The Commodity Futures Trading Commission’s (“CFTC”) climate-related market risk report released last week could not have come more timely. A record four and three-quarter million acres of forestry were lost in California; skies over San Francisco bay loomed with an apocalyptic tone; and communities in the states of Oregon and Washington were completely wiped out.
When CFTC Commissioner Rostin Behnam underscored in the report, “Beyond their physical devastation and tragic loss of human life and livelihood, escalating weather events also pose significant challenges to our financial system and our ability to sustain long-term economic growth,” the future had arrived, and projections had become a reality.
A few days earlier, Kate MacKenzie in a Bloomberg Green article published an article “Central Bankers Aren’t Using Their Climate Superpowers Yet” and mentioned that, “All the scenarios, stress tests and disclosures in the world will have little effect on climate change if central banks don’t explicitly favor green assets and penalize polluting ones, both in their investments and market interventions and in the rules they set for financial institutions.”
The 53 CFTC recommendations pull no punches. These recommendations are the most unprecedented regulatory advisories ever made by a U.S. supervisory authority regarding climate risk. Commissioner Behnam deserves enormous respect for shepherding these endeavors. The scope, detail, and depth are impressive and comprehensive; one would only wish they had been released 30 years earlier. Some of the principal recommendations are listed below:
- The United States should establish a carbon price.;
- All relevant federal financial regulatory agencies should incorporate climate-related risks into their mandates.;
- The Financial Stability Oversight Council (FSOC)—of which the Commodity Futures Trading Commission (CFTC) is a voting member—as part of its mandate to monitor and identify emerging threats to financial stability, should incorporate climate-related financial risks into its existing oversight function;
- U.S. regulators should join, as full members, international groups convened to address climate risks, including the Central Banks and Supervisors Network for Greening the Financial System (NGFS), the Coalition of Finance Ministers for Climate Action, and the Sustainable Insurance Forum (SIF);
- Financial supervisors should require bank and non-bank financial firms to address climate-related financial risks through their existing risk management frameworks;
- In light of global advancements in the past ten years in understanding and disclosing climate risks, regulators should review and update the SEC’s 2010 Guidance on climate risk disclosure to achieve greater consistency in disclosure to help inform the market;
- The United States should consider the integration of climate risk into fiscal policy, particularly for economic stimulus activities covering infrastructure and disaster relief; and
- Financial innovation is required not only to manage climate risk efficiently but also to facilitate the flow of capital to help accelerate the net-zero transition and increase economic opportunity.
The Socratic question remains: who will enforce the implementation of such recommendations? Who will move first on which proposal?
Yet the time to act is now. As if more confirmation was needed, here is a quote from the BP Energy Outlook 2020, released on September 14:
“The world is on an unsustainable path. A rapid and sustained fall in carbon emissions is likely to require a series of policy measures, led by a significant increase in carbon prices. These policies may need to be reinforced by shifts in societal behaviors and preferences. Delaying those policy measures and shifts may lead to significant costs and disruption.”
The Business Roundtable endorses a nationwide initiative to adopt a more comprehensive, coordinated and market-based approach to reduce emissions.
Establishing a carbon price should become an immediate priority. Last year, more than 3,500 US economists and 27 Nobel Price laureates demanded a levy on carbon activity.
Annual, global humanmade greenhouse gasses equate to 43 Gigatons of Co2 equivalent. There is a current carbon reserve of approximately 1,050 Gigatons of Co2. If there is serious intent to keep global warming to below 2 degrees Celsius (which is borderline safe harbor), then emissions must be cut in half by 2030 and eliminated by 2050.
The carbon credit demand should be fostered by linking US apportioned greenhouse gas emissions at both U.S. local production and point of entry of imported goods to the reduction target of half of GHG (Greenhouse Gas) emissions by 2030. All data points, including the remaining U.S.-allocated CO2 reserve of 1,050 Gigatons, are readily available to start designing a reliable carbon credit demand and supply curve. A minimum price of $40 per ton should be set as to procure credibility to the market led effort and in order to offer sufficient incentive to meet the 2030 target. This price signal will spur VC resource and effort into development of GHG reduction technologies.
Flightradar24, a Swedish company established in 2006, tracks real-time commercial airplane traffic globally. The busiest day in history was recorded on July 24, 2019, with more than 225,000 aircraft in one single day. Since Covid-19, the number of daily flights averages around 150,000. Record temperature levels matched that infamous July record. This correlation continues to be ignored as total airline generated greenhouse gas emissions were left out of the 2015 Paris accord. So, who is connecting the dots, and what governance could be envisaged to amend this concurrent trend in the absence of a self-regulating regime?
Time is now of the essence to accelerate the implementation of CORSIA, which is a global market-based measure designed to offset international aviation CO2 emissions to stabilize the levels of such emissions from 2020 onwards. CORSIA efforts could be tied with creating the voluntary carbon market platform, in combination with identifying a minimum carbon offset price coupled with pushing for more ambitious caps.
There is maybe one bolder recommendation to be made: the creation of a Federal Reserve Bank managed “bad bank for stranded assets.” Stranded assets, according to CarbonTracker, can be defined as those assets that at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn a financial return (i.e. meet the company’s internal rate of return), as a result of changes associated with the transition to a low-carbon economy (lower than anticipated demand/prices).
