Agencies must ensure a climate-smart recovery from Covid-19 and mandate climate stress tests and climate risk disclosure to protect capital markets
Climate change poses a systemic threat to the stability and competitiveness of U.S. financial markets, and financial regulators have the responsibility and the authority to better protect against that threat, according to a new report from the Ceres Accelerator for Sustainable Capital Markets.
The report Addressing Climate as a Systemic Risk: A call to action for U.S. financial regulators examines the wide-ranging and compounding impacts of the climate crisis on U.S. financial markets, establishing how these impacts fall within the purview of seven different federal financial regulatory agencies as well as state regulatory agencies. It studies what models for action are already being implemented by regulators around the world, and recommends more than 50 specific actions U.S. regulators can take right now -- including what regulators can learn from the Covid-19 recovery effort.
“The Covid-19 pandemic has revealed just how vulnerable our interdependent and multi-layered financial market is to the impacts of sudden and disruptive events,” said Steven Rothstein, Managing Director of the Ceres Accelerator for Sustainable Capital Markets. “Stresses and failures can have cascading impacts across the system and, unlike in the possible resolution to the Covid-19 pandemic. This report makes clear that it is the job of U.S. financial regulators to protect capital markets from the impacts of the climate crisis, and provides a carefully curated set of recommended actions for doing that job and doing it well.”
The report’s recommended action steps are directed at the Federal Reserve Bank (Fed), the Securities and Exchange Commission (SEC), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corp., (FDIC), Financial Stability Oversight Council (FSOC), Commodity Futures Trading Commission (CFTC), Federal Housing Finance Agency (FHFA) and federal and state insurance regulators, and fall within several key categories:
Affirmation and Research. Financial regulators must affirm climate change as a systemic threat to capital markets and conduct research to determine how it impacts the aspects of the economy they’re responsible for safeguarding, such as financial markets writ large, the securities market, the commodities market, the insurance market or the mortgage market.
Prudential supervision. Financial regulators that supervise banks, insurance companies, commodities traders, and other financial institutions, have a mandate to ensure they are operating in a way that plans for a changing climate and for the inevitable market and regulatory adjustments that come with that change. This includes requiring climate stress testing for financial institutions.
Disclosure. Financial regulators must mandate consistent, comparable, reliable and decision-useful climate risk disclosure -- including the disclosure of carbon emissions from their lending and investment activities -- from companies and financial intermediaries.
Coordination. Financial regulatory bodies must coordinate and share findings to better understand the intersecting ways climate change relates to their respective mandates, and to work together in lock-step. The report also recommends that U.S. regulators collaborate globally by joining and becoming actively involved in the global Network for Greening the Financial System, currently composed of 65 global members.
Download the full report for the complete list of recommendations.
In light of the Covid-19 pandemic and the associated economic collapse, the report also urges the Fed to consider the climate-related impacts of its efforts to infuse liquidity into the economy. It points out that capital can get directed into risky, high-carbon sectors, which can worsen climate change impacts -- citing how the Fed’s Main Street Lending Program makes it easier for oil companies to qualify for loans. The report stresses that, at a minimum, such support should be underpinned by conditions relating to improved climate risk management and guarantees regarding repayment. The report also points to action being taken in other parts of the world, such as Canada, where the government is linking access to financial stimulus packages with climate risk disclosure.
“This report helps us see that in this place and time there is a portal – a gateway – to an economy that is resilient and up to the task of handling the fast-unfolding effects of climate change,” said Sarah Bloom Raskin, Former United States Deputy Secretary of the Treasury and Former Member, Federal Reserve Board of Governors. “We must rebuild with an economy where the values of sustainability are explicitly embedded in market valuation. This transformation will come, in part, from urging the leaders of our financial regulatory bodies to do all they can – which turns out to be a lot – to bring about the adoption of practices and policies that will allocate capital and align portfolios toward sustainable investments that do not depend on carbon and fossil fuels.”
Although the U.S has already sustained more than $1.775 trillion in costs from more than 265 climate-related extreme weather events since 1980, and more than $500 billion in economic losses between 2015 and 2019, and with unmitigated climate set to take between a five and 20 percent of bite out of GDP, U.S. financial regulators are far behind their counterparts in China, Europe, the U.K., South America, and Canada, who are are already responding to climate change as a systemic risk and are taking steps to protect their markets.
For example, The Bank of England’s regulatory body plans to ask banks, insurers and asset managers to conduct stress tests for climate resilience. The central bank of The Netherlands has begun conducting stress tests of climate risks. Norway’s central bank said that climate risks “must be integrated in the risk assessment and hence in the overall assessment of the capitalization and funding of financial institutions.”
“As climate change continues to wreak havoc on our country, our communities and the global economy, financial regulators must take on the vital role of ensuring that climate-related risks are recognized and addressed across markets, said Washington state Insurance Commissioner Mike Kreidler. The insurance industry, which is at the epicenter of these risks, is vital to these efforts. I continue to engage with the industry to encourage insurers to be prepared to be the economic backstop for consumers and businesses.”
This report makes clear that, as well as having precedent abroad, financial regulator action on climate change falls within the existing mandates of the U.S. agencies in question. As we’ve seen from the Covid-19 response, financial regulators already have broad authority that can be leveraged to require financial institutions to address systemic threats like climate risk.
“A multi-industry chorus of big investors, central banks, rating agencies, insurers, and top economists warns of severe economic disruption from climate change – what the Bank of International Settlements termed ‘green swan’ risks; systemic and catastrophic, said U.S. Senator Sheldon Whitehouse (D-RI). “For safety’s sake, U.S. financial regulators must prepare and adapt. This report reviews the work overseas regulators are already doing, and makes recommendations for our U.S. regulators on navigating the dangers ahead.”
“U.S. regulators have a long way to go toward making sure our capital markets systems are resilient in the face of a changing climate”, said Illinois State Treasurer Michael Frerichs. “The good news is that we know what regulatory changes are needed, and they’re all well within the normal duties of regulatory agencies. With this report, and with continued engagement and education, we expect to see progress in the right direction.”
“Prudence is a core conservative principle, and the common sense practices that Ceres recommends for U.S. financial markets in its new report ‘Addressing Climate as a Systemic Risk,’ epitomize that principle,” said David Jenkins, President, Conservatives for Responsible Stewardship. “The adverse impacts of climate change are already stressing key sectors of our economy, such as agriculture and real estate, and as these climate impacts worsen, it is essential that associated market risks be planned for and mitigated as much as possible. With this insightful report, Ceres is showing us the way.”
About Ceres Accelerator for Sustainable Capital Markets
The Ceres Accelerator for Sustainable Capital Markets (the “Ceres Accelerator”) is transforming the practices and policies that govern capital markets in order to accelerate action to reduce the worst financial impacts of the global climate crisis and other sustainability threats. The Ceres Accelerator spurs capital market influencers to act on these systemic financial risks and drives the large-scale behavior and systems change needed to achieve a net-zero carbon economy and a just and sustainable future. It focuses on four flagship initiatives: Regulating Climate as a Systemic Risk, Achieving Paris-Aligned Portfolios, Financing a Net-Zero Carbon Economy, and Board Governance for a Sustainable Future. For more information visit: ceres.org/accelerator.