Lofty Words
A research to how and to what extent intensified climate
policies lead to a new paradigm in financial regulation
AbstractAccording to the Carbon Tracker, the current financial architecture is not strong enough to manage transition risks that arise as a result of intensified climate policies established under the UNFCCC. A response from central banks and financial regulators is therefore required. However, there is debate on what type of response is required. On the one hand there is a group that pushes for policy change within the current mandate of most central banks and financial regulators, to ensure that regulated financial institutions are safe and sound and further financial stability. On the other hand, there is a group that advocates for a response that goes beyond a financial regulator’s mandate and thus pushes for a new paradigm in financial regulation. The Bank of England (BoE) was one of the first central banks to acknowledge that transition risks arising from intensified climate policies are a threat for the financial system, hence incorporating it in its research agenda. It appears however, that despite the lofty words of the BoE no new paradigm in its financial regulation could be identified. Moreover, while it appears that there is first order policy change on its way, there is no first order nor second order policy change identified in its financial regulation until today. Thesis MSc Political Science – Political Economy 22-06-2018 Lisa van den Boogaard (10326677) Supervisor: dr. J.G.W. Blom Second reader: prof. dr. D.K. Mügge
2
Table of Content
1. Introduction ... 3
2. Background ... 4
2.1. Global Financial Governance ... 4
2.2 Finance and Society ... 6
2.3 Financial risks arising from climate change ... 7
3. Theoretical Framework... 8
4. The debate ... 12
4.1 What role for central banks in addressing financial climate risks? ... 12
4.2 The extent to which central banks and financial regulators have to respond to
intensified climate policies: two groups divided within a theoretical framework ... 13
4.2.1 The “normal policymaking” group ... 14
4.2.2 Advocating for a new paradigm ... 15
5. Research Design ... 17
5.1 Case selection ... 17
5.2 Methods... 18
5.3 Data collection ... 18
5.3.1 Document analysis ... 18
5.3.2 Interviews ... 20
6. Analysis ... 21
6.1 Financial Stability Reports ... 21
6.1.1 Financial Risks ... 21
6.1.2 Latent and Indirect Financial Risks ... 22
6.1.3 Concluding remarks ... 23
6.2 Prudential Regulation Authority ... 24
6.2.1 Report on Climate Change ... 24
6.2.2 PRA Annual Reports ... 25
6.2.3 Policy proposals presented by the PRA ... 26
6.2.4 Concluding remarks ... 27
6.3 Research reports published by the Bank of England ... 28
6.3.1 Working paper published in 2016 ... 28
6.3.2 Quarterly Bulletin 2017... 28
6.3.3 Working paper published in 2018 ... 29
6.3.4 Policy proposals ... 30
6.3.5 Concluding remarks ... 30
6.4 The Bank of England’s Climate Hub... 31
6.4.1 Concluding remarks ... 33
7. Conclusion ... 34
8. Discussion ... 35
Bibliography ... 36
3
1. Introduction
“Carbon bubble will plunge the world into another financial crisis” is the heading of an article from The
Guardian and is an example of how climate change is threatening financial stability (Carrington, 2013). More specifically, the article refers to transition risks arising from intensified climate policies. Three decades ago already, political actors on the international level recognized the urgent need to come together in order to make an action plan on how to fight climate change and ever since, more and more parties have joined. As a result, the United Nations Framework Convention on Climate Change (UNFCCC) was established in 1992 as the foundation of global intensified climate policies. Within this framework consensus arose regarding the goal that countries must do everything they can to keep the rising global temperature below 2 degrees Celsius until 2050. However, these intensified climate policies to fight climate change at their turn pose new systemic risks for the financial system: transition risks. According to the Carbon Tracker (2013), around 80 percent of oil, gas and coal reserves will remain under the ground in order to meet the targets set in intensified climate policies established under supervision of the UNFCCC. As a result, reserves of oil, gas and coal have to remain unburnable. This leads to stranded fossil fuel assets which pose a threat to financial stability. This over-valuation of fossil fuel reserves might lead to a carbon bubble resulting in another financial crisis when stock markets are not aware of this risk.
The current financial architecture is not strong enough to manage transition risks that arise as a result of the transition towards a low-carbon economy and a response from the financial sector and economy is therefore required (Carbon Tracker, 2013). According to the Carbon Tracker (2013: 24-26) central banks and financial regulators are responsible for preventing the world from another financial crisis and thus they have to align their financial regulation with intensified climate policies to make sure that they fulfil their duty to further financial stability. However, there is debate about how central banks and financial regulators should respond to intensified climate policies that pose financial risks. On the one hand there is a group that pushes for policy change within the current mandate of most central banks and financial regulators, to ensure that regulated financial institutions are safe and sound and further financial stability. On the other hand, there is a group that advocates for a response that goes beyond a financial regulator’s mandate and thus pushes for a new paradigm in financial regulation. Consequently, the question arises whether intensified climate policies as an external impulse influence the policymaking process of financial governance. This resulted in the following research question: ‘How and to what extent
do intensified climate policies lead to a new paradigm in financial regulation?’
The Bank of England (BoE) is one of the first central banks to acknowledge that intensified climate policies could pose a threat to (global) financial stability in 2013 already, hence incorporating the topic to its research agenda. Because the BoE uses lofty words regarding acknowledging climate change and intensified climate policies, the research question is applied to the case of the BoE as case study. In order to answer the central research question, the theoretical framework on policy change developed by Peter Hall (1993) is used to assess policy change in financial regulation posed by the BoE. The framework contains three orders of policy change: first order change, second order change and third order change.
4 These orders of change provide tools to demonstrate the phase of policy change. A first order change is equal to a change in the settings of a certain policy instrument. In the phase of second order change, policy instruments have changed. In these first and second order changes, the overarching goal of the policy remains the same but in a third order policy change the goals or hierarchy of goals of a certain policy change (Hall, 1993). After applying this framework of policy change to the current financial regulation posed by the BoE, it appears that there is no new paradigm that can be identified in its financial regulation. Hence, there is no third order change. Additionally, there is also no second order change nor first order change that can be identified in financial regulation by the BoE. However, some of the results demonstrate that it is likely that first order change in BoE’s financial regulation is on its way but other results contradict this by stating that the BoE does not regulate on financial risks arising from intensified climate policies at all.
2. Background
This chapter presents the background and context in which the main research question “How and to whatextent do intensified climate policies lead to a new paradigm in financial regulation?”, is embedded.
Therefore, I will start outlining how global financial governance is organized in order to give an idea how financial policy is developed and who is responsible. This is followed by a section that examines the role of finance for society. Subsequently, the financial risks arising from intensified climate policies are explained to provide insight and understanding of the issues at stake.