The purpose of creation of the bad bank would be sixfold:
- to pivot the energy sector full swing towards renewable energy and further lower the price of renewables;
- to ensure keeping fossil fuel in the soil;
- to foster significant regeneration effort of land and forests, as well maintaining major carbon sinks intact;
- to introduce a gradually increasing carbon price with a minimum floor;
- to safeguard financial market stability by avoiding large scale climate change triggered material risk, by accelerating the pivot into renewables away from fossil fuel; and
- to strengthen the Central Bank balance sheet after several years of monetization of debt through the introduction of a combined renewable energy and natural assets backed Central Bank stable coin.
These efforts should be supported by a credible alternative energy plan, articulated by expert climate scientists. The plan should cover respective demand in transport (alternative supply source for E.V. and aviation), agriculture (decarbonization of and substitution of synthetic fertilizer), heating & cooling (sustainable (green-house gas-free) cooling components), industrial production (decarbonization of steel and plastics) and construction (decarbonization of concrete.)
The creation of “bad bank for stranded assets” would solidify the carbon demand and supply curve. The recently announced Private Sector Voluntary Carbon Market initiative should become a partner platform for supporting carbon price discovery. The effort should be internationally coordinated and deployed in conjunction with E.C.B. and People’s Bank of China.
The Fed led initiative would also ensure a more rapid transition from the current twenty-six (26) oil and gas companies in the S&P 500 Energy (Oil and Gas) index to a broader representation of the renewable energy sector in the S&P 500 index, currently standing at three (3) companies.
U.S. Congress is familiar with the concept of a bad bank. In the wake of the thrift crisis, triggered by maturity mismatched Savings & Loans (S&L) institutions, Congress enacted the creation of Resolution Trust Corporation (RTC) in 1989. RTC was established to resolve the remaining troubled financial institutions in that sector.
During the Financial crisis of 2008, Congress approved the $750 billion Troubled Asset Relief Program (TARP) program. The TARP program was enacted to execute the “whatever it takes” phase to keep the Great Recession from becoming worse.
A comprehensive 2009 McKinsey report provides several templates for the establishment of a “bad bank”. The German-inspired holding company structure offers an attractive vantage point for assessing the transfer of fossil fuel bank assets transparently and seamlessly. The holding company would be an umbrella shell for each respective U.S. bank willing to offload its fossil fuel assets at the discounted price.
Congress could request a horizontal review of the 15 largest U.S. financial firms regarding their fossil fuel exposure on the back of an “as is scenario” and a “worse-than-anticipated fossil fuel scenario.”
A 2020 report from the Rainforest Action Network revealed that 35 global banks advanced $2.7 trillion in bank loans to the fossil fuel industry since 2016. Top US Banks extended about $1 trillion of that bank credit total to the fossil fuel industry since that time.
On the back of the stress tests outcome, price proposals could be made to purchase fossil fuel assets from the banks. The price tag might oscillate between $1.2 and $1.4 Trillion on the assumption of average 5-year maturity and 10 cents on the dollar discount.
There is a probability that most of the assets might still be performing and that some of the counter-parties might even have plenty of financial resources. But the Fed’s rationale is to seize on a tipping point in climate history and to act in the citizens’ interest to pursue its six targets strategy.
The Federal Reserve bank could gradually exert the following powers:
- A Bank which sold its fossil fuel assets could no longer extend cash to the fossil fuel industry; neither could any of the financial and non-financial clients of that institution (on the principle that money is fungible in a world of communicating vases), if new liquidity procuring transactions were to be offered by the selling bank;
- The fossil fuel assets would be sold at market value, while the banks would be allowed to amortize the losses (if any) over a 5-year (negotiable) period. During that period, no share buybacks or dividends would be allowed;
- A fossil fuel counterparty could consider accelerating redemption of the bank asset through a bond offering. Such intent would be met by an institutional investors majority, members of Climate Action 100+ representing more than $ 37 trillion in assets under management, who would only underwrite a commitment if a similar pivot strategy to renewables and major effort in carbon sink initiatives would be undertaken;
- The Fed could offer both a maturity extension of the fossil fuel loans staggered over a period between 2030 and 2040 and offer a discount to principal redemption as a function of the extent by which fossil fuel companies are switching their portfolio towards renewable energy;
- The Fed could oppose any buyback and dividend payouts by the fossil fuel counter-parties through covenants, until the Fed would be made whole on their loans;
- Upon any payment default, the Fed would negotiate an equity position as a result of the fossil fuel company restructuring:
· The Fed could now impose the fossil fuel counter-parties to stop any extraction activity and shift further substantial resources to renewable energy initiatives.
· Any future capital expenditure would only be authorized for pivoting towards renewable energy, regeneration of land, and large-scale reforestation projects.
- The Bad Bank Holding Company would be co-managed by certified third parties and closely supervised by an expert group from Congress.
The initial funding of the Bad Bank could be inaugurated with a jumbo Green Bond issue by U.S. Treasury.
In a previous article, considerations were given regarding potential CBDC and Central Bank stable coins. The portfolio of stranded assets could now be used as a collateral portfolio for the Central Bank stable coin. As the portfolio would eventually consist of merely renewable energy assets combined with exposure to forests, mangroves and topsoil regenerated agricultural land, the stablecoin would represent a significant store of value and procure seamlessly anchor status in relation to fiat currencies. The stable coin would offer an attractive hedge on the balance sheet of the Fed. This applies especially for the citizen, who, through Congress, allowed further monetization of Treasury debt, at the time of purchase of the stranded (fossil fuel) bank assets by the Fed.
German philosopher Goethe observed that in the realm of ideas, everything depends on enthusiasm; in the real world, all rests on perseverance.
Commissioner Behnam and Governor Brainard have already persevered in the realm of ideas, now is the moment to enchant the real word with their enthusiasm in their idea execution.