Paul 00:06
Hello and welcome to Macro Bytes the economics and politics podcast from abrdn. My name is Paul Diggle,Deputy Chief Economist here at abrdn, and today we're kicking off a series of episodes leading up to and during COP 26, in which we will be talking to our economists, investors, and policymaker contacts about the macroeconomic, political and investment implications of climate change. And today, we're going to focus specifically on the role of the judicial system and the courts and central banks in climate policy, and the profound impact that climate litigation and central bank action has on investment markets. So joining me in this discussion are Anna Moss, Climate Change Scenario Analyst here at abrdn, and Luke Bartholomew a familiar voice on the podcast, a co-host, and our Senior Monetary Economist. And as always, there is a lot to discuss. So let's get straight into it. So Anna, you've been thinking about and writing about climate change litigation. For the uninitiated, could you just give us a very quick sort of cliff notes of what climate litigation actually is? Why are we talking about this?
Anna Moss 01:18
Thank you. Yes. So we've seen a really steep increase in the amount of climate-related litigation that's being brought to the courts. So this is, in general, litigation that is brought that is trying to strengthen climate policy or take action against those who are seen as the climate villains, if you like. So the large emitting companies, for example, but you also see climate change litigation in the other direction as well. So in terms of companies, for example, that might challenge strengthening of climate policy where it is interrupting their activities, limiting their activities, for example. So we've seen this really steep increase, as I say, since really about 2006.
Paul 01:20
Why Anna is that a rising trend over time? Why is climate litigation on the increase
Anna Moss 01:33
with some of the leaps that we've seen in the number of cases being bought, have been triggered really, by some of the major international agreements, so the Kyoto Protocol, for example, or the Paris Agreement, both of those were followed by large leaps in litigation. And whilst the vast majority of these cases continue to emanate from the US, the US dominates in terms of litigation, we are also seeing an increase in the important cases being brought to courts elsewhere. So particularly in Europe and Australia, for example. And in those courts, actually, you're proportionately more likely to see ruling in favour of those that are championing climate action than you will in the US currently.
Paul 03:10
So we're talking about this, of course, in the lead up to COP 26, around which we might also expect a further ramping up in climate litigation just as happened after those previous large set piece conferences. What about the role then of improving science and the ability to identify and assign climate blame and costs - has that also had a role here in increasing in climate litigation?
Anna Moss 03:41
Yes, this is really critical. So as well as seeing leaps in relation to specific agreements, you also see relationship with the publication of major scientific evidence. And in August, for example we saw the publication of the physical science report of the IPCC sixth assessment, and the urgency of the message in that new report and the strength of the science and language that report uses, is very likely to trigger an increase in litigation, as well as strengthening those cases themselves. You could very well see an increase in the success of litigation. The common barrier to litigation successes is the ability to establish the link between cause and effect. However, that report highlights the increased ability to attribute specific extreme events to human-induced climate change. And that allows those experiencing loss and damage to bring cases against those governments and companies deemed responsible for that climate change due to their relative emission levels, for example.
Paul 04:49
So let's dig in then a little bit more into the parties involved in climate mitigation. Tell us who are the people, the organization's, bringing these cases and who are they being brought against? What are the sort of common groupings there?
Anna Moss 05:05
Yes, some of the trends we're really seeing. So whilst cases against governments and government departments continue to dominate - so they're really around the kind of strengthening of policy, for example. We're also seeing interesting trends in the nature of some of those cases. So you're seeing a rise in the use of human rights arguments, for example, such as the successful case that was brought against the the Dutch government that forced them to strengthen their emission reduction targets. You're definitely seeing a rise in litigation by activists and advocacy groups. So they're seeing the courts as a very useful way to raise to not only have the chance of successful litigation, but also the positive publicity that can be brought from such cases, even if they're not successful. And you're also seeing a diversification of strategies used against corporations. So you're seeing cases that are forcing compliance with non financial disclosure regulations, for example. Charges of greenwashing, are becoming very common. So companies are at risk of becoming targets if their statements are deemed to be misleading, such as the successful case was brought against BP. And shareholder activism, which is putting pressure on the boardrooms. So you're seeing a big increase in the number of climate resolutions going to those financial company annual general meetings, as well as kind of the litigation actions that you're seeing.
Paul 06:45
So to what extent is there this push back by some of the typical defendants in these cases who are in turn bringing climate litigation for, say, lost earnings or overly strict regulation against government? Is there also a trend in climate litigation,
Anna Moss 07:05
It definitely is a trend. But I think we're likely to see a kind of downturn in that trend, given the reputational risk to those companies that accompanies them challenging strengthening of climate policy by governments or local government, for example.
Paul 07:24
Right. So then let's end this section then by just making this really explicit in terms of what it means for investors. So how does this impact the investment opportunity in individual companies? And how do investors have to incorporate the rise in climate litigation into their investment decision making?
