Pathway to Cop26: What next for central banks and supervisors?

  • Dr Ben Caldecott Director
  • 16 September 2021
  • Blog | Green Finance | Thought Leadership Insights | Blog

Dr Ben Caldecott Director, Oxford Sustainable Finance Programme

The threat of climate-related risks stranding assets has spurred work by financial supervisors and central banks, who have announced new supervisory expectations and climate stress tests to help improve the solvency of individual financial institutions, as well as the resilience of the financial system as a whole. 1 The G20 Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) has created a framework to help companies and financial institutions consistently measure, manage, and report their climate-related risk exposures.2 There have also been a plethora of new initiatives, products, and services intended to help financial institutions measure and manage climate-related risks.

But climate risk management (CRM) is often erroneously conflated with seeking or achieving alignment with climate outcomes (ACO). While there is some overlap between CRM and ACO, they have different objectives and often different results.

CRM can make little or no contribution to ACO. For example, reducing a company’s exposure to projected increases in Country A’s carbon prices could entail moving emitting production to Country B, which has lower environmental standards, potentially increasing net carbon pollution overall. Or a company could hedge its exposure to projected increases in carbon prices through derivatives contracts such as swaps, which would not alter the underlying economic activities of the firm and thus have little or no impact on emissions.

This is not to say that CRM cannot, intentionally or unintentionally, result in better climate outcomes. A way to reduce Company A’s exposure to projected increases in carbon prices could be reducing the company’s carbon emissions, thereby helping ACO. A universal owner, such as a large pension or sovereign wealth fund, by advocating for timely and effective climate action by governments could potentially contribute to lower climaterelated transition risks across their holdings if governments heed their advice.

CRM and ACO can also work together in specific financial products, for example, a bank providing a sustainability-linked loan. Company A secures a lower cost of capital from the bank if it achieves ambitious, predetermined carbon reduction targets. A lower cost of capital is possible because Company A has calculably lower credit risk due to less energy use, resulting in lower energy bills and lower potential future carbon price liabilities. The lender can share some of that reduction in credit risk with the borrower, creating a winwin where the borrower secures a lower cost of capital and the bank makes more money.

These synergies between ACO and CRM are clearly important and it makes sense to maximise them at every opportunity. But that is different from saying there is always a positive relationship between them both, or that CRM automatically and inevitably leads to ACO. It does not.

Instead of incidentally contributing to ACO through CRM initiatives like the TCFD, we need specific ways of dealing with and contributing to the challenge of alignment. These need to be articulated, developed, and scaled across the financial system rapidly. Without rebalancing the distribution of effort and spending more time explicitly on ACO, we cannot ever hope to align finance and the financial system with climate change objectives.

While central banks and financial supervisors have shown significant and growing interest in CRM, they have generally shown much less interest in ACO.

The focus of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) has primarily been on micro-prudential supervision, and to a lesser extent macro-prudential supervision, followed by monetary policy and financial conduct.

Perhaps the area that has most overlapped with ACO from a NGFS perspective has been growing concern about greenwashing and the mis-selling that could result. The UK FCA has recently warned that, “[greenwashing] could undermine confidence in the green finance sector, leading to unsatisfied demand, reduced participation and competition and insufficient investment in the transition”.3

If a product is claiming it will make a contribution to ACO, it should be clear how it will do it and there should be an accountable and transparent way of measuring the claimed contribution over time. Financial supervisors should be much stricter at authorising and monitoring such product and fund claims.

While central banks and supervisors have been more interested in CRM than ACO, there are clearly potential levers they could pull to ensure financial institution and financial system ACO. Sidestepping the question of whether this is within their mandates and assuming they would be given proper instructions from politicians held to account by the public, what could these levers be?

Central banks and supervisors, together with policymakers, should work on these and other related ideas to understand their pros, cons, and delivery challenges.

  • Capital charges for ACO – capital charges for finance provided to Paris Agreement incompatible assets could be introduced. This would go beyond aligning capital charges with climate-related risk and would overlay ACO considerations onto the setting of risk weights.
  • ACO targets for supervised firms – ACO targets for portfolio and loan books could be introduced. Supervisors could ask firms to disclose voluntary targets or they could set mandatory ones. If targets were introduced, they should set out the ultimate destination in terms of the percentage of assets that will be compatible with Paris aligned global warming thresholds for every 5-year period starting in 2020 up to 2050 for a given confidence level. For voluntary target setting, supervisors could require standardised levels of confidence, as well as common metrics and assumptions, to ensure comparability.
  • Introduce carbon budgets to Asset-Liability Matching (ALM) and Strategic Asset Allocation (SAA) – risk budgeting is used to guide ALM and SAA. Supervisors could require that carbon budgets be factored into these processes, which would allow institutions to determine the most efficient use of a given carbon budget allocated to their institution. This carbon budget would need to take account of carbon lockin and could be introduced either voluntarily or compulsorily.
  • Senior Managers Regime ACO – in a similar way to how the Senior Managers Regime is now used in the UK for climate-related risk management, ACO could be added to this framework. 4 This would create clear supervisory oversight and accountability of senior executive management.

Supervisors clearly have options for accelerating ACO, but these should not be entered into lightly and there are significant and very legitimate questions about the remits of central banks and financial supervisors in society. While these are debated, there is a noregrets need to explore the options they have together with policymakers, including the pros, cons, and delivery challenges. In many instances the first-, second-, or even thirdbest options will not be action by central banks and supervisors, but action by policymakers or the private sector.




1 NGFS. (2019) First comprehensive report: A call for action Climate change as a source of financial risk.

2 TCFD. (2019) Task Force on Climate-related Financial Disclosures: Status Report 2019.

3 FCA. (2019, p. 27) FS19/6: Climate Change and Green Finance: summary of responses and next steps. London. Retrieved from:

4 Bank of England. (2019) Supervisory Statement | SS3/19: Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change.