2.1. Global Financial Governance
Before outlining what is meant by global financial governance, it is important to conceptualize finance and financial systems. According to Randall Germain (2010: 5), a financial system can be defined as “…a bundleof institutions and their collective interactions that create, allocate and facilitate the use of a resource commonly called money.” He (Germain, 2010: 5) continues by arguing that finance is more than just money
and demonstrates that finance has a temporal dimension by providing access to money at any given time. Subsequently, financial governance can be defined. Global financial governance is making rules, standards and policies that prescribes financial institutions to meet certain requirements to pursue financial stability (Herring and Litan, 1995).
Global financial systems are traditionally organized around a particular combination of four pillars. The fist pillar concerns banks and banking systems. The second pillar is about capital markets which includes investment banks and all kinds of active funds. The third pillar is concerned with saving money to be able to pay retirements which is consequently embodied by pension funds. The fourth pillar is mostly assigned to insurance firms protecting institutions and individuals for specific types of losses.
5 Germain (2010: 7) argues that it is important to realize that these four pillars have merged for the most part and consequently, they are not as separate as outlined above.
As aforementioned, financial stability is a central aspect of global financial governance. The International Monetary Fund (IMF, 2004: 6-7) argues that financial stability is a far-reaching concept because it contains the whole range of elements included in the financial system such as the financial infrastructure, financial institutions and financial markets. This is in line with the four pillars of a financial system as demonstrated by Germain (2010: 7). Consequently, according to the IMF (2004: 6-8) financial stability is concerned with adequately allocating financial risks and resources, creating savings and buffers, facilitating economic growth and welfare and taking care of a smoothly functioning global payment system. Moreover, financial stability is about taking precautionary actions as well as remedial measures. As a result, financial stability can be best defined as facilitating and enhancing economic and financial processes, managing threats and risks and re-establishing the financial system after confrontations with shocks (IMF, 2004: 6-8).
The Prudential Regulation Authority of the BoE links a financial system directly to financial stability: “The PRA focuses primarily on the harm firms can cause to the stability of the UK financial system. A stable financial system is one which firms continue to provide critical financial services – a precondition for a healthy and successful economy.” (PRA, 2015: 16). In order to protect the financial system from instability, central banks also engage in global financial governance and are presented in a number of international financial governance forums next to Ministers of Finance. Governors of central banks collectively engaged with global financial governance at the G7 summit, which merged into the G20 in 1999. The reason that the G7 transformed into the G20, was that the Ministers of Finance and the governors of central banks recognized the urgent need to have a more inclusive forum and collaboration in order to have a stronger impact on global financial governance (G20, n.d.).
Not only was the G20 established in 1999, the Financial Stability Forum (FSF) was founded as well. The forum aimed to promote global financial stability by bringing together authorities responsible for supervising the national financial stability such as treasuries, central banks and other supervisory bodies. In 2009 in the aftermath of the financial crisis from 2008, the Financial Stability Board (FSB) was established as the successor of the FSF to take the lead in reforming international financial regulation in response to the crisis. The national Ministers of Finance and national financial supervisors are members of the FSB. Central banks are the financial supervisors or regulators in most of the countries as they set standards and rules and monitor the activities of the national financial sector (FSB, n.d.).
Global financial governance is also concerned with risks arising from climate change and intensified climate policies. In 2015 the G20 requested the FSB to focus on risks arising from climate change within the scope of global financial governance. As a result, the FSB set up the Task Force on Climate-related Financial Disclosure (TCFD). The main objective of the TCFD is to promote information sharing and to provide information for the institutions and individuals engaged in a financial system (Scott et al., 2017: 105). The G20 took action as well with regards to climate related risks. As a result, it established the Green Finance Study Group which is chaired by the BoE and the People’s Bank of China
6 and assisted by the UNEP Inquiry (Scott et al., 2017: 105). More recently, a Network for Greening the Financial System (NGFS, 2017) has been established by eight central banks and financial regulators.
2.2 Finance and Society
Attention is increasingly paid to the impact of a firm’s activities on the environment, society and governance (ESG). Often, ESG is seen as an investment strategy that includes and integrates environment, social and governance (ESG) criteria into investment strategies (Van Duuren et al., 2016: 525). ESG criteria are seen as a dimension of socially responsible investment (SRI) which aims to pursue an investment portfolio based on ethical grounds. As a result, SRI excludes and includes particular types of industries and resources from their portfolio based on ethical considerations. The main goal to be achieved by integrating ESG criteria into SRI strategies is to exercise a positive influence on the environment, the society and the way in which institutions and firms are governed. (Syed, 2007:2). Moreover, by using SRI strategies, financial systems can deliver a positive contribution to the environment and society by doing their core business activities (Cerin and Scholtens, 2011 and Weber et al., 2011).
Robert Shiller (2013: 25) argues that the capitalistic financial system only adds value when it engages with activities on a philanthropic basis. He (Shiller, 2013: 25) continues by arguing that the architecture of the capitalistic financial system has to be designed in such a way that finance benefits society. Additionally, Scholtens (2008 and 2011), financial institutions can have a strong influence on sustainable development of the economy and society through the type of their financial activities (Scholtens, 2008, 2011). Consequently, he (Scholtens, 2006: 19) argues that the reason that the economy can function smoothly is because of finance.
Weber et al. (2014: 322) highlight three aspects of the relation between finance and development towards a sustainable economy. First, the financial sector is able to exert influence over socially and environmentally desirable activities by financing projects or setting criteria for borrowers. Second, intensified and more stringent climate policies affect the financial sector. Climate risks and climate policies both pose a significant threat to financial stability and thus have to be regulated (Weber et al., 2008 and Weber et al., 2014: 322). Third, increasing pressure coming from stakeholders to improve performance on ESG issues is linked to the reputation of a firm or bank. The pressure on the financial sector to perform morally and in line with ESG criteria has increased, especially after the financial crisis in 2008.
Central banks are the financial supervisors and regulators in most of the countries as they set standards and rules and monitor the financial activities pursuing a stable financial system. As aforementioned, financial institutions can deliver a positive contribution to the environment and society by sticking to their core business activities. Therefore, central banks can impose rules and standards in such a way that the firms and banks they regulate deliver a positive contribution to the environment and society by sticking to their core business activities. However, whether or not central banks use their
7 mandate as financial supervisory tool that could direct the financial sector into more socially and environmentally desirable core business activities, depends among others on the way in which central banks interpret their mandate and how they make use of their disposal resources (SOMO, 2015: 24). Therefore, central banks must be made aware of the fact that they are not just bodies that screen and monitor, but that they can be innovators by promoting ESG activities. This shows the importance and power of financial instruments, as it clarifies why there is such a crucial role for financial regulation as driver for socially and environmentally desirable activities (Scholtens, 2015: 20).
