Climate litigation a growing risk for central banks, says ECB paper

A paper published by the European Central Bank (ECB) says regulators should consider tougher supervision of finance firms to ensure they are prepared for the growing risk of climate litigation. Central banks are themselves exposed to such risks via their monetary policy operations and should adapt their frameworks accordingly, the paper also argues.

There has been a sharp rise in the number of climate-related legal cases in recent years, with more than 1000 filed in the six years since the Paris Agreement. These include claims that institutions’ activities have breached their fiduciary duties or mandates, or violated fundamental rights such as to a safe and healthy environment.

Firms face a range of direct and indirect costs as a result, from fines and payouts to legal fees and reputational damage. The ECB working paper notes that central banks and other public authorities are an increasing focus of such activity.

“There is evidence of a growing trend of climate change litigation in financial markets. As the recent Belgian National Bank (BNB) case illustrates, this trend has now reached central banks. Such direct exposure gives central banks a strong incentive to better understand climate change litigation risk,” the author writes.

The BNB is currently the subject of proceedings brought by the environmental law charity ClientEarth, which argues that the bank has failed to fulfil environmental protection and human rights requirements when purchasing corporate bonds.

The charity alleges that by directing capital into polluting sectors, central banks in the euro area are at odds with the bloc’s commitments to address the climate crisis. It says that if its legal challenge is successful, the ECB would have to take all measures appropriate to “remedy the illegality” inherent in the current programme.

The paper makes a number of recommendations as to how the ECB could take closer account of climate litigation risks, both as a regulator and market participant. These include setting clear expectations that firms should consider such risks and including relevant questions in an upcoming supervisory stress test.

The Bank of England has assessed insurers’ exposure to climate litigation via its exploratory scenario earlier this year, but the paper warns that this focus may be too narrow, as the risks of litigation go well beyond insurance costs. It says the consideration should be applied to other institutions taking part.

As well as being aware of its own exposure to possible legal action, as in the ClientEarth case, the author argues that the ECB should also consider the risks faced by relevant third parties. This might include action taken against the issuers of assets it holds as collateral, or the counterparties in its open market operations. The paper therefore recommends working climate litigation into the ECB’s risk management framework.

Although the report is a staff working paper rather than an official statement of ECB policy, its argument that central banks face intensifying litigation risks if they do not take bolder climate action was echoed earlier this year in a speech given by executive board member Frank Elderson.

“From where we currently stand, the risk of doing too little too late is significantly larger than the risk of central banks and supervisors overstepping their mandate,” he told the Green Swan conference in June.