For all the column inches dedicated to central bank meetings
this month, one potentially seismic change to monetary policy
has slipped under the radar over the last few weeks. In the most
recent UK budget, chancellor Rishi Sunak announced that the
Bank of England should reflect the “importance of environmental
sustainability”1 in policy decisions, which includes asset purchases.
The prospect of central banks determining which assets to support
based on environmental credentials points to a significant increase
in the importance of environmental, social and governance
(ESG) factors for investors, and also raises questions about the
appropriate role of central banks going forward.
Rishi Sunak’s announcement has certainly not emerged from a
vacuum; the Bank of England conducted a review of climate risks
to the insurance sector in 2015, expanding this to the banking
sector in 2018. Outside of the UK, Christine Lagarde has sought to
make climate policy a key part of the ECB’s strategic review and has
already introduced new climate stress tests for Eurozone banks.
Even the Fed is now flagging the dangers that climate change poses
to financial stability in the US, although it remains a politically
contentious issue in Congress.
Before the financial crisis, this sort of ambition from central bankers
was near unthinkable; governors were expected to be independent
of politics and predominantly focussed on controlling inflation.
The rationale behind this remains sound; politicians are required
to retain office every few years through elections, and so may have
ulterior economic motives which are incompatible with long term
price stability.
After two historic global recessions, the role of central bankers
is now much broader. Not only have large quantitative easing
programs become the norm, but so has buying direct corporate
bonds and equity ETFs (the Bank of Japan is now the largest owner
of Japanese stocks). Even the notion of political impartiality has
been stretched, with the likes of Janet Yellen and Mario Draghi
moving into high profile political roles shortly after their tenure as
leaders of the two most important banks in the world came to an
end.
Of course, the widening remit of central banks can rightly be justified
by their mandate for ensuring financial stability. Increased flooding,
droughts and storms are just some of the potential damaging
effects of climate change, and it is difficult to argue that these will
not create problems for the financial sector. Furthermore, the risk
of delaying climate action now could create problems associated
with a rushed, disorderly transition to a low carbon economy later.
To some however, there is a question as to how much power should
be in the hands of unelected technocrats. Are central bankers best
placed to determine which companies are the worst polluters?
Such decisions are not trivial, and there is plenty of nuance when
you delve into the weeds.
Here at Momentum, we believe that you need much broader
participation from a range of institutions to tackle environmental
issues meaningfully. The change in mindset from central bankers
is certainly welcome, but individual companies and investors also
need to think in ESG terms. Active managers are particularly well
placed in this regard as they have more involvement, knowledge,
and influence over the companies in their portfolios. At Momentum,
our business was among the first to sign the UN Principles for
Responsible Investment back in 2006. We acknowledge that we
are in a privileged position to act as fiduciary to our clients and
stakeholders, and we take our ESG responsibilities seriously. With
the most important global financial institutions now changing
policy, it could be costly for investors to ignore