If we take a closer look at how global financial governance has developed over the past years, we must conclude however that this has been separately from social and environmental policies despite growing awareness of the need for promoting ESG activities (SOMO, 2015: 7). The G20 Ministers of Finance and Governors of Central Banks came together after the crisis in 2008 to internationally agree on standards to radically reform the financial sector and financial markets. Remarkably, during the G20 meetings right after the crisis in 2008, the focus was on reforms aimed at financial stability but sustainability issues were still hardly on the agenda and not even discussed. Subsequently, Rens van Tilburg (2013) argues that the banking sector has alienated itself from society. When banks do not interact with societal and environmental developments, they might miss or miscalculate risks and miss opportunities to foster the transition to a sustainable economy (Van Tilburg, 2013). Most of the time is money not invested in socially responsible activities such as developing sun cells or other practices that foster the transition towards a sustainable and low-carbon economy, but in building destructive financial products (van Tilburg, 2013). Consequently, Scholtens (2006: 19) also argues that there is still much left to do in order for finance to function as promotor of socially and environmentally desirable activities.
2.3 Financial risks arising from climate change
In 1988 the International Panel on Climate Change (IPCC) was established by the UNEP and the World Meteorological Organization (WMO) to inform the world about climate change and its impacts on the environment, society and economy. Based on the work published by the IPCC, the United Nations Framework Convention on Climate Change (UNFCCC) was established in 1992 under supervision of the United Nations in order to bring all relevant parties together to prevent further climate change. Under the UNFCCC yearly meetings are organized called the United Nations Climate Change Conferences. These yearly formal conferences are divided statutorily in different meetings because not all parties have signed the UNFCCC in 1992 but did sign other agreements within the UNFCCC. The Conference of the Parties (COP) is the governing body of the UNFCCC because those parties have signed the overarching UNFCCC in 1992. During the yearly meetings parties come to agreements and evaluate the progress of earlier agreed statements. All of what has been agreed during those meetings is written down in reports and published at the website of the UNFCCC.8 emissions within a limited time period. Throughout the years, this has developed into agreements stating that parties have to do everything they can to keep the rising global temperature below 2°C and pursue the effort to keep the global temperature below 1,5 °C Parties officially agreed on this in the Cancun Agreement in 2010 with the aim to reach the targets before 2050. In order to meet those targets, the amount of GHG emissions must be tightened by a budget. Carbon dioxide (CO2) is the primary GHG that leads to a rising temperature and therefore the main focus is on the carbon budget (Carbon Tracker, 2013: 9). The Carbon Tracker calculated the carbon budget that is available for a 2°C scenario until 20150 and the result is that approximately 565 to 886 billion tonnes of carbon dioxide can be burned. The alarming message is however that this carbon budget to meet the 2°C target is only a very small part of the carbon which is embedded in the carbon assets. It is estimated by the International Energy Agency (IEA, 2012) that the current amount of carbon asset reserves is around 2860 GtCO2. This means that roughly only 20 % of the fossil fuel assets can be used in the time period until 2050. Consequently, the global economy will face a massive disruption with the prospect of 80 % of the assets becoming stranded. On top of that, this massive problem will become even worse if the current investment policies remain the same as they have been since decades. Eventually this might lead to what we call a carbon bubble. Even a less ambitious scenario to fight climate change would not be sufficient to burn all the fossil fuel reserves until 2050. A carbon bubble therefore poses an immense risk on the financial stability and can be the cause for another financial crisis (The Carbon Tracker Initiative, 2013). The financial system is currently not strong enough to survive in a world that is in transition to a low-carbon economy. Therefore, a stringent transformation of financial regulation is required to prevent the world from another financial crisis.
3. Theoretical Framework
As mentioned in the introduction, this paper aims to find an answer to the question “How and to what extent do intensified climate policies lead to a new paradigm in financial regulation?”. To be able to answerthe central research question, a theoretical framework on policy change is applied to assess the policy making process for financial regulation posed by the BoE. This chapter outlines the theoretical framework of Peter Hall (1993) because it provides the required tools to examine and analyse policy documents of the BoE and interviews.
The theoretical framework developed by Peter Hall (1993) approaches the nature of policy making as social learning (Hall, 1993: 275). The concept of social learning is defined by Hall as: “a
deliberate attempt to adjust the goals or techniques of policy in response to past experience and new information.” (1993: 278). His view of the policy making process as social learning is similar to the notion
of policy making formulated by Hugh Heclo (1974). He outlines that he views political learning as a type of puzzling: “an enduring alteration of behaviour that results from experiences” (Heclo, 1974: 306). Nevertheless, in his significant study on social policy making in Britain and Sweden he demonstrates that the policy making process is not only driven by puzzling, but is also driven by power (Heclo, 1974: 306). Subsequently, it is argued by Boin et al. (2005) that in times of crisis policy makers are not in a position to
9 puzzle or to learn from past experiences because they need to act swiftly. Consequently, this is the moment where power comes at play and drives the policy making process. However, Zahariadis (2016: 468) argues that knowledge and policy failure do play a role and thus puzzling does occur during sudden policy disruptions. He mentions that it is not entirely clear yet when the learning curve starts and in order to shine light on this, he outlines his argument on the basis of May’s (1992) theory on policy learning.
To continue, Zahariadis (2016: 468) argues that learning takes place when elites base their decisions on evaluations and past experiences. This demonstrates that feedback and accumulated knowledge from the past play a crucial role in addressing policy disruptions, also during times of crisis. Moreover, dissatisfaction with a certain policy or status quo are a trigger for developing new ideas as input for the policy making process. According to May (1992: 341) this shows us that it is not the reality of policy failure that is most important, but rather that acknowledgement of policy failure pushes for policy learning and thus for policy change. Accounting on policy learning, Zahariadis (2016: 468) and May (1992) mention two different types of policy learning. The first is about switching instruments to implement policy which is referred to as instrumental learning. The second is on changing the overarching policy goal and is called social learning. This brings us back at the theoretical framework on policy change developed by Hall (1993). He (1993: 278) argues that three distinctive orders of change can be identified during a process in which a certain policy changes: a first, second and third order change. These three orders of change identified by Hall (1993) will be outlined below and clarify that they refer to the different kinds of learning as mentioned by Zahariadis (2016: 468) and May (1992): instrumental learning and
social learning. First order change A first order change refers to a small change in the level or settings of the basic policy instrument without changing the policy instrument itself or changing the overarching goal. Settings of policy instruments are modified in light of past experiences and new information (Hall, 1993: 278 & 281-283). Consequently, a little change in the level or settings of a particular element of financial regulation imposed by the Bank of England is an indicator for a first order change in financial regulation. An example of a first order change is a change in the level of capital required in case a capital buffer is being used as a financial policy instrument to meet certain goals.