Anna Moss 07:45
Yes, so we're not seeing very much litigation bought directly against the financial sector. And there's been little success on that, due largely the inability to prove the activities would have halted if the finance was was withdrawn, for example. But as we have corporations, the financial sector is definitely open to accusations of greenwashing, and lack of disclosure. And I think we're likely to start to see challenges there. But also, in terms of the the financial impacts for investors, the risk there is really this kind of indirect risk from investing in companies that are facing litigation and reputational risk from investing in major emitting companies.
Paul 08:34
So I suppose the bottom line is you have to do your your ESG homework, you have to do your due diligence, your screening, partly because of this trend of climate litigation, and the legal risks that are embodied in that trend.
Anna Moss 08:51
Absolutely. I don't think the financial sector is going to be able to sit at as much distance as it has been able to in terms of these court cases.
Paul 09:03
Brilliant. So Luke, we're going to get on then to thinking about central bank's role in climate policy as well and how that impacts investors. And central banks are increasingly involved in climate policy. The ECB, the European Central Bank, is probably the leader here. What have they said? What have they done in terms of the involvement of a major central bank in climate policy?
Luke Bartholomew 09:29
Yeah, thanks Paul and I think it is fair to say that the ECB probably has been the leader here, both rhetorically and also in substance. President Lagarde has talked about how she wants the ECB to be the pace setter in this regard. And I do think that was quite a big part of her pitch for the job back when she was going for it 18 months / two years ago. So in terms of what they've done, well, the ECB had a big strategic review that concluded earlier this year around July time when it was looking at a whole suite of issues around how it conducted policy. And a big part of that is that they also released their Climate Action Plan as part of that strategic review. So set up climate policy as a key component of the way in which it felt it needed to tackle the issues of the future. And that Climate Action Plan sort of, at least in the short term doesn't involve a huge amount of changes, they're mostly spending the next year or so collecting better data, building up expertise, and then sort of enforcing stronger disclosure requirements on companies. But come 2022 that activity there starts to increase somewhat. At that point, they intend to introduce climate stress tests as part of the standard and stress tests for financial institutions, to apply differential haircuts, collateral posted by banks and various counterparties, depending on the results of those stress tests, and other sort of environmental climate based assessments. And third of all, and I guess this is the one that gets the most attention is so called green QE. So to explicitly direct the purchase as part of their corporate purchase programme towards companies that on the basis of their disclosures are more green.
Paul 11:20
So the ECB is unambiguously the leader, when it comes to central bank involvement in climate policy. But what have other major central banks been saying on this, and I'm thinking in particular, about the Bank of Japan, the Bank of England, perhaps even the US Federal Reserve?
Luke Bartholomew 11:34
Sure, so there's bits of progress from all of them. From the Bank of Japan, we've seen them introducing this subsidised lending programme for companies that are more involved in the green transition. So helping to increase their access to finance and to cheap finance explicitly. The Bank of England has had its mandate from Parliament updated to include climate related issues. And I think, ultimately, what that's going to amount to when it's operationalized, is green QE. So again, skewing its corporate sector, asset purchases towards those companies that meet whatever green criteria. From the Fed, I think it is fair to say that it is something of a laggard. There has been work they have done in terms of increasing the modelling work they do about the impact of climate change on the economy, and there is sort of talk from Powell that there might be sort of more moral suasion and regulatory pressure brought to bear on certain financial institutions in the way they finance certain non green behaviour. But as I said, I think the Fed is going to remain a laggard. And there are pretty good structural reasons for that. The first is that the Fed actually in some ways has a more restrictive mandate than those other central banks in that it very tightly pins them into achieving full employment and stable inflation. There isn't the kind of what the ECB has their secondary mandate to support the other projects of the EU - or indeed, other central banks sort of have soft secondary mandates to ensure that they are supportive of policy. The Fed doesn't really have anything like that, which sort of speaks to the potentially slightly deeper structural issue in the US, which is that client policy is just profoundly more political in the partisan sense of the word than it is elsewhere. And for a technocratic institution, like a central bank to pursue certain policies is extremely important as part of their democratic legitimacy to have buy in across the political spectrum. There's a sense in which there's full political support in what they're doing. And that sort of just isn't there with the Fed at the moment. And indeed, we're sort of seeing that to some extent around questions of Powell's reappointment. And one of the big issues of contention is whether certain members of Congress would like to go with a leader, a new leader of the Fed who would be more inclined to support green issues. And these kinds of politicisations of climate policy do make it harder for the Fed to, to pursue anything until there is a settled political mandate, which I suppose quite nicely illustrates the point that central bank behaviour in this regard can't be thought of as a substitute to substantive political solutions. It is part of a political solution, not a substitute to it.
Paul 14:42
Yeah. So let's spend some time then thinking about the justification for central bank's doing things like green QE or differential haircuts on green versus brown bonds. And it's not as naive a question as it might strike some people in the first instance precisely because, as you said, Luke, central banks are technocratic organisations that operate under strict mandates and rules. They're not directly elected, they're not directly accountable to the public. So what are the different justifications that are being given for central banks to become over time increasingly involved in climate policy?
