There is a market failure to price climate risk and the European Central Bank (ECB) must analyse and manage its own exposure, according to Executive Board Member Fabio Panetta.
In a speech on Tuesday to the Italian Society of Financial Analysts, Panetta said the ECB was obliged to protect itself from the financial risks posed by climate change. “By performing its own analysis of these risks on the basis of rigorous methodologies, the ECB can contribute to the accurate valuation of these climate-related risks,” he said.
Panetta’s remarks received widespread coverage in European and North American financial media. However, the position that markets fail to accurately price climate risk is neither new or controversial.
The recommendations of the Task Force on Climate-Related Financial Disclosure (TCFD), and the support they have received from regulators and investors, are based on the premise that markets currently reflect neither the substantial physical risks of climate change, nor the transitional risks of policy and societal response. The very purpose of climate risk disclosure is to give investors and other market actors the information needed to incorporate these climate risks into their decisions. Markets cannot accurately price climate risk without this information.
An analysis of climate risk on its own balance sheet is a first step for the ECB in making its climate-related financial disclosure, following the Bank of England’s (BoE’s) pioneering disclosure last year. The ECB has strongly and publicly called for climate risk disclosure from banks and companies, but the bank’s failure to disclose its own climate risk has damaged its credibility in this area.
As the ECB reviews its strategic policy framework to include climate change for the first time, a cross-party group of MEPs has called for it to follow the BoE’s lead and disclose its own climate risk in time to inform the discussion. Delayed by the COVID-19 pandemic, the strategic review is now expected to conclude in the second half of 2021.
A recent assessment of sovereign physical climate risk by 427, the Moody’s-owned climate risk analysts, estimates that 41% of the global population and $78 trillion of assets will be exposed to damaging floods by 2040. Additional substantial risks include sea level rise and more frequent and extreme storms, droughts and wildfires, with impacts on trade balances, tax bases, labour productivity and even political stability.
The report places France, Italy, Spain, Portugal and Greece at high sovereign climate risk, with all European countries exposed to at least some risk, especially flooding. Meanwhile, an assessment of transition risk by the Principles for Responsible Investment forecasts a policy response to climate change by 2025 that will be “forceful, abrupt, and disorderly”, with significant effects on asset values.
With TCFD implementation only beginning, substantial and unpriced climate risk clearly exists in almost all portfolios, including that of the ECB. Understanding and disclosing these risks would not only help the bank protect its balance sheet, but would set a powerful example to the banks and other companies it regulates and seeks to influence.
This page was last updated April 20, 2021
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