Second order change
The second order change is used to refer to the switch of using one policy instrument to another without changing the goal or the hierarchy of goals behind the policy. In other words, the goal of the policy remains the same, but the instrument to reach that overarching goal is changed here. This is often because of dissatisfaction about the undesired outcome of the current policy instead of only in response to new issues in the economic order (Hall, 1993: 278 & 281-283). Translated to the empirical reality of the Bank of England, a financial policy instrument used by the Bank of England is imposing a capital buffer with a certain level of capital that is required to function as the buffer for potential shocks. One can recognize a
10 second order change in financial regulation when the overarching goal of the financial regulation remains the same, but the goal is achieved by using another instrument than a capital buffer. According to the theory of Zahariadis (2016: 468) and May (1992), this can be seen as instrumental learning. Third order change The third order change entails a much more radical change than a first and second order change. In this type of policy order change all components of a certain policy have changed simultaneously (Hall, 1993: 279). This means that the level or settings of certain policy instruments have changed, as well as the policy instruments itself and moreover and most importantly is the overarching goal or hierarchy of goals behind the policy have changed radically as well. A third order change is often accompanied by a radical change in discourse and analysis of the issue at stake (Hall, 1993: 290). Consequently, due to a shift in the overarching goal or hierarchy of goals of a certain policy and radical change of discourse, a third order change is seen as a paradigm shift which is defined by Hall (1993: 290) as follows: “… a particular set of ideas and a specific discourse which is used as a mean to structure the policy making process.” The shift to third order policy change is similar to the concept of social learning applied by Zahariadis (2016) and May (1992). Besides a first order and second order change that might take place prior to a third order change or a simultaneous change of the first and second order, Hall (1993) illustrates a number of additional circumstances and events that characterize the development of a policy making process towards a paradigm shift. This explanation provides us with a set of indicators that can be used for analysing financial regulation implemented by the Bank of England. Firstly, the change from one paradigm to another often entails a particular set of thoughts with a rather political tone. Therefore, Hall argues that the choice to shift paradigms is rarely solely a scientifically based choice. Instead, the position of a relevant actor in the context of a broader institutional framework and other exogenous factors that influence an actor’s position are of significance as well. Secondly, issues with regards to authority are likely to play a central role in the process of a paradigm shift. Here, the question of whom to view as “authoritative” is central and especially when it comes to technical issues. Hence, a paradigm shift is likely to be preceded by changing positions of authorities and experts (Hall, 1993: 280). The third feature that is likely at play in the movement from one paradigm to another, is policy failure and experimentation. A fourth characteristic of a paradigm shift is that it is initiated by a specific event that disturbs the status quo and threats the dominant paradigm, whereby that specific paradigm does not anticipate to the new and/or disturbing events. Lastly, a paradigm shift usually occurs in situations and fields where policymaking is concerned with highly technical and difficult issues and where a body with specialized knowledge is involved. Hall (1993:279) follows Thomas Kuhn (1970) with regards to positioning the different orders of change in relativeness to each other by arguing that he views both first and second order change as “normal policymaking” as these orders of change only adjust existing policy without changing or
11 challenging the overarching goal of the policy or the policy discourse. First and second order changes can be the status quo for a while, without (immediately) resulting in a paradigm shift. In most cases incrementalism is a feature of first order change, while second order change associated with switching policy instruments, is already moving to a more strategic level of activity. Consequently, instrumental learning can be seen here as a type of “normal policymaking”.
Additionally, it is important to mention that according to Hall (1993: 279-280), a third order change does not necessarily follow after a first and second order change in a policy making process. This means that policy change can stick at a first or second order change as a means of remedying. However, the contrary might also be the case which has been proven during the aftermath of the financial crisis of 2008 where macroprudential regulation (MPR) was adopted as the new principal interpretative framework for thinking about the financial crisis and financial regulation and bypassed the first and second orders of change (Baker, 2013: 112). MPR as framework contained a totally different approach to market relations and implied a redefinition of the role of public authorities that stood for more power for public authorities to intervene and setting boundaries to financial market activities. Moreover, MPR became also known as the financial policy framework that promotes safety in the financial system as primary emphasis (Baker, 2013: 113-114).
Baker (2013: 117-118) eventually summarizes the contribution of MPR as a framework that shines light on the unstable nature of the financial activities before and during the crisis and therefore it was able to demonstrate that it was necessary to move towards a situation where financial regulators have the responsibility to prescribe banks and listed institutions what to do. The reason that MPR became the dominant interpretative framework after the financial crisis in 2008 is that it’s ideas of the framework were able to explain the crisis such as why it went wrong and what was required to solve the problem (Baker, 2013: 119). Consequently, the rise and dominance of MPR as new financial policy framework led to adopting a different policy discourse, overarching policy goal or hierarchy of goals behind the policy. Therefore, Baker (2013: 128) argues that the shift to MPR in financial regulation and supervision can be seen as an example of third order change because it had radically changed the view on financial markets. The sequence of orders of change developed by Hall (1993) is illustrated by Baker (2013: 129) as a sum equation “1+2=3”. As a result of the exceptional case concerned with the MPR shift, it is argued by Baker (2013) that the equation “1+2=3” does not hold in the MPR case. Instead, Baker reformulates the equation to “3 = 2+1”. This demonstrates that the third order change might eventually lead to a second and first order change. He continues by arguing that the sudden shift to MPR can act as an interesting case for testing whether a paradigm shift always follows the sequence as identified by Hall (1993) and presented in the sum equation “1+2=3” (Baker, 2013: 129). To conclude with, the three different orders of change and the notions of instrumental learning and social learning that can be identified in a policy making process, provide a good toolkit to assess the BoE’s policy making process for financial regulation. The reason that the issue of sequence is discussed above, is because we can also observe several ideas about the sequence in which the orders of change follow each other with regards to policy change in financial regulation imposed by the BoE. Roughly, two
12 groups can be identified: one pushing for first and second order change and the other advocating for a third order change and thus a paradigm shift. This however, will be outlined extensively in the following chapter.
