Interview: Luiz Awazu Pereira da Silva

Interview with Luiz A Pereira da Silva, Deputy General Manager of the BIS, in Central Banking, conducted by Ms Rachael King and published on 16 February 2020.

BIS deputy general manager talks about the obstacles central banks face with regard to climate change and why the status quo needs to evolve.

Does the Bank for International Settlements have a climate change policy in place?

Regarding climate change, at the BIS we are working on several fronts. On the analytical front, we have just issued a new book called The Green Swan with friends and colleagues from the Banque de France, the private sector and academia, which considers the impact of climate risks and whether current assessment models are adequate.

We are also working on the BIS's pension fund, where we take into account environmental, social and governance (ESG) criteria. In addition, we have a working group looking at how we can also consider these ESG criteria within our own investments. And last, but not least, another group in our banking department has recently published a paper on how central banks can introduce 'green' sustainability criteria in their reserve management policy.

The BIS also launched in September 2019 a Green Bond Fund as a new investment vehicle for the central bank community, totalling about $1 billion in subscriptions. Altogether, I think these policies highlight to the wider community the direction in which we could work.

Do you have any further internal administrative policies that would reduce the BIS's own carbon footprint?

We have an internal 'green team', which is looking into the carbon footprint of how we work here at the BIS. How we can reduce it in terms of our consumption of paper, systems, efficiency of heating and also how we travel to work. They are also looking at how we process food in our cafeteria and whether we use reusable coffee cups, for example. Those are the sorts of things, when put together, that will help everyone in the organisation contribute in a practical way to battling climate change.

Does the BIS have a formal process in place for identifying climate change-related risk that could affect its business?

Our risk management unit is looking at precisely that. As part of this approach, the team is examining the various dimensions of ESG criteria. As you know, this is a complex field and the criteria are constantly evolving; there are now many indices and filters through which you can consider these various dimensions. For example, you have different approaches taken by the MSCI index and the S&P index. All of this is being studied carefully by our risk management team and banking department.

Are you able to go into any specifics with regard to your pension fund's ESG policy?

We have incorporated ESG policy requirements in our pension fund, some of which concern how our investment committee works. But, of course, specific exposure is an area that requires confidentiality.

How should central banks and other financial regulators measure and forecast the economic cost of climate change?

First, it is a good start that financial institutions are using better models to integrate climate change dimensions into evaluating portfolios and their associated climate-related risks. These models are increasingly complex - trying to link a climate module to the macro economy, for example - but experts are increasingly recognising these links do not fully capture uncertainty.

The range of events that can affect financial market participants is very broad. So instead of just looking backwards and using historical data to model the effects of climate change, we should move towards two things. One is to have more forward-looking, scenario-based analysis, which is already being implemented by some central banks in the form of stress tests. Incidentally, this is one of the Network for Greening the Financial System's (NGFS) work streams.

And secondly, there needs to be a broader, more holistic approach to climate risk. As well as focusing on specific scenarios, we need to look at the overall changes in our ecosystems and use this as a basis for building a picture of what will happen if a certain path is followed.

There are a lot of expectations, naturally, on central banks because they played such an important role in helping to solve the financial crisis. There is still a view they could be the 'white knights' ready to save the day. But this not something the central banking community can solve by itself, as we say in The Green Swan. This is a complex, collective-action problem. This requires co-ordinating the actions of many stakeholders, primarily governments.

How far can central banks stretch their mandates on climate policy without risking a loss of legitimacy?

We are cautious about stretching their mandates. There are some people who are advocating for central banks to engage in asset-purchase programmes focused on green assets - a type of quantitative easing that would have a green flavour. We think this isn't a good idea because it can distort markets further.

The taxonomy of what is green and what is not is also evolving. We much prefer central banks to focus on their existing financial stability mandates, and use concrete actions to better evaluate the risks associated with climate-related events.

Potential policy options include stress-testing, for example, or looking at the portfolio composition of their financial sector, or looking at some of these climate-related vulnerabilities. They could also look at risk models and incorporate a better assessment of climate change. Central banks can also look into their own investments and see how vulnerable they would be to climate-related risks.

Is there a need for new specific, climate-related financial regulation?

