Climate and crypto fraught with challenges for regulators
A decade or so after the financial crisis, the singular sense of purpose that drove a frenzy of regulatory intervention has faded.
Banks and insurers are so much safer now that regulators seem unconvinced of their resilience, even as countries including the United States and Britain flirt with recession and the fallout from Russia’s invasion of Ukraine threatens untold damage.
For financial regulators trying to recapture the relevance and adrenaline of the heady post-crisis era, crypto and climate are tantalizing topics. The wild west of crypto offers regulators a platform to save hapless consumers from scams and idiocy, while protecting underlying technology that can improve all of our lives. Climate gives the more old-fashioned regulators the opportunity to, literally, save the world.
But the two Cs that have replaced capital in the hearts and minds of regulators are fraught with difficulties.
Crypto is an area that many financial regulators cannot avoid getting involved in. There are rules that prohibit most individuals from putting their money in various bonds and complex products; it’s hard to argue that the same logic doesn’t apply to volatile crypto offerings.
There are also anti-money laundering issues that most regulators, and their governments, need to address to make it harder for crypto to be used by criminals, tax evaders and terrorists. And there are attempts to establish parameters for the use of crypto in the regular market world.
The challenge for regulators is that the crypto world is moving so fast that it is almost impossible for them to keep up.
In Europe, the long-awaited Markets in Crypto-Assets Act legislation that regulates the EU’s crypto activity is still under the hammer and won’t take effect until 2024. ECB President Christine Lagarde is already privately pushing officials to start work on a new iteration to capture recent developments outside Mica’s scope, such as the digital collectibles known as non-fungible tokens.
Doing something but not enough to prevent disaster risks popularizing crypto by offering a veneer of respectability. Regulators can also be held responsible for a crypto explosion that the rules were not broad enough to prevent.
Climate change presents various challenges. In banking, the most regulators can do to protect the environment is to discourage lenders from supporting “brown” polluting projects, and encourage support for greener projects. But the effectiveness of this is far from clear – banks are not the only sources of funding in the city.
One of the tools regulators have used to drive behavior is stress testing. Stress testing is a construct that hit its stride in the post-crisis era, and is a “what if” exercise that examines the impact of imagined crises. The problem with climate stress tests is that the range of scenarios is endless and the timelines stretch for decades, so the results depend entirely on where in the air the scenario-setters choose to stick their fingers.
The ECB recently found that 41 of the eurozone’s largest banks may be underestimating their short-term climate impact by 70 billion euros. They might as well have come up with a number of €170 billion.
The Bank of England ran its climate stress tests assuming that banks did not change anything about the composition of their lending for three decades, as seas rose, temperatures rose and industry was wiped out, an assumption so divorced from reality that it made the exercise easy to dismiss.
With such limitations in mind, José Manuel Campa, head of the European Banking Authority, told the Financial Times that he is arguing against quantitative outcomes in the EU’s first ever climate stress tests, as the methodology would not be robust.
A former regulator says Campa’s view is the right one, and not just to prevent the climate stress test results from being mocked. The greater danger is that a flawed climate stress test could undermine the normal stress tests the EBA runs to assure investors of European banks’ resilience.
The former regulator, along with one of his peers in a time of crisis, sees an even more important risk. That danger is the opportunity cost – every minute spent on things regulators can’t and shouldn’t do anything about is a minute not spent on the core job. And these summary minutes could become important if it turns out that the financial system is not as safe as regulators think it is.