4. The debate
As the central question “How and to what extent do intensified climate policies lead to a new paradigm infinancial regulation?” demonstrates, is there debate about how central banks or financial regulators
should respond to financial risks arising from intensified climate policies and the extent to which they have to respond. The “how” part of the question refers to the role central banks and financial regulators have in addressing climate change. The extent to which central banks and financial regulators respond to intensified climate policies refers specifically to the order of policy change in financial regulation.
4.1 What role for central banks in addressing financial climate risks?
As becomes clear from the calculation of the Carbon Tracker (2013) and IEA (2012), if financial institutions do not change their behaviour because of new stringent climate policies, a carbon bubble is about the arise. There is extensive literature and debate about whether or not central banks and financial regulators should respond to bubbles in general. Dirk Schoenmanker and Rens van Tilburg (2016: 2) ask the question what role central banks have in addressing asset bubbles created by climate change and intensified climate policies specifically? By asking this question they want to design a policy framework that can be used by central banks to incorporate the climate and ecological dimension into its financial regulation and prudential supervision. They use the case of carbon emissions in order to illustrate the framework because this is seen as the most important climate risk that pose a threat to financial stability (2006: 2).
They (Schoenmaker and van Tilburg, 2016) start by arguing that the health of the ecological environment and climate are closely interlinked with the economy. History has shown that environmental shocks have led to financial instabilities and eventually to financial crises. Therefore, central banks should be at least concerned about global environmental imbalances. When they (Schoenmaker and van Tilburg, 2006) dive deeper in the discussion of what role financial supervisors have in addressing environmental risks, they begin reasonably by saying that financial supervisors must start off with identifying the environmental risks that could pose a threat to financial instability and mapping those financial risks originally coming from intensified climate policies. To do so, central banks have to do a climate stress test or more specific; a carbon stress test, which is derived from a regular stress test. A stress test is a financial supervisory tool that is used to test current market activities against specific future scenarios and thus to indicate the future state of affaire regarding financial stability. In a situation where the stress test indicates that there are severe financial risks originating from intensified climate policies, it is argued by
13 Schoenmaker and van Tilburg (2016) that central banks should use their policy instruments to identify which institutions or portfolios are most carbon intensive in their assets and deal with it. Campiglio et al. (2018: 462) also acknowledged that in order to meet the targets set in the Paris Agreement, an intensive transformation towards a low carbon economy is required and therefore they also examine the role of central banks and financial regulators in addressing financial risks arising from climate change and intensified climate policies. They (Campiglio et al., 2018: 462) start by arguing that governments have the primary responsibility and task to promote and manage the transition to a low-carbon economy. Nevertheless, due to the complexity of risks arising from climate change, it requires a broad range of policies and comprehensive implementation which might need help from central banks and financial regulators. However, it is very important to mention that Campiglio et al. (2018: 465-466) only see a task for central banks in assisting governments within the boundaries of their mandate. Subsequently, they argue that climate related financial risks do not require central banks and financial regulators to regulate and operate beyond their mandate (Campiglio et al., 2018: 465-466). Instead, Campiglio et al. (2018: 466) argue that the rise of climate related financial risks does not requires from central banks and financial regulators to adjust or change their mandate. Moreover, they argue that it is in general undesirable when central banks and financial regulators adjust their mandate in order to include wider environmental and societal goals (Campiglio et al., 2018: 466).
To be clear, Campiglio et al. (2018) see maintaining financial stability by promoting effective function of financial markets as central bank’s and financial regulator’s mandate. Thus, only in cases where climate change or intensified climate policies pose a severe threat to financial stability, central banks and financial regulators should be concerned with incorporating those risks into their regulation. This demonstrates that Campiglio et al. (2018) approach the same question from a different angle and consequently, they come to a different conclusion than Schoenmaker and van Tilburg (2016).
4.2 The extent to which central banks and financial regulators have to respond to
intensified climate policies: two groups divided within a theoretical framework
As afore demonstrated in the chapter that outlines the theoretical framework used for the purpose of this research, the three orders of change developed by Hall (1993) do not always run in the same sequence. Moreover, third order change does not automatically follow after a first and second order change (Hall,1993: 279-280). The case of the sudden MPR shift during the aftermath of the last financial crisis demonstrates that a paradigm shift can arise bypassing the first and second order change which is expressed in a “3 = 2+1” sum equation by Baker (2013: 129). With regards to this research paper, we can also observe several ideas about the sequence in which the orders of change follow each other. Roughly, two groups can be identified. Both acknowledge the urgency for the financial sector to align with the targets set in intensified climate policies. Besides acknowledging the urgency of this problem, these two groups both push in public debates as well as in scientific debates for adaptation and mitigation to climate14 related risks in financial regulation. However, they differ in what they require from financial regulators in order to reach the goals set in intensified climate policies. In other words, they differ in what order of change they require to be sufficient in responding to intensified climate policies. On the one hand there is a group that pushes for first and second order change in financial regulation to adapt to intensified climate policies. On the other hand, there is a group pushing for a new paradigm in financial regulation thus for third order change. 4.2.1 The “normal policymaking” group The group advocating for first and second order change is labelled as the “normal policymaking” group, because according to Kuhn (1970) and Hall (1993: 279) these orders of change only adjust existing policy without changing or challenging the overarching goal of the policy or the policy discourse. One of the actors in this group is Nicholas Stern who published his influential Stern Review on the Economics of Climate Change in 2006. This report examines the impact of climate change on the global economy in general, and the economics of stabilising greenhouse gas emissions and the policy options for the transitions to a low-carbon economy in specific. The report presents a range of scientific research results that demonstrate that climate change poses an immense threat. These research results do mention that climate change has irreversible consequences for the environment and society, but its main focus is on its economic impact. The emphasis of this report is that early and strong policy intervention to mitigate the risks arising from climate change do outweigh the costs. Hence, the earlier action is taken, the lower the costs and moreover the easier it is to avoid irreversible consequence of climate change. Consequently, the main goal of this report is to push for policy action as soon as possible because the sooner action is taken, the better it is for economic growth and thus financial stability. The report includes a chapter where policy options aiming to mitigate are outlined. The first policy option discussed in the chapter is the introduction of carbon pricing which is seen as a crucial element in climate policy because it is argued that greenhouse gas emissions are externalities in economic language (Stern, 2006: 308). By introducing a pricing system for carbon, people producing greenhouse gas emissions contribute to the social cost they cause. This change in behaviour results in a move away from carbon intensive activities towards low-carbon activities. The second policy option discussed by Stern is technology policy which aims to promote technological innovation and development that speed-up the transition to a low-carbon economy in an efficient way. With regards to carbon pricing and technological innovation, it is important to note that according to Stern (2006) those policy will not be implemented by financial regulators, but that governments should implement it.