Luke Bartholomew 15:21
Yeah, so well, given the mandate for almost all central banks is some form of price level inflation stabilisation, you might think that an obvious route that you could go down to try and justify climate based policy would be to justify in terms of price stability and inflation stabilisation. And it is unambiguously the case, that green transition and climate change more generally will have implications not just for relative prices, but I suspect also for inflation rates at times as well as the big shifts in relative prices that will be required as certain energy sources become much more expensive, will I expect sort of show up as periods of higher inflation. So you might think that that's a justification there. I'm not so convinced about that, for several reasons. First of all, central banks already have pretty well articulated frameworks for thinking about energy price shocks and how they behave with regards to energy price shocks in accordance to their current mandates without sort of needing to give any extra baggage to climate policy. And second the sort of horizons, that those price changes, that those inflationary pressures, are going to be over are likely to be much longer than the sort of standard central bank time horizon when it's targeting inflation stabilisation over a two, three year horizon, at which point, it's really just the standard business cycle dynamics that are likely to dominate. So as appealing as that sort of inflation route seems, I'm not sure that it is actually that powerful when you think about it. I think a slightly more powerful justification is that another big role for central banks is not just stabilising the price level and inflation, but also the financial system more generally. And it does seem extremely likely that, again, the green transition climate policy does potentially pose systemic risks for the kind of institutions that central banks regulate, the financial system, the way in which it's invested in certain companies whose assets might be rendered significantly less valuable, depending on certain policies, or insurance companies that suddenly face significantly high catastrophe risk as a consequence of climate change. And so the thought is that part of their role as a financial stability regulator involves them having to take views and set policy on the basis of climate considerations. And I think that is a somewhat stronger argument. Although it does rely on the idea that, you know, fundamentally, the central bank knows better how to price and regulate these kinds of risks than the market does. And that might not be an implausible assumption, at least at the moment, while the degree of information disclosure perhaps isn't strong enough for markets to correctly price all risk, but that may not always be true in time. And indeed, a large part of what central banks are trying to do is increase disclosure so markets can price this activity better. So it's quite a contingent kind of justification, which sort of in some sense, hopefully, is not always true, you would, you would hope that markets would be better able to account for those risks and price them accordingly at some point in the future. And so what we think of is really being the strongest argument is just that pretty direct case that, look, climate change is an existential risk that at times where societies face existential risks, it's extremely important that all institutions that can make a difference do make a difference. This is exactly how central banks behave. For example, during wartime, where other considerations are put to one side and the central banks are involved in financing governments. I think the analogy fits well here, that the kind of risks that are at stake are such that it is appropriate for the central bank to be involved because of that. And sort of a standard objection you get to that is it violates this principle of neutrality that the central bank shouldn't be involved in favouring one sector over another. And we're rather unconvinced by that case, at least when it comes to climate policy. Because neutrality is pretty much impossible to achieve anyway. And so once you've accepted that, that is the case you're sort of brought to point B, which is well, we might as well ask, what ways do we want to be non neutral, accepting that neutrality is impossible? And what better way to be non neutral than to you know, help deal with the greatest risk that humanity is facing?
Paul 19:50
Brilliant, so the same final question to you as to Anna then - let's make explicit how this matters for investors. So what does all this central bank action on climate policy in the end mean for markets and those that invest in financial markets.
Luke Bartholomew 20:07
So I think in the short term, central banks are going to be responsible for sort of pushing us towards a situation where corporates are forced to disclose much more information through moral suasion, regulatory pressure, sort of setting certain standards around what's required to be involved in asset purchase programmes. All of this will force corporates to disclose more. And so that means more information for investors to be able to assess the kind of risks that companies are facing given a transition and climate risks. And so yeah, the responsibility on investors to take on that information and price assets accordingly. And then the other is that it's just very likely that the central bank action green QE setting different collateral requirements will lead to a sustained shift in relative prices for green assets versus brown assets. To put it simply, and you know, there are sort of, depending how furiously you take the efficient market hypothesis, reasons for thinking that affection be so big, you know, if you take the view that the only thing that matters for pricing an asset is its cash flow, it shouldn't matter who owns it, whether it's the central bank or the private sector, or whoever else it might be, the fundamentals pin down the price. But I think that's a rather too literal reading of the efficient market hypothesis, at least in this case, I think there are good reasons for thinking central bank action does have sustained causal impact on prices. First of all, there are frictions in markets, that mean the impact of central bank purchases persist. And second, because there is an important signalling that comes with the central bank buying these kind of assets and not buying those kind of assets, they tell you something about the way in which the state and regulation more generally is shifting towards those kind of behaviours. And that is information that is important for investors when they come to pricing assets. So it is the case that already there was sort of this drift towards a sustained wedge between the pricing structure of green and brown assets. The private sector was doing that work already, but I think central bank action will sort of accelerate and reinforce those existing trends.
Paul 22:24
Brilliant. Luke, Anna, thank you both very much. It's a really useful overview of how climate litigation, central bank involvement in climate policy really matters for the macro economy, and for investment markets. And thank you for listening to Macro Bytes, please tune in for further episodes as we build up to COP 26 - thinking through the macro and market implications of climate policy and climate change. Don't forget to give Macro Bytes a like or subscribe on your podcast platform. But until next time, goodbye and good luck out there.
23:10
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