelerate the transition to a low-carbon economy by profoundly reforming financial markets across Europe.

“IIGCC has continuously called for European leadership on climate change – something Europe rightly prides itself for. However, this leadership must be reinforced by enabling the financial system to fully support action against climate change,” the group said in a policy paper published on Tuesday (20 September).

“Financial regulation needs to enable and facilitate the changes occurring in the real economy,” it said, calling for an orderly transition to a low-carbon economy.

Exposure to climate-related disasters such as floods, storms, or sea-level rise can have a huge impact on the valuation of property and infrastructure, destroying assets and raising insurance rates overnight.

“Climate risk needs to be better reflected in the price of risk so that a shift in capital can be encouraged,” the IIGCC wrote. This includes fostering “a financial system that encompasses time horizons capable of dealing with the challenge of climate change” and steer investments into clean technologies, it said.

“We call on EU institutions to develop an action plan to make the capital markets union more sustainable,” the IIGCC said in reference to a flagship initiative by the European Commission to build a single market for capital across the 28-member bloc.

Investors have stepped up warnings about climate change, saying global warming poses a systemic risk to global financial stability, and calling for an orderly transition to a low-carbon economy that includes a massive divestment from fossil fuels.

“There will be a transition. But if it is an unmanaged transition, it will be very, very expensive,” warned Frido Kraanen, director of corporate responsibility at PGGM, a Dutch service provider in the field of pension administration and asset management who spoke at a recent event in Bratislava.

Investors fear next financial crisis will be climate-related

A rushed transition to clean energy triggered by extreme weather events linked to global warming “will be very expensive” to swallow for the economy, investors warned policymakers at an event in Bratislava last week.

Risk disclosure

Stephanie Pfeifer, CEO of the IIGCC, said the low-carbon transition “presents a huge opportunity for investors in renewable energy, energy efficiency, infrastructure and other areas.”

The group contends that, in order to ensure a green transition, incentives for innovation are necessary not only in the power sector, but also for other parts of European industry.

Among its key recommendations, the IIGCC proposes a standard disclosure regime for companies to report on their green policies so that fund managers can assess their exposure to climate risk. “In particular, we support the disclosure of climate risk across the investment chain, from companies to investors themselves,” the IIGCC said, calling for reporting standards to be made as stringent as possible.

Loose reporting standards would go against the G20 push for having strict climate risk disclosure methods, it warned, saying this “would also undermine the comparability of disclosures across the EU”. The G20 launched an industry-led Task Force on Climate-related Financial Disclosures (TCFD) last December, which is expected to publish its final report in February 2017.

The IIGCC believes “mandatory full stress-testing of asset owner’s climate risk exposure would be premature at this time”. But basic stress-testing “should be encouraged to the extent currently possible,” it adds.

Other policy recommendations include tightening the EU’s cap-and-trade scheme for CO2, and the decarbonisation of the transport and buildings sectors, all of which are seen as “critical to shifting capital” into clean technology investments.

EU expert group on green finance

The European Commission has so far remained cautious about policy initiatives to prop up green finance, saying it needed more time to determine the best set of metrics to underpin corporate reporting and disclosure standards.

“Where we see the most potential is disclosures by institutional investors to explain their commitment to climate policies – how their balances sheets reflect taking into account these considerations,” said Niall Bohan, head of unit at the European Commission in charge of the Capital Markets Union, who spoke at an event last April.

EU pushed towards ‘climate disclosure’ regime for investors

Pressure is building on global regulators and the European Commission to “stress-test” portfolios of large institutional investors against long-term objectives to reduce climate change, in a move that could shift billions in investment away from fossil fuels.

But the Commission says it is now ready to move forward, pointing to some “fresh” new priorities for the Capital Markets Union (CMU) that were unveiled last week on Wednesday (14 September).

Vanessa Mock, EU Commission spokesperson for financial services, drew attention to an expert group that was announced last week and whose task will be “to develop a comprehensive European strategy on green finance”.

The group will issue its final report “in the coming months,” she said.

More broadly, the Commission “will also adopt non-binding guidelines on the methodology” used by all companies to report about environmental, social and governance issues to investors and consumers, Mock told in emailed comments.

In addition, she said work was “ongoing” to increase the availability of green funds through the European Fund for Strategic Investment, by earmarking at least 20% of the EU 2014-2020 budget available for climate action, and by setting up a platform for financing the circular economy.

Infrastructure investment

The IIGCC report actually recognised some of those efforts, hailing the establishment of the EU expert group on green finance.

It also acknowledged progress made in how long term direct infrastructure investments are now considered under insurance sector rules known as ‘Solvency II’.

“We appreciate that Solvency II encourages long-term investment that matches assets and liabilities […]. Infrastructure assets have a unique risk profile that warrants defining them as their own asset class,” the coalition said.

However, it called on the Commission to go further in this area by extending the definition to cover other infrastructure investments, like those made by electricity transmission system operators.

“For example, many assets in European countries that have a less favourable political context, infrastructure investments in emerging markets and assets that still carry certain types of construction risk might not qualify for the special infrastructure category,” the IIGCC remarked, calling for extending the special infrastructure category under the Solvency II standard formula.

The European Systemic Risk Board, an EU advisory body set up during the 2008 financial crisis, has warned about the risks of moving too late and abruptly towards a low-carbon economy.

Banks which are exposed to ‘carbon-intensive’ or CO2-heavy assets could face systemic risks, it warned in a report published in February.

“Policymakers could aim for enhanced disclosure of the carbon intensity of non-financial firms,” says the board’s report, Too late, too sudden. “The related exposure of financial firms could then be stress-tested under the adverse scenario of a late and sudden transition.”

Central Banks have equally warned about consequences of a sudden transition. “Extreme weather events raise costs for insurance companies, reduce investment valuations and lower the value of collateral posted for bank loans,” the Bank of Finland said in a statement released on 22 March.

“It is important to ensure that the financial markets and their participants, as well as the supervisory authorities, are aware of the effects of climate change on financial stability,” said Erkki  Liikanen, a former EU Commissioner in charge of digital policy who is now Governor of the Bank of Finland.

The Bank of England issued a similar warning in December, saying investors faced huge potential losses from climate change.

The warning was followed by the creation of a new industry-led global taskforce under the aegis of the G20. Launched during the UN climate conference in Paris, the Task Force on Climate-related Financial Disclosures (TCFD) was set up to develop “voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to lenders, insurers, investors and other stakeholders".

Its final report is expected to be made public in February 2017.


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