The third policy option that is put forward by Stern is concerned with promoting behavioural change. Providing information in order to promote behavioural change is put forward by Stern and should be implemented by financial regulators (Stern, 2006). One of way of providing information is disclosure and Stern (2016:377) argues for specific carbon disclosure. This can be seen as a first order change because disclosure is a policy instrument used by financial regulators to provide information to the market, and in the case of carbon disclosure the instrument is specified on providing information
15 regarding the amount of carbon which is a certain setting of disclosure as policy instrument. Despite the aforementioned policy ideas, two of which that should implemented by the government and the other by financial regulators, the goal is to manage the financial risks arising from climate change and intensified climate policies timely to prevent the world from dramatic economic downturns, thus ultimately aiming to establish financial stability. Besides this Stern report on the Economics of Climate Change, Stern was also co-writer of a report on the carbon bubble published by the Carbon Tracker in 2013. Carbon Tracker is a non-profit organization aiming to align the economy with targets set in intensified climate policies in order to overcome the problem of wasted capital and stranded assets that lead to a carbon bubble (Carbon Tracker, 2013: 2). Based on the research results discussed in the report, Carbon Tracker in cooperation with Stern as chairman of the Grantham Research Institute on Climate Change and the Environment by the London School of Economics, have formulated a number of policy recommendations for financial regulators.
First, financial regulators should require firms to disclose their portfolio to show how much carbon they have embedded in fossil fuel reserves and to report and explain how their business aligns with achieving the targets set in intensified climate policies (Carbon Tracker, 2013: 24-26 and 37). Disclosure and reporting in general are policy instruments and used to provide information to the market in order to promote financial stability. However, the carbon disclosure and reporting on carbon-related activities are first order changes as it only changes the settings of the policy instrument to a carbon focus. Second, financial regulators should undertake a carbon stress test in which current market activities are tested against the scenarios from intensified climate policies (Carbon Tracker, 2013: 24). Besides these concrete policy recommendations, the Carbon Tracker report also gives a number of general recommendations. For example, it recommends to search for new business models, to redefine risks arising from the transition to a low-carbon economy and to make sure that credit rating agencies and other firms address climate change as systemic risk. However, these general recommendations are not translated into particular policies or settings of policy and therefore it does not apply to one of the orders of change. As afore-demonstrated, the “normal policymaking” group consists of a group of researchers that has worked on two reports which conveys that active response from the government is urgently required, However, they only require first order policy change in financial regulation by using carbon disclosure and reporting on carbon-related activities, in order to maintain financial stability and economic growth. As this group focuses on the economic impacts of climate risks and addresses the issue in economic terms, it does not require a third order policy change in financial regulation. 4.2.2 Advocating for a new paradigm A couple of actors push for a third order change in financial regulation. They want the financial sector and thus financial regulators to embrace a new paradigm that directs financial activities towards incorporating societal and environmental aspects in financial regulation. One of the actors is SOMO, a
16 Dutch founded centre for research on multinational corporations. In 2015 SOMO published a report written by Myriam Vander Stichele with the title “Mobilising the financial sector for a sustainable future”. The report aims to provide an overview of existing initiatives that should contribute to adopting a new paradigm in financial regulation (Vander Stichele, 2015: 5). The new paradigm they desire is a financial sector that not only aims to maintain financial stability, but a financial sector that also: “…serves the needs
of societies and economics that develop in an equitable, inclusive and environmentally sustainable way.” (Vander Stichele, 2015: 5). This demonstrates that the financial sector should broaden its main goal.
It is argued by Vander Stichele (2015: 7) that since the last financial crisis, the financial sector is mainly focused on financial stability and does not pay enough attention to the important role it should play by contributing to society and environment. Consequently, in these times it is even more urgent to push for more awareness in the financial sector about the crucial role they should play. SOMO directed by Vander Stichele (2015) is not the only actor that advocates for a new paradigm in the financial sector. Instead, they are strongly assisted by the United Nations with the UNFCCC. During the 16th COP in 2010 in Cancun the parties have agreed that all parties have to realize the following: “…that addressing climate change requires a paradigm shift towards building a low-carbon society that offers substantial opportunities and ensures continued high growth and sustainable development, based on innovative technologies and more sustainable production and consumption and lifestyles, while ensuring a just transition of the workforce that creates decent work and quality jobs.” (UNFCCC, 2010: 4) This shows that in order to shift towards a situation where the financial sector serves the society and the environment actively, a paradigm shift is required. Also, the type of language used in the reports emanating from the yearly UNFCCCs, protocols and treaties demonstrates that a radical change is highly required. Besides the UNFCCC, there is the United Nations Environment Programme (UNEP), an authority that takes the lead in setting the agenda on environmental issues globally and a powerful promotor of scientific based intensified climate policies. With its activities it is raising awareness on how to deal with climate change and intensified climate policies (UN Environment, n.d.). The UNEP pushes for change in the financial system with regards to mobilizing capital that flows towards a green and inclusive healthy economy and society in order to create social and environmental value for the long-run (UNEP, 2015: 13). Another reason the UNEP has focused on finance in the light of intensified climate policies is that designing a robust and stable financial system has moved to the centre of much policy debates since the financial crisis in 2008. However, the process of designing a resilient financial system has been mainly focusing on financial stability since the last crisis and not on the role finance can play in promoting activities that serve the society and environment. The inquiry teams’ approach is to put a range of experiences and ideas into a framework which can be used by those responsible for setting the rules in the financial system such as financial regulators. Among other things, this framework must enable financial
17 regulators to reset their broader purpose, mandate and scope of governing and encourage them to embrace the idea of a sustainable financial system and to take action towards that goal (UNEP, 2014: 2). The UNEP emphasizes this again at the beginning of the chapter about how to mobilize finance for the purpose of sustainable development: “To place the global economy onto a sustainable development pathway requires an unprecedented shift in technology and business models, public policies and institutions, as well as individual values, attitudes and competencies. It also requires a willingness to invest our accumulated financial resources in securing tomorrow’s sustainable livelihoods and prosperity.” (UNEP, 2014: 5).
To conclude with, both SOMO, the UNFCCC and the UNEP argue that a new paradigm for the financial sector to act upon is highly required. This new paradigm must guarantee that the financial sector serves society in its broadest sense. However, it does not mean that the paradigm of financial stability must be replaced, but that the new paradigm exists parallel to it.
