'Any future investment in fossil fuel extraction is doomed to fail'

The risk weighting of climate change in capital allocations is a fraction of what it should be, says Thierry Philipponnat of Finance Watch.

Steam clouds in the evening sky pass the Schkopau power plant in Schkopau, Germany. Thierry Philipponnat of Finance Watch advocates the need for higher risk weighting in prudential regulation for fossil-fuel related assets because they are particularly risky due to climate change. Martin Schutt / ANP

CV

  • Head of Research and Advocacy, Finance Watch, 2019 – present
  • Member of the European Commission Platform on Sustainable Finance, 2020-present
  • Chair of the Climate and Sustainable Finance Commission, AMF (France’s regulator), 2019-present
  • Chairman, French Sustainable Investment Forum, 2015-2017
  • Set up Finance Watch in 2010
  • Between 1985-2007 Philipponnat held various positions in the financial sector, including Head of Equity Derivatives at Euronext, Co-Head Global Equity Financing Structuring at BNPP and Head of Equity Derivatives France at UBS.

Thierry Philipponnat is a man with a sense of urgency. “It is important that elected officials do more than pay lip service to (environmental and social) sustainability, says the Head of Research and Advocacy at Finance Watch, the European campaigner for better financial regulation.

“We have three main battles we are seeking to fight: financial inclusion, financial stability and financial sustainability.”

In 2010 a group of Members of the European Parliament (MEP) came together to launch a call for a new organisation that would seek to represent the public interest in the debate about financial regulation. The result was the foundation of Finance Watch.

The initiative received strong support throughout Europe. In seeking someone combining civil society experience and the detailed, technical, financial knowledge to run the project, the MEPs approached finance veteran Philipponnat.

“When it comes to regulation you must be very precise in your demands – regulation is not a piece of poetry,” he tells Impact Investor.

Finance Watch is supported financially by various leading foundations including the European Climate Foundation, The Sunrise Project and The Laudes Foundation, but also by the European Commission itself.

Not afraid to criticise

Nevertheless, Philipponnat, a scion of the champagne house that bears his name, is not afraid to be critical of his ‘masters.’ But he does so in a constructive way.

Thierry Philipponnat of FInance Watch: “We have three main battles we are seeking to fight – financial inclusion, financial stability and financial sustainability.” Finance Watch

“The direction of travel by European regulators is correct, but the scope of the topics covered is too narrow,” he says. “There is too much reliance by regulators generally on the provision of information as if this in itself will change things.” More information about sustainability doesn’t in itself make the financial world more sustainable.

“This is to the detriment of other essential subjects,” he believes. He cites urgent issues like “prudential regulation, sustainable corporate governance and bringing capital to productive use, especially sustainable economic activities.”

He believes the logic that greater information lowers the cost of capital does not apply. “I do not think all financial products are equal when it comes to sustainable investment: those products which provide capital for enterprises should not be treated the same as, say, ETFs.” In other words, Philipponnat believes direct investments should be rated more highly in sustainability taxonomies.

On financial inclusion, Finance Watch believes “the less privileged should receive greater protection from regulators. The caveat emptor approach simply doesn't work” with the less financially educated sections of the population. They need to be protected from financial institutions.

“I do not believe lending should take place to someone where it is simply impossible for them to repay the loan,” Philipponnat says.

Fighting Greenwashing

Having said that, Philipponnat believes the European Union is doing good work to make the different sustainability obligations relatively coherent.

“I understand what they are trying to achieve through the SFDR The EU's Sustainable Finance Disclosure Regulation which came into effect in March,” he says. “But the danger is that they are not going far enough, and the result has been a compromise.”

“At the end of the day, the problem is that we are not yet living in a green world,” the Frenchman says. Asset managers managing billions of dollars of capital are forced to buy into the world ‘as is’.

“Inevitably financial institutions end up investing in a universe that is not yet sustainable,” Philipponnat notes. “When I hear large asset managers tell us that their entire assets are managed on a sustainable basis, I simply do not believe that is possible.”

To avoid greenwashing he believes two things are important. Firstly, that managers are truthful in disclosing their intentions, and here SFDR is “achieving progress, if imperfect.”

But the second area, impact measurement, is an area where more needs to be achieved. Philipponnat: “I fear that this is something that the regulators themselves will never be capable of discharging correctly. What I hope is that private investment analysis evolves and that an industry measuring impact develops further.”

How Finance Watch achieves change

The mission of Finance Watch is to achieve change through legislation and regulatory action. To this end, they publish approximately thirty research papers a year. Six or so in some depth.

“This is not academic research, but what I call applied research,” the lobbyist notes. “Research that is aimed at policymakers.”

Philipponnat believes his organisation made “considerable progress in the last year.” The proposal put on the table by the European Commission for the Consumer Credit Directive is apparently “very close to what we've been advocating.”

His recent paper Breaking the climate-finance doom loop has led to more than fifty meetings with different policymakers including the European Commission, central banks and different governments.

Need for higher risk weighting for fossil-fuel related assets

The paper argues that there is a huge mispricing of risk in prudential regulation. Under the current system, the risk weighting placed on climate change in capital allocations is a fraction of what it should be. It argues that this could change with a more appropriate use of the existing legislation.

Under EU regulation, CRR (Capital Requirements for Credit Risk) Article 128 already calls for a risk weighting of 150% to be applied to assets deemed particularly risky, and that is currently applied, for instance, to private equity and real estate.

But Philipponnat argues this should also “apply to fossil fuel exposures: climate risk is a reality that is already with us.”

Explaining his argument further, Philipponnat says that the fossil fuel industry saw a depreciation in assets of $150 billion in the last year. “The world’s largest coal company Peabody has gone belly up. It is important for regulators and investors to recognise that fossil fuel assets are particularly risky.”

When it comes to the future development of fossil fuels, the mathematics of this is “quite simple.” Known reserves of fossil fuels are estimated to be more than six times the amount that we can extract and burn to avoid temperature rises above 1.5°.

“Any future investment in fossil fuel extraction is therefore inevitably doomed to failure and capital allocated to that should have the appropriate risk rating,” Philipponnat says.