This is being addressed by a working group established by the Basel Committee. The discussion must be conducted with a great deal of technical expertise because the transmission between climate events and financial stability is complex. As Mark Carney has stressed numerous times, there is a concern that if you act hastily, new regulation could potentially have financial stability implications. If you implement regulation too early, there is a risk you trigger changes in asset-holders' behaviour that could cause mass sell-offs. We do not want to increase the chance of transition risks materialising.

At the moment, all regulators are likely to be looking at the financial stability impact of climate risks as it is a concern to all financial ecosystems. But it is not just regulators: asset managers are also looking into these dimensions. This is good news as it shows there is an alignment in thinking among financial players on the subject of climate change. But I do think we need to look at the issue with a slightly more positive attitude.

The financial sector is, of course, facing huge risks and there is a need for urgency; we have seen an increase in very dramatic and tragic weather events. But the way to avoid climate risks is to pool all our resources and co-ordinate policy in areas that will result in a win-win for everyone.

A number of regulators have started to ask firms to publish their exposures to climate risk. Do you think central banks should mandate the firms they supervise to publish such data?

This relates to the Financial Stability Board's initiative to publish disclosures. I think this is a very good move to start opening the minds of asset managers to what they are doing and what we are asking of them.

But I would, again, be a little cautious. We do not want to start finger-pointing. You need to provide the opportunity for everyone to begin assessing adequately the climate risks in their allocations, and evolve to less carbon-intensive portfolios, and production and consumption patterns. This will require co-operation and should not involve shaming and blaming.

Financial firms may complain it is costly to gather such data. Do policy changes need to be enacted to make the process more efficient?

We are trying to work on this with the NGFS, and one of our next meetings will be used to address these data gaps. It is important, as you rightly say, that there is one centralised place so people do not waste time looking for information. One area in particular we are looking to streamline is green bonds. We want to create a data set that will detail the way in which they are priced, their valuations and so on.

There are arguments the green bond market suffers from supply constraints. Do you think this is harming investment in the area? Why?

It is a relatively small market at the moment, but it is growing. And it is growing at an impressive speed. It means many institutions are already thinking of the patterns in which they wish to issue these instruments, with the idea they may need to define new policies that are consistent with green denomination. I see good prospects for the market to expand. Asset managers are becoming more aware of the need to alert issuers to these concerns. All these forces are pulling in the right direction.

Do you think the European Union's incoming green bond standards will help issuers moving forward? Is reconciling different taxonomies (eg, EU and China) a problem?

I think the role of the NGFS will be to help address these issues that need to be discussed.

How important will the green bond market be in the future?

You need more green financing; this is one of the dimensions many international forums have been discussing, the G20 included. Green financing will grow, but we need more than that. When I was speaking of co-ordination, I meant co-ordination with other policies and the role of government; fiscal policy should not be forgotten and research is also important. While you can aim for a zero-carbon objective, you can also use science to see if there are other ways to capture carbon. Research requires financing.

Last and not least, international co-operation is necessary because carbon and global warming disproportionately hit low-income countries and poor households. The rising temperatures will affect those living in low-income countries in South America, Africa and Asia. There's a need for international mechanisms that address the changes that might occur, and are already occurring. People are realising that these events are becoming more frequent and more devastating.

The NGFS has been successful in fostering a discussion about climate change. What has the BIS gained from its membership within the NGFS?

We are an observer, so we participate heavily in the discussions and all the work streams. We discuss the data, practical ideas and regulatory objectives, and mutually understand the limitations each of us might have. This allows us to set goals for the group.

What should the NGFS's focus be for 2020?

The NGFS meets regularly and they are defining their work programme for the next couple of years. You can see the modelling of climate risk is one key objective on the agenda, as is solving the issue of data gaps. The way you design scenarios for stress tests and other models are also a concern.

There is a need to gather as much information as possible about what is happening in the community. The BIS's contribution is to try and steer the debate. And that's what we are doing with this book.

As much as this is a tragic event for many people, there can be a positive aspect if you remember that social economic systems transform by creative destruction. We have to find a positive side to this issue in that it may lead to investing in better research and policy, structural changes in how we approach these problems, but also changes in the way we live that result in sustainable growth. Climate risk-related new investments can ignite the new growth cycle.

It is important that central banks frame the debate by saying: we are not going to do this alone, it is not possible. We need the assistance of other policy-makers. But we can also foresee the possibility that all this contributes to pulling us out of the current crisis and bringing us back to a much less carbon-intensive growth path.