5. Research Design
This section outlines the research methods used in order to find answers to the question “How and to what extent do intensified environmental policies lead to a paradigm shift in financial regulation?”. It first introduces and justifies the case selection. Second, it explains which techniques were used to collect the relevant data. Subsequently, it explains which specific research methods are used and why they are used to process and analyse the collected data. Then the shortcomings of this research are discussed as well as the validity and reliability of this research. At last, the ethical considerations are addressed and discussed.5.1 Case selection
This research contains an intensive study of one single case with N=1 and is extracted from a population of theoretical interest. One must consider how many cases to study for the purpose of the research. The rule of thumb often used is ‘as many as you can study intensively’. Due to the time constraints of a master’s thesis, I am limited to studying one single case intensively. However, this results in a trade-off between depth and breadth where I have chosen for depth. The specific case chosen for the purpose of my research is The Bank of England because it was one of the first central banks that recognized climate change and intensified climate policies as a threat for the financial stability. One of the other central banks that has signalled and recognized this phenomenon early is the People’s Bank of China. However, I do not have any Chinese language skills and as most of the policy documents from the People’s Bank of China are published in the Chinese language, this was not an option. Regarding the external validity or generalizability which refers to the question whether a single case is representative for a broader range of cases (Bryman, 2012: 69-70), it is important to mention that the BoE was the only exceptional case I was able to select for this research. As aforementioned, it is widely18 known that the People’s Bank of China is one of the other central banks that are progressive on this issue however it is difficult to assess the other banks on this issue as it is a sensitive topic.
In the process of selecting cases and designing a case study, it is important to think of the following question: what is my case a case of? This question refers to the broader theory or phenomenon the selected case can contribute to and the phenomenon I am interested in. My answer to that question would be that with my research and case selection I aim to shed light on a broader class of cases to demonstrate how and to what extent central banks and financial regulators in general respond to external impulses to financial governance. In my research, external impulses refer to intensified climate policies as a consequence of climate change. Moreover, the Bank of England as a case is a case of sustainable finance because it is concerned with how central banks respond to climate change and intensified climate policies. More specifically, I aim to investigate to what extent the BoE adopted a new paradigm in financial regulation as a result of intensified climate policies.
5.2 Methods
As outlined before, I take the Bank of England as the case for my research to explore how and to what extent intensified climate policies might lead to a paradigm shift in financial regulation. The qualitative research method that fits best with my type of research question is process tracing because it aims to explore the pathways through which a certain phenomenon develops. Furthermore, process tracing allows me to analyse the processes and sequences of events within the case of the Bank of England. Moreover, through analysing the decision-making process, we are able to understand how and why outcomes occurred. Eventually, process tracing gives me the chance to provide a thorough overview of how and to what extent the Bank of England responds to intensified climate policies and climate change and enables me to provide a narrative explanation of the causal pathways that might lead to a paradigm shift in financial regulation.
5.3 Data collection
As I use process tracing as qualitative research method, the data collection techniques that fit best for the purpose of this research are document analysis and semi-structured interviews. 5.3.1 Document analysis The documents selected for the analysis are all composed and published by the Bank of England itself. The concerned documents are Financial Stability Reports, Prudential Regulation Authority reports and research reports and working papers by the BoE. These documents are selected based on the task they are concerned with. Below, I will demonstrate for each document why it has been selected for the purpose of this research. Additionally, I have chosen to analyse the aforementioned documents that are published19 from 2012 until now (2018) because in 2012 the well-known article “Global Warming’s Terrifying New Math” written by Bill McKibben is internationally seen as the starting point of the public debate about the carbon bubble (2012, McKibben). Moreover, the Bank of England recognized intensified climate policies as threat for the financial stability since 2012 as well.
As most of the documents contained at least 90 pages, I started the analysis by searching on particular words: climate change, environment, Paris Agreement, carbon, fossil fuels, extreme weather events. After doing so, it appeared that in almost none of the documents these words were found. This was particularly the case for the Financial Stability Reports and the PRA Annual Reports. Consequently, I decided to search for financial risks discussed in Financial Stability Reports and the PRA Annual Reports more broadly in order to find out what type of other risks they are focussing on. Also, I examined in all reports what the department that issued the report was aiming for. In other words, what the main objective of the department within the BoE is.
Financial Stability Reports
The Financial Stability Reports are chosen because they are issued by the Financial Policy Committee (FPC) which is charged with the task to objectively monitor and identify potential systemic risks that can threaten the financial stability. Moreover, the FPC has the responsibility to take action and address identified systemic risks in order to maintain financial stability and the resilience of the national financial sector. No Financial Stability Report has been published in 2018 yet and consequently it is not included in the analysis. Reports issued by the Prudential Regulation Authority The Prudential Regulation Authority (PRA) is a department within the Bank of England. Since April 2013, the PRA is the financial regulator and supervisor for banks, building societies, insurers and other major investment firms. This includes nearly 900 banks and building societies and around 700 insurance firms (PRA, 2015: 15). The objective of the PRA is threefold. At first, the PRA has the general goal to maintain and promote stability of the firms it supervises. Second, there is a specific objective with regards to insurance firms. The PRA aims to maintain a certain degree of protection for insurance policyholders. Third, since July 2013 the PRA has in some exceptional cases the objective to facilitate competition in markets where its regulated firms are active in. Another important element is that the PRA is concerned with forward looking as they call it itself. The PRA assess firms not only with regards to current risks, but also against potential risks that might arise in the future. The PRA publishes reports on a regular basis and presents annual reports where its objectives and supervisory activities are outlined. Eventually, the most important regulatory decisions are taken by the PRA board which is chaired by the Governor of the Bank (PRA, 2014: 7).
20
Research papers and working papers
Research papers and working papers on climate change published by the BoE are analysed for the purpose of this research as they provide an insight in how the BoE approaches the issue and thinks publically about how to respond by putting forward policy recommendations.
5.3.2 Interviews
Preferably, I would have conducted interviews with people working for the BoE’s Financial Stability Committee, PRA and Research Department. I selected the people working for these departments based on their engagement with climate related projects within the bank, but also based on the feasibility to get in contact with them. Therefore, although it would have been great to speak to Mark Carney, it was not feasible to speak with him as he is the BoE’s Governor and chairs a number of committees within the BoE and of other Boards outside the BoE. Subsequently, I have been contacting the selected people by e-mail to request for an interview via Skype. With some of my e-mail accounts it was not possible to send e-mails to BoE mail accounts which was the first obstacle. Not surprisingly, it appeared to be very difficult to get in contact with those people by e-mail as none of these people responded. After a week I have been calling the BoE trying to get in contact with the people I was looking for. This turned out be easy at first sight as I was directly forwarded by phone to the people I was looking for. However, all of those people did not pick up their phone. After calling the BoE two times, I have send a “reminder” e-mail to the people I wanted to speak with. Also, I connected with those people via LinkedIn by sending LinkedIn messages. Eventually, I received a response from Ms. Tanaka (head of the Research Department of the BoE) after I connected with her via LinkedIn. She responded by saying that she had forwarded my interview request to the Climate Hub of the BoE. The Climate Hub responded soon to my request but it took a while to plan an interview because the Climate Hub has a high workload at this moment. Finally, we planned a phone call interview on Friday 1st of June 2018 and had an interview with two people. Important to mention is that one of those two people took the lead, but the other interrupted the conversation several times.
Moreover, I have conducted two interviews with two academics aiming to get some more background information: Bert Scholtens and Rens van Tilburg. These two responded very quickly to my interview requests and were willing to speak with me. Bert Scholtens is working at the University of Groningen and its research concerns among others the relation between finance and society in the broadest sense. I travelled to Groningen on Tuesday 5th of June 2018 to speak with Bert Scholtens. I spoke to Rens van Tilburg by phone on Monday 4th of June 2018. I requested an interview with Rens van Tilburg as he is the head of the Sustainable Finance Lab constituted at Utrecht University and has worked for SOMO earlier in his career. Moreover, Rens van Tilburg has published articles concerning the role of financial governance in addressing climate change. I planned the interviews in such a way that I first spoke to the BoE aiming to discuss the results from that interview with academics in order to get a more thorough understanding of the context in which I could place the interview results with the BoE. Eventually, the information I gathered by the interviews
21 with Rens van Tilburg and Bert Scholtens are not included in the analysis. Furthermore, I prepared all interviews with an interview guide specifically focused on the position of the respondent and its knowledge. However, a number of questions and topics have been discussed in all interviews in order to compare answers and to reach the point of saturation which refers to the point in the process of data gathering where you do not find new insights anymore and thus everything within the scope of the research has been explored (Bryman, 2012: 717).
6. Analysis
6.1 Financial Stability Reports
The analysis of the Financial Stability Reports of the Bank of England is outlined in this section. Each Financial Stability Report roughly has the same structure to present the results. All reports start by outlining tasks of the FPC. All the Financial Stability Reports mention the following as its task and responsibility: “The primary responsibility of the Financial Policy Committee (FPC) … is to contribute to the
Bank of England’s objective for maintaining financial stability” (FPC BoE, July 2015). Subsequently, key
developments in the global financial environment are mapped by the FPC. This is followed by chapters that examine the short-term and medium-term risks to financial stability. Additionally, the report formulates expectations for the resilience of the financial sector in the future. All Financial Stability Reports within the time frame from June 2012 to November 2017 are analysed in order to find out whether the BoE adopted a new paradigm in its financial regulation.
6.1.1 Financial Risks
Each Financial Stability report contains a ‘Global Financial Environment’ chapter where the FPC expresses its concern with regards to international events and developments such as the imbalances across the euro area, the economic growth rate in emerging market economies and how they contribute to global economic growth (FPC BoE, June 2012), declining oil prices (FPC BoE, December 2014, July 2015, December 2015, July 2016), financial market fragility (FPC BoE, December 2015), misconduct in the financial system (FPC BoE, July 2015), the consequences of the US elections in November 2016, the referendum in Italy and national elections in several euro countries, global trade patterns (FPC BoE, November 2016, June 2017), the activities of China (FPC BoE, November 2016), geopolitical risks related to conflicts in Ukraine and the Middle-East (FPC BoE, December 2014) and operational risks such as cyber-attacks (FPC BoE, June 2017, November 2017, July 2016, November 2016, July 2015, December 2015, June 2014, December 2014, June 213, November 2013 ).
The FPC also outlines domestic issues and events that pose a threat to UK’s financial stability. Recurrent domestic concerns for financial stability in all the reports are the UK property and housing market and UK household indebtedness. In the July 2016 report (FPC BoE, July 2016), the national
22 referendum about EU membership and the eventual Brexit procedure itself are addressed as threats to UK’s financial stability.
Some of the aforementioned risks are labelled as indirect risks which suggests that the FPC does not see it as a risk that immediately or in the near future threatens financial stability, or as something that can cause major disruptions for financial stability, but apparently it is severe enough to monitor and to mention in the report: “…it also entails some risk to financial stability” (FPC BoE, December 2014: 7) or “In
making these recommendations, the FPC has judged that household indebtedness did not pose an imminent threat to financial stability…” (Bank of England, July 2016: 11). Consequently, it happens that particular
risks are identified and monitored, but after some time it might appear that the risks are not that threatening for financial stability. Nevertheless, the FPC formulates policy recommendations in the reports for all risks initially identified and monitored by the FPC. In all Financial Stability Reports, the FPC reflects on the recommendations formulated in previous reports in order to monitor progression.
While the global and domestic financial environment is extensively discussed in terms of a number of international economic and political developments, it is remarkable that no attention is explicitly paid to risks arising from climate change and intensified climate policies because important steps have been undertaken by establishing the Paris Agreement on Climate Change in 2015. In the Paris Agreement is stipulated that the Parties have the obligation to keep the rising global temperature below 2°C degrees above pre-industrial levels and that they have to pursue for efforts to keep the rising temperature below 1,5 °C degrees above pre-industrial levels until 2050 (Paris Agreement Art. 2, 2015: 3). However, many years of negotiating took place prior to the finalisation of the agreement in 2015. Already during the 16th COP 2010 held in Cancun, it became clear that the eventual agreement would impose countries to keep the rising temperature below 2°C degrees (UNFCCC COP Cancun, 2010: 4). As a result of these intentions, a number of scholars have calculated what the effects would be on the economy. These calculations were serious and shocking ever since they were published and demonstrated that a carbon bubble is rising if firms do not change their investment strategies (Stern, 2006). Also, the international negotiations towards an agreement on how to fight climate change collectively and the establishment of the eventual Paris agreement, can also be seen as a major political development. Moreover, the consequences that the agreement can have on the economy are even more important but the FPC does not pay any attention to this major international development. It is not even mentioned indirectly as threat to financial stability in one of the reports.
6.1.2 Latent and Indirect Financial Risks
A number of the aforementioned financial risks that are explicitly outlined and identified by the FPC are not even direct risks, but indirect. For example, it is illustrated by the FPC that the sharp decline of oil prices does not pose an immediate and significant threat to the financial system, but if the oil prices appear to stuck at that low level or fall even lower, then it will change into a systemic risk (FPC BoE, December 2014: 22). Moreover, the oil prices are not even framed in terms of environmental risks. Despite the fact that climate change and intensified climate policies are not explicitly mentioned as threat
