“Anyone who wants to be successful in the financial sector in the long run will have no choice but to eventually take sustainability into account.” These were the words of BaFin’s President, Felix Hufeld, as he opened the supervisory authority’s first sustainable finance conference at the Umweltforum in Berlin. Around 350 guests from industry, academia and associations seized the opportunity to attend the event in early May to discuss new supervisory approaches. The focus was on imminent environmental and climate risks for the financial sector. “Climate change is both a global threat and a challenge,” said Hufeld. For this reason, he pointed out, it is all the more important to raise awareness in the financial sector of both the material risks and the opportunities that climate, environmental and social change brings. This is true for both individual financial market participants and the financial market as a whole, he added.

BaFin, too, has a duty to take action: “As a financial supervisory authority, it is our duty to detect risks for the financial system and to call on supervised undertakings to take these into account appropriately. To do this, we must be able to thoroughly examine, quantify and understand the complexities of sustainability risks,” Hufeld explained.

Sustainability is nothing new for BaFin. In 2017, BaFin became one of the founding members of the Network for Greening the Financial System (NGFS). Central bank and supervisory authority representatives are involved in this network to work towards a green financial system. In early 2018, BaFin's Executive Board categorised sustainability as a strategically important issue. As a result, the undertakings that are supervised by BaFin have since been required to take into account material environmental and climate risks in their risk management systems.

Harald Lesch, a physics professor at Ludwig-Maximilians-Universität in Munich and science journalist at German broadcaster ZDF, analysed the actual magnitude of the challenges ahead from the perspective of climate researchers. “Humans must limit climate change – otherwise we will have blood on our hands,” he warned. He went on to say that there are still too many people denying the effects of greenhouse gases despite scientific evidence.

“The Earth is faced with the threat of a period of dramatic warming”

“The Earth's climate may be more fragile than we think,” said Lesch. He referred to climate models predicting large inhabitable areas along the Equator in Africa and South America in just a few decades. “The Earth is faced with the threat of a period of dramatic warming – a ‘hot’ age,” the professor predicted. He called on the audience to encourage everyone to move their investments away from harmful activities and invest in causes that are beneficial for the environment instead. He named the protection of the Amazon rainforest in Brazil as an example.

Dr Levin Holle, Head of Financial Market Policy at the Federal Ministry of Finance (Bundesministerium der Finanzen – BMF), agreed with the other speakers at the conference. In his view, attitudes in the financial sector need to change. He also considered national, European and international initiatives to be prime examples. For instance, Germany’s Minister of Finance, Olaf Scholz, became a member of the Coalition of Finance Ministers for Climate Action in April 2019. The members of this coalition for more climate protection are finance ministers from over 20 countries who are involved in in-depth discussions on the contribution that private capital and the financial industry can make to meet the climate targets in the Paris Agreement. The G20 Sustainable Finance Study Group, which comprises the finance ministers and central bank governors of the top 20 industrialised and emerging countries, is also advancing the topic of sustainability.

“The Federal Government wants to make Germany a leading sustainable finance centre,” said Holle. To this end, the Federal Ministry of Finance is examining how sustainability-related aspects could be taken into account in the Federal Government’s investments. In Berlin's political scene, it is also assumed that sustainability will be a key issue for the next term of the European Commission and the German presidency of the Council of the European Union in the second half of 2020.

However, Holle does not support the concept of a “green supporting factor”. In his view, reducing capital requirements solely on the basis that investments or loans are considered sustainable goes against the objective of achieving financial market stability.

EU promotes and calls for sustainability

Jan Ceyssens, Member of the Cabinet of EU Commission Vice-President for the Euro and Social Dialogue, Valdis Dombrovskis, asserted that the European Commission is working intensively on “the development of a generally accepted sustainability taxonomy,” as only those who determine the rules for this first will later be in a position to lead the discussions on global standards. Ceyssens referred to environmental, social and governance (ESG) criteria for the definition of such a taxonomy.

BaFin welcomes this initiative at European level: “A clear taxonomy and a high level of transparency can have a greater impact on the financial sector than any regulation,” said BaFin President Felix Hufeld. He went on to say that as soon as high-quality ESG data becomes available to all, these environmental, social and governance criteria will become the norm and penetrate into financial markets, ultimately changing them. Elisabeth Roegele, Deputy President and Chief Executive Director for Securities Supervision at BaFin, expects a practical European taxonomy to bring key momentum for the development of sustainable financial products. “In addition to such a taxonomy, improved transparency requirements will help investors to find out about the sustainability of financial products and thus base their investment decisions on this information,” she explained. BaFin therefore supports the European Commission’s efforts to incorporate sustainability-related aspects into prospectus requirements for certain financial products in order to provide investors with more extensive information than ever before.

No banking business without sustainability

Institutions must also contribute to sustainable finance, warned Raimund Röseler, Chief Executive Director for Banking Supervision at BaFin. “The banks that are not addressing sustainability will no longer manage to find investors in the long term.” For this reason, institutions will also have to take into account climate-related risks in risk management, he declared. Alongside BaFin and the Deutsche Bundesbank, another 32 central banks and financial supervisory authorities are pursuing this objective as part of the NGFS (see “NGFS Report ” - only available in German).

As part of these efforts, BaFin intends to submit a guidance notice on how to deal with sustainability risks for consultation to the undertakings it supervises at the end of 2019. In addition to the physical and transition risks in each business segment, undertakings should also list long-term sustainability risks. In a few years, climate change risks could then flow into bank stress tests, Röseler noted as he answered a question from the audience. “A robust financial industry is vital if we want to be able to adequately tackle the challenges posed by climate change,” said Röseler.

No regulatory bonuses

Dr Frank Grund, Chief Executive Director for Insurance and Pension Funds Supervision at BaFin, focused on the opportunities that sustainability brings. “German life insurers and Pensionskassen alone hold investments with a book value of over EUR 1 trillion that must be invested profitably in the long term,” Grund explained. In his opinion, the financial sector needs to do its part and get involved in the transformation of the real economy towards more sustainability. He added that, in this context, sustainable investments are not generally less risky than conventional investments without an ESG approach. “No regulatory bonuses can be granted for sustainable investments if such bonuses are not justified,” Grund clarified.

Dr Christian Thimann, CEO of Athora Deutschland, and Silke Stremlau, Member of the Management Board at Hannoversche Kassen, demonstrated how banks, insurers and Pensionskassen can prepare for the challenges that climate change brings. Every single decision-maker must take responsibility in both their professional and private life. The goal should be “a climate-friendly lifestyle,” said Stremlau. She then asked the audience a rhetorical question: “Who has given up their company car, cancelled their flight or decided not to order an extra dress?”

The transport, agriculture and energy sectors are about to undergo huge changes, according to Stremlau. The financial industry, too, is closely intertwined with these sectors. “This is why you have a duty to take action!” she warned. Aware of its responsibilities, Hannoversche Kassen has been taking social, ecological and ethical selection criteria into account for all asset classes and investments for several years now, according to Stremlau.

Voluntary pledges considered ineffective

From her experience, voluntary pledges made by the industry are virtually ineffective. For this reason, Stremlau urged legislators and supervisors to set out “clear, rules-based regulation”. Ultimately, she explained, “gigantic financial streams” would need to be redirected. According to a number of studies, EUR 180 billion a year would be needed to simply implement the EU’s climate targets by 2030. It would also cost USD 3-5 trillion a year to meet the United Nation’s 17 Sustainable Development Goals.

The former CEO of the French insurance group AXA knows from experience how important it is for a company to take the lead in terms of sustainability. Thimann was responsible for ensuring that the AXA Group became the first insurance company ever to move away from coal financing due to significant climate risks. Other international insurers then decided to follow suit. However, Thimann still warned that the implementation of sustainability criteria in Germany is leading to excessive regulation and said that all options to find a solution towards sustainable finance should remain on the table.

Finally, BaFin President Hufeld stressed again the immense time pressure to counter climate risks and that moral pressure and calls for ethical action are not enough. “We need to take action and we will need binding standards too,” said Hufeld. However, he also noted that he considers it important that, in a state based on the rule of law, discussions take place and decisions are made publicly as part of a democratic process. This process then results in standards similar to laws or regulations. Without such standards, there would otherwise be a risk that powers on a wide range of ethical and personal issues would be privatised and thus land in the hands of private financial institutions, which would be unacceptable in his view. He went on to say that even in light of fundamental challenges such as climate change or other ESG goals, the issue of legitimacy cannot be dismissed lightly in a democratic state based on the rule of law.