The world’s financial system has been upended

While politicians across Europe have been fighting a culture war over air-conditioners and the causes of the deadly heat shock, central banks have been taking matters into their own hands.

The Bank of England has slipped through market notice 11, entitled “Changes to collateral eligibility in the Sterling Monetary Framework”.

In essence, it warns that fossil fuel companies will face bigger haircuts from October onwards. Their debt will be worth less as collateral for borrowing money or securing a trade, depending on how far along they are on the green-to-brown spectrum.

This seemingly minor adjustment in the city’s plumbing can have far-reaching effects. It will not stop fresh drilling in the North Sea, but it is a warning to Shell, BP and the other European oil majors that they may face a penalty if they abandon the “green stuff” and keep doubling down on oil and gas.

“The implications are pretty serious. They won’t be able to repo their paper so easily,” said David Owen, a bond expert and founder of Saltmarsh Economics.

Lenders will also have to integrate the financial risks of climate change in their stress testing and models. “The direction of travel is clear. Banks are going to have to set aside more capital when lending to some fossil companies,” he said.

The European Central Bank (ECB) is acting in parallel, using pillar two of the global “Basel regime” to squeeze loans to high polluters and shift incentives for the capital markets.

Banks in Europe already have to run a stress test for a “fossil debt shock”. The ECB is selling down its own holdings of corporate bonds with a high carbon footprint. It is exploring extra capital charges for banks that hold fossil assets, all in the name of financial stability.

Donald Trump’s America will have nothing to do with such policies, but that may not protect the US from the consequences. The country depends on huge inflows of global capital to fund investment and enable Americans to live beyond their means on the never-never.

The United States’ fiscal deficit is running at 7–8 per cent of GDP as far as the eye can see. The savings rate has collapsed to 3 per cent of GDP, a level seen only once before in US history: just before the Lehman crash.

The US has accumulated debt liabilities of circa $US10 trillion ($19.3 trillion) to foreign creditors. It needs net inflows of $US1.2 trillion a year to stay level. Half of this money comes from Europe.

Sooner or later, that dog is going to bark. Some 40 central banks and supervisors now publish the “weighted average climate intensity” (Waci) scores of their bond and foreign exchange holdings. They are in turn pushing pension funds, insurers and the likes of Amundi, Legal & General, BlackRock and Vanguard to follow suit.

The easiest way to meet your Waci target is to toss some US treasuries out of your portfolio and buy the debt of low-carbon states such as the UK, France, Switzerland and the Nordics, with emissions of four to five tonnes per capita.

“This is a huge advantage for gilts,” said Owen, who thinks markets have badly mispriced UK sovereign debt.

The mid-tier emitters are Germany, Japan, Holland, and Italy at seven to nine tonnes. The fossil bloc is the US, Canada, and Australia at 14–16 tonnes.

This tightening regulatory squeeze is not the reason global investment in renewable energy surged to $US2.2 trillion in 2025, twice the $US1.1 trillion spent on the oil, gas, and coal nexus.

The green blitz is driven chiefly by China’s quest for energy autarky and supremacy over the whole gamut of electrotech, which Beijing thinks will be a far bigger economic prize than fossil dominance over the next quarter-century.

Energy analysts at Ember say we are seeing the mirror image of the “Great Divergence” after 1800, when the West pulled ahead with a technological system built on coal, oil and the engines that burn them.

Asia is not only closing the gap: it may leapfrog ahead with a more advanced system based on electrotech unless the West gets a grip, and fast. Asia’s lack of oil and gas resources was a weakness in a fossil world. “It is a blessing in an electric one,” the analysts said.

The free market is pushing the rest of the switch. Ember says solar and batteries together – de facto baseload in sunny latitudes – are now so cheap that half of humanity can power itself at under $US80 a megawatt/hour, and four-fifths at $US100. Try telling the Global South to waste their money importing liquefied natural gas from the US or Qatar. The Iran war has driven home the point like nothing before.

Central banks can see the economic geography and the cost curves, and they can do the maths. They know that the estimated $US20 trillion–$US30 trillion assets and $US7 trillion debts of the global fossil complex – wells, rigs, pipelines, storage, refineries, tankers, and booked hydrocarbon reserves – are under historic threat and are vastly greater than the distressed property that caused the global financial crisis.

It is an oddity of human character that the West’s pro-fossil backlash should peak just as the scientific facts on the ground become so evident, the costs so clear, and the alternative technologies so easily and cheaply available.

London Climate Action Week was a watershed gathering for other reasons, not only because the session entitled “Extreme Heat” at the London School of Economics had to be cancelled last Wednesday because of a Met Office red alert on … extreme heat.

The subplot was no longer the moral case for conserving the natural order and bequeathing the world to our grandchildren more or less as we inherited it – a sacred conservative principle, note well, you heretic Tories – but rather the balance-sheet costs of letting greenhouse gases do their worst.

We are discovering how much it costs to deal with the mess that we have already created. The social and transport infrastructure of much of Europe is built for a climate that no longer exists. Blocks of flats in French cities became a death trap last week. IT systems that run modern life broke down. Hospitals, schools and railways could not cope.

A study by the ECB and Mannheim University warned that productivity and supply chain losses in Europe could reach 0.8 per cent of GDP annually as soon as 2029, which may cost Germany and Italy the only economic growth they still have.

TheCityUK says uninsurable “protection gaps” are emerging because insurers can no longer judge risk as the climate breaks out of its normal oscillating bands. This has become a “foundational concern for bankability, investability, and orderly economic activity”. In other words, it is subverting the financial system itself.

It is an oddity of human character that the West’s pro-fossil backlash should peak just as the scientific facts on the ground become so evident, the costs so clear, and the alternative technologies so easily and cheaply available.

My guess is that the political pendulum will soon swing back, with a vengeance, perhaps led this time by the billionaire brotherhood with a sharp eye on the fortunes of the future.