February 7, 2012 12:08 am

Bank assesses fossil fuel investments

Sir Mervyn King has said the Bank of England is prepared to consider claims by influential green investors that investments related to fossil fuels could pose a risk to the UK’s future financial stability.

The Bank governor has written to the group to say he doubts the financial system actually faces such a threat but “there is clearly scope for further evaluation of these issues”.

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“To this end, we will endeavour to include this in the list of topics we regularly discuss with market participants, to assess whether or not this is a risk of which they are aware and the extent to which they are taking it into account in their investment decisions,” he said in the letter, dated February 1.

“In addition, Andy Haldane, the Bank’s executive director for financial stability, would also be happy to meet with you and discuss the issues you raise.”

A group of 20 people including the founder of the Climate Change Capital investment firm, James Cameron, and Zac Goldsmith MP wrote to Sir Mervyn last month to warn that high levels of exposure to carbon intensive investments posed a potentially “major problem” amid a transition to a low carbon economy.

“As policy and technology work consistently over time to reduce returns in high carbon areas while supporting low carbon ones, investing in high carbon sectors, say as an institutional investor looking to generate good returns over a 20 to 30 year period to successfully cover future pension liabilities, could result in stranded assets,” the group said.

“Counter intuitively, institutional investors, as well as banks, companies, mutual funds and retail investors, continue to risk exactly that by deploying significant amounts of capital into high carbon sectors, or in companies with significant exposure to them.

“This could be another example of our capital markets fundamentally mispricing assets and, as a result, building up a systemic risk that threatens long term growth.”

Sir Mervyn said for such a risk to become a reality, three “key ingredients” would be needed. First of all, the exposures of financial institutions to carbon-intensive sectors would need to be large relative to overall assets. Second, the market would have had to have failed to price in the impact of policy and technology on reducing returns in high carbon areas. And third, any subsequent correction would have to happen too quickly for the relevant financial institutions to adjust their portfolios in an orderly manner.

“The necessity of all three conditions being met raises a question in our minds as to whether or not this is a potential threat to financial stability,” he said.

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