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Why 2 degrees Celsius will be more important than 2% CPI for Central Banks (part 2)


A big difference at this year’s IMF annual meetings has been the extent to which discussions on climate change have dominated proceedings. New IMF chief, Kristalina Georgieva, has taken over from (the already supportive) Christine Lagarde and has turned up the volume. She described climate change as being “front and centre” for economic risk assessments by the IMF.


The Washington gathering was also used by The Central Bankers Club and the Network for Greening the Financial System (NGFS) for the launch of a new paper(1).

The NGFS argue that policies aimed at addressing climate change should come from government, and not from Central Banks, even when the policies themselves may need to be implemented by the local Central Bank. Consider Insurance risks in coastal areas, or financial risks for the banks who lend to fossil fuel industries. Central Banks need to regulate insurance companies and banks, but they should not be asked to pick winners when stress testing these industries.


However, governments can (and arguably, should) ask Central Banks to tilt the playing field in some areas, as argued by a group called the Climate Bonds Initiative, in their recent paper (2).


The most obvious way that this can be done is via Central Bank policy portfolios. QE is the place to start. Why are Central Banks not directed to tilt? The current market cap approach to QE actually favours carbon emitters because of their large weight in market indexes. The current market cap approach is not green/brown neutral. Thus, it can be argued that current QE is actually not consistent with many government’s existing commitments on sustainability (such as to the Paris accord).


Reserves management is also a candidate for greening, and the traditional mantra of “safety, liquidity and return” for FX reserves managers need not be compromised by the buying of green bonds.


At the most basic level, what could be more important than the safety of the planet?

The liquidity question is more nuanced, because green bonds are such a tiny proportion of outstanding issuance. However, note the recent Dutch government issue of Euro 6.5 billion 20 year bonds was three times oversubscribed. Issuance needs to catch up with demand!


Demand can solve the liquidity point.


Return? Some believe that the first green Bund from Germany will come cheap to existing Bunds, and get cheaper. I will place a bet that the first green Bund from Germany will come at a flat yield to the regular Bund. It could even then trade rich, because buy and hold (forever) green buyers may dominate.


The climate change topic is enormous and it is complex. My original article arguing that “2 degrees Celsius would top 2% CPI” was written in July (3). I am even more convinced today that for Central Banks this will indeed be the case. Maybe the first Central Bank to become more explicit will be the one with an incoming new governor.


Over to you, Ms Lagarde.


1. Network for Greening the Financial System https://www.ngfs.net/sites/default/files/medias/documents/ngfs-a-sustainable-and-responsible-investment-guide.pdf


2. Climate Bonds Initiative. https://www.climatebonds.net/files/reports/cbi-greening-the-financial-sytem-20191016.pdf

3. Why 2 degrees Celsius might become more important than 2% CPI for central banks. https://www.barings.com/global/institutional/institute/why-2-celsius-may-beat-2-cpi

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