This asymmetry contributed to the sharp increase in market volatility, the dramatic reduction in market liquidity, and the impairment in market function following the Lehman failure. Fear that this could happen again if another firm failed, encouraged flight from other dealers perceived by market participants to be relatively weak that might have large potential exposures. Of course, as if this were not bad enough, the opaqueness of the OTC derivatives market made the situation much worse. No one had a clear insight into the financial health of their counterparties. Although each market participant could calculate its bilateral exposures to a particular dealer and the particular dealer could understand its own exposure to each of its own counterparties, this didn’t answer the broader question: how exposed were the clients and dealers to others in the financial system through their derivatives trades and other open positions? Because there was no easy way to know who was in difficulty or not, the incentives were all on the side of assuming the worse – closing out open trades, hoarding liquidity, and retreating to the sidelines. The crisis had made it crystal clear that the regulatory regime had not kept pace with the rapid growth of the global OTC derivatives market. In assessing the shortcomings of the OTC derivatives market after the crisis, a global consensus has been reached. Although I will be over-simplifying in the interest of time, I view the following aspects of reform as the most important.
[3] Moreover, studies have uncovered a significant lag in discerning the benefits of mitigation measures,[4] which makes it much harder to impose costs on society today if measurable results are available much later. By making the costs of a major, truly global crisis more tangible, the pandemic may help to remove the “tragedy” from Mark Carney’s horizon: after COVID-19, the dramatic consequences of a global climate crisis may be much easier to imagine. And given the need for fundamental structural change after this crisis, the willingness to use this chance to take precautions against the even bigger risk of a climate crisis may have increased. In order to achieve the European Union’s target of net-zero greenhouse gas emissions by 2050, our response to the growing risks of climate change has to start with the way we rebuild our economies after the pandemic. In my remarks this morning, I will argue that three complementary pillars are needed to accelerate the transition towards a low-carbon economy: an effective carbon price, a strong investment programme and a greener financial market. I will also argue that central banks have a role to play in mitigating climate-related risks, even within their traditional mandates, because global warming poses severe risks to price stability. Carbon pricing as the central tool So let me start with the first pillar, the introduction of global carbon pricing. Europe is already spearheading global efforts, which is essential at times when a global solution